Joanna Nolasco May 20, 2016
In an ever-changing private equity landscape, sponsors and portfolio companies alike have evolved with the industry’s shifts to continually create value within their businesses. Notably, the role of the portfolio company CFO has shifted from a financial scorekeeper to more of a strategic leader driving growth under PE sponsorship.
We spoke with Nick Leopard, founder and CEO of financial consulting firm Accordion Partners, about how the role of a portfolio company CFO has changed, the shifts driving those changes, and what private equity may have in store for CFOs in the future.
What is the unique role that CFOs play in creating value within a portfolio company?
Think about private equity funds in general: They know finance better than anyone. So what’s the role that gets scrutinized the most in a portfolio company? It’s finance. But sponsors and management teams alike also realize this is an area from where many strategic insights into value creation opportunities can emerge.
A lot of the PE sponsors are so data driven, and they expect their CFOs to be able to respond to them not just with data but with actionable insights to help them get a better grasp on the business. You can talk to a CEO about macro trends in a marketplace or overall strategy, but when they want to validate those decisions, the office of the CFO in general—beyond just the CFO—should and can act as a business partner across the enterprise to help shape strategic decisions, acting as a leader across the entire organization.
This is very much a shift over the last 15 to 20 years. Now the CFO is most commonly the non-CEO management team member with a real voice at the table in most board meetings.
How has the role of a portfolio company CFO changed over time?
In a lot of companies that come under first-time institutional ownership—most times it’s family-run or founder-run businesses—the CFO is often the controller that was promoted up to CFO sort of out of opportunity. They were sitting in the seat and closing the books monthly. PE is placing such a higher strategic value on the CFO that it’s sort of table stakes to be able to close the books and get financial statements out. Now it’s not just understanding the company’s cash flow forecasting, but how do we think about better cash-flow management? How does finance extend beyond the organization? It becomes much more of an operational role, and requires a much broader combination of both technical and soft skill sets.
When we think about merger-integration work, a lot of times it’s the CFO leading that now. It used to be, ‘OK, we need to get this newly acquired company on our accounting system.’ But now it’s often the CFO leading the project-management efforts of that because they’re starting to track and really weighing in on the performance of the integration beyond just the financial statements. How are we going to be tracking various divisions that we acquired? How are we thinking about cost optimization? Where are we identifying synergies within the merger integration? How are we realizing those synergies? It has become less and less just about the numbers and really about being a true partner to the various functional leaders within an organization.
What are the macro private equity driving forces behind that shift in the CFO’s role?
There has been a meaningful evolution of macro drivers the last seven years. There’s more dry powder now than ever before. LPs have become a lot more confident in their discussions with existing and potentially new GPs, and so they are putting much more pressure on management fees and what you can pass through and what you cannot pass through.
Let’s take a step back for background, look at the role of the operating partner. Even 10 years ago, PE firms had operating partners as sort of a network of seasoned executives that could sit in board seats for the PE sponsor and be an advisor to the management team—and then everyone started doing that. As a result, there is now a view that in order to lure LP dollars in, we need to be better than our competitive fund set. A lot of PE sponsors started bringing operating partners in-house on their payroll to help source new opportunities and help shape the investment thesis. Those operating partners really started playing a more hands-on role within the portfolio companies and that all of a sudden creates more competition among GPs as being increased value-added partners to management teams. Now in the LPs’ eyes, there’s much more of a focus on operational improvement. LPs expect PE funds to be great at financial structuring and to be able to get a good deal done, but what are they bringing to a management team beyond just the finance aspect of it?
Certainly longer hold periods are another relevant macro shift. I think people are seeing the recent fundraisings like Altas Partners, and Blackstone and Carlyle being in the market raising vehicles that exceed the typical five-year hold period for individual investments and 10-year fund life. There’s also a lot of dry powder out there. PE sponsors don’t need to feel the rush to an exit in three years; they often need to have the flexibility to have more longer-dated investments and to be able to implement a lot of operational improvements that take time but can yield sizable value. Sometimes those are not just a year fix, two-year fix; sometimes you don’t realize the returns on that for three or four years so companies are being held for longer.
When you think about all those things combined—management-fee pressures, more focus on operational improvement, longer hold periods—sponsors would love to have a big portfolio operations group to be able to support the management teams, including the CFO, but they may not have the fees internally to be able to do it. They know they need to stand out from the crowd from the operational improvement perspective. How do we bring more and more value to management teams? How do we prove that to LPs in order to be an attractive GP for them? Those are the things that are constantly on the PE firms’ minds, whereas operational improvement used to be sort of a secondary priority behind deal sourcing, deal structuring and closing deals.
Do you foresee further macro shifts in private equity that would impact the role of a portfolio company CFO? What are they and how would a CFO’s role evolve in response?
Macro-wise, I think there is an inevitability to continuing to pay high multiples in the cycle. A downdraft could be coming and PE CFOs will need to be two things: fanatical about margin optimization and more connected to sales than they were previously. Expect PE CFOs to have to be smarter on cost rationalizations and have incremental focus on operational drivers to financial results, such as sales-pipeline conversions. These probably seem like general truths, but the macro environment may make it a 10-year trend in terms of what private equity sponsors value in the skill sets of their CFOs.
We are seeing an ongoing trend where the data needs and requirements of PE sponsors are increasingly moving towards real-time. Sponsors need real-time actionable information to facilitate thoughtful, data-driven decisions around a variety of pressing strategic issues. In response, CFOs will feel increasing pressure to provide up-to-date operational and financial metrics to drive these decisions. CFOs will need to have the proper data, processes, reporting capabilities and key performance indicator metrics in place to respond to the heightened, time-sensitive demands of the PE community.
One thing we see often is the idea of the ‘Private Equity CFO’. The idea is that as PE firms exit and have great experiences with a CFO, trying to tap that CFO and recruiting them full-time into other areas of the portfolio, either once the tasks they’re best at have been addressed at a given company or when they’ve monetized. For such CFOs who thrive in a fast-paced, high-pressure PE environment, there is an opportunity to position themselves as a de facto resource for a GP for the remainder of their career.