How Portfolio Companies Can Build Financial Management Capabilities

Middle market private equity firms take different approaches to building financial management capability at their portfolio companies. After closing the deal for investment in a company, they often choose to keep the financial manager in place, whether he or she is titled CFO, controller or something else.

This incumbent typically knows the business and its operations. In the most common middle market PE scenario, the founder or CEO remains at the helm of the company, with some form of earn out provision. A well established, trusting relationship between the founder/CEO and the CFO helps to launch the Sponsor’s plan to grow the company and its valuation aggressively over a 5 to 7 year period.

There is another reason why PE sponsors may not choose to upgrade the CFO of a portfolio company: cost. Sponsors tend to want to invest in areas that they see as producing growth, such as production capacity, product development, marketing and advertising. They may well believe that beefing up their finance function can come “later”, as their growth plan starts to click and the business becomes more far flung and complex.

Risks In Delaying A Finance Function Upgrade

First, right from the start, the Sponsor will need information to monitor and manage consistent execution of the portfolio company’s strategy. This will require work plans, financial and operational metrics and analytics; essential for creating time frames, milestones and accountabilities to realize the value that was envisioned in the deal and the price the Sponsor paid. They must have a capable partner within the portfolio company to assist with these activities.

Second, there is a risk that by the time the company has started to grow and the sponsor recognizes the need to invest in financial personnel, the business may be running out of control, unable to take advantage of opportunities and deal with competitive threats. Adding a capable CFO at that time may well be “too little, too late.”

As a PE firm looks ahead, a portfolio company’s long term needs for financial management capabilities may break down as follows:

• Managing internal and external financial reporting in an efficient, timely and accurate manner.

• Setting accounting policies.

• Maintaining an efficient and effective system of internal and management controls.

• Managing the financing of growth at each stage of the company’s development.

• Providing leadership to manage and close more complex, strategic transactions.

• Forecasting the company's cash, working capital, and operating and financial performance.

• Ensuring the flow of financial information for management decision-making and to identify emerging opportunities and threats.

• Enhancing the confidence that a prospective buyer or merger partner has in the accuracy and integrity of the company’s numbers.

There are a growing variety of innovative ways that a sponsor can start early to build these capabilities, without unduly burdening the portfolio company’s cost structure. A part-time or per diem CFO who brings knowledge of the company’s industry can be the fulcrum for a longer-term program. The right “advisory” CFO can develop and oversee a program to remediate near-term risks and performance gaps; monitor and mentor the controller or CFO; and create a road map the company will need as its growth accelerates and it looks toward an exit transaction.

Specific details of a phased, economical program to build portfolio company financial capabilities will be the subject of the next article in this series. 

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