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July 14th, 2021
Years ago, when discussing a CFO brief for a private equity backed business, the Investment Director in charge of the search stressed that the ideal candidate would boast experience leading an exit or transaction for private equity shareholders. Yes, relevant sector expertise and other factors were important, they said, but a proven track record in private equity was seen as critical.
This is not an unusual mindset and approach. As an investor, you want to mitigate any risk associated with the hire. It makes sense to bring someone on board who has been there and done it in the context of a private equity value creation event.
However, in taking this approach, investors are significantly limiting their pool of talent which poses two interesting questions. First, how can a CFO make an effective transition from a non-private equity or corporate background to a private equity backed business? And second, is previous private equity experience a pre-requisite for success?
Private Equity’s changing perspective
When asked recently about the desirable skills and experience CFOs should possess to be successful in a private equity backed investment, Drax client and Managing Partner of the private equity firm ECI Partners, Tom Wrenn, suggested that when hiring CFOs, to an extent “it’s about compromise.”
He added: “If you look for the perfect CFO – someone who is hungry for success, has experience in a PE-backed business, is available in the right timeframe, and is in the right location so they’re not travelling hours every day – then you’ll probably be looking forever. So, the question becomes: where do you compromise?”
We know that the CFO requires a high level of commercial acumen, given the limited timeframe to drive growth and value in a business prior to exit. It is also the case that in mid-market private equity investments a business will often have a flatter structure, requiring the CFO to operate across multiple functional areas and stakeholder groups. This necessitates a high level of emotional intelligence in addition to the technical capabilities and experience normally associated with the CFO position.
To this end, Tom Wrenn points out that “the top CFOs are not seen as people who sit in the corner producing company management accounts and paying invoices. They are seen as a partner to the business,” which means “they are actively driving value and complementing the CEO, rather than someone who is following and reacting.”
He added: “We’ve had some great ex-corporate hires come into our portfolio companies. The key is that they are coming from the right culture. They’ve got to have had that ‘owner’ mentality rather than the limited authority of a middle manager.”
At Drax, our search process keys into this owner mentality. Given the critical nature of the appointment, it’s perhaps unsurprising that the checklist of CFO hiring requirements has increased over the years – but it’s also become more nuanced.
There has been a shift away from requiring generic track records in private equity and instead towards a cultural fit with the management team. Importantly, this cultural fit is heavily couched in situational experience and approach, regardless of the business’s ownership structure.
The ex-corporate CFO
Andrew Jenner, an experienced Group CFO, spent the majority of his career in senior finance roles at PLC organisations, culminating in the Group CFO role at FTSE 250 service provider Serco. He was there for twelve years. Now as CFO for Petainer, a global manufacturing business backed by KKR, he has seen both sides.
For Andrew, the real positive of a private equity backed environment is the “goal convergence” in strategy and aspiration for the business between investors and management. Boards are efficient, value creation is a key focus, and there is a “good balance between business performance and governance,” he says.
Elsewhere, Ed Hannan, the Group CFO of commercial insurance broker Jensten Group (backed by Livingbridge), had always viewed the opportunity to work in a private equity backed business positively. Early in his career at PwC, he worked with private equity clients, but stayed on the corporate side and ultimately progressed to senior finance roles at RSA and BUPA, with a focus on international emerging markets.
For Ed, his experience of corporate M&A and working with fast growth businesses in a relevant sector allowed him to transition effectively. And the reality has lived up to expectations, he says. “Highly motivating”, “clarity of purpose” and “the ability to influence the whole organisation” are for him the most positive aspects of the private equity ecosystem.
He also noted that the ability to operate at pace while focusing on a broad agenda is key. As such, there can often be a steep learning curve when transitioning from larger groups in divisional roles to the Group CFO role of a smaller business. Namely, the requirement to “juggle many balls at one time” and to be “comfortable operating with ambiguity.”
Ed’s comments reinforce the idea that to be a successful CFO in an investor-backed business one needs to be comfortable operating with less support from group functions and also at ease seeking out solutions where there is no obviously defined process or structure. This requirement for an agile approach, in addition to being detail and execution focused, is consistently highlighted in our search mandates.
Drax’s data-enabled approach
Following the development of our drx business, and through rigorous analysis of the private equity deal and exit landscape, we have been able to better understand the propensity for management change across key functional disciplines during the life cycle of a private equity investment.
drxDATA shows that, for the financial year 2018/2019, “73% of upper quartile performing (private equity backed) companies will change their CFOs during the PE cycle, up from 69% for the average business.”
This would suggest that changing (or appointing for the first time) a CFO in a business to suit the requirements of the new environment and value creation plan disproportionality improves the performance. While there is no sure way to guarantee the success of an appointment, we believe that there are certain types of experience which successful CFOs in private equity backed businesses possess.
The drx propensity modelling tool (see fig 1, below) has been developed to examine an individual’s dominant behavioural characteristics. Our feedback suggests that high performing CFOs in private equity backed businesses are functional specialists, with a high degree of situational experience (as opposed to domain or sector). As a result, strong CFOs are often more able to transition across multiple sectors, and from outside private equity, if the situational experience is rich.
For instance, we saw via Ed’s example that if a CFO has experience leading a buy and build strategy for an autonomous business unit in a larger listed business, we’ll expect them to be successful in the CFO role for a private equity backed services business, whose growth strategy is centred around inorganic growth.
In addition, ensuring the complementary fit of the CFO as part of the management team is key. The overall profile of the team has a greater effect on value creation than the specific strengths of individual members of the team. Therefore, it is more significant to have a balance of experiences across the team than it is to have a leadership team with a particular strength in one area.
That’s why we seek to understand the strengths and weaknesses of an existing team in order to evaluate where a CFO can bring complementary experience and skills. This process is achieved through a combination of interview and evaluation, extensive referencing, and the recent introduction of the PACE model of development. (You can read more about PACE here and you can reach Director of drx, Samuel Robberts at firstname.lastname@example.org if you would like to learn more.)
Cultural fit as priority
By now, all investors and CEOs agree that having a high performing CFO who also blends well with the prevailing culture and behaviours of the business is a huge asset, and one that is guaranteed to increase the value creation plan and likely ROI at the point of exit. The challenge – particularly if a business has grown/changed rapidly or is upgrading to a CFO for the first time – is understanding what type of CFO will be most effective, and what prior experience is most relevant.
Our hypothesis is that while there are risks associated with appointing a non-PE-experienced CFO for the first time, there is a far greater chance of them being successful when there is clearly aligned situational experience, regardless of sector or ownership structure.
CFOs who have been successful in private equity backed businesses vary hugely in their experiences, behaviours, and styles. As a result, there cannot be a ‘one size fits all’ approach to hiring a CFO for a particular business. While recognising that hiring is not an exact science, recent experience shows that via a thorough mapping of a management team against their CFO candidates to understand complementary fit, there is a much greater chance of achieving the desired outcome.
There are an increasing number of tools available to ensure the best fit and a likelihood to add value from day one. This is an exciting challenge for all of us at Drax, and if you would like to discuss any of the topics in this article, please do get in touch and I would be delighted to a have a conversation.
Director, CFO Practice
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