The carve-out conundrum: Effective steps to fast track the finance & accounting function

When a private equity firm carves out a business unit from its parent company, they’re left having to build a new infrastructure for that stand-alone entity. Bill Klein, President and Co-Founder of Consero Global discusses effective steps to fast track the building of a finance team for the new business.

Corporate carve-outs might be a popular acquisition tactic for private equity groups, but that’s not because they’re easy. Whatever the potential upside, GPs will need to build all the functional teams that the parent company provided, all while trying to execute on the strategic improvements that were the rationale for buying the business in the first place. And given the private equity lifecycle, time is of the essence.

And of the various functional teams to be assembled, GPs know that the accounting and finance department is vital, but often they underestimate how hard it is to get the right people, systems and procedures in place. This is why Bill Klein of Consero argues that a finance-as-service model might be the best way to meet the needs of a carve-out investment.

Whether the GP is carving out a single business line or several business units from a parent company, they face the same dilemma. “GPs negotiate terms for the carve-out company to be reliant on the parent company’s systems, software and staff for their finance function when the deal is done,” says Klein. “They can’t begin building that finance department prior to close, for fear of eating those costs if the deal falls through.”

So, on day one, the GP faces the prospect of having the carve-out company build a finance and accounting function from scratch. Klein explains: “The Oracle system the unit is currently using probably doesn’t make sense for the stand-alone business, and since most large corporations centralize such functions, the carve-out is left without staff or software to handle it.”

The high cost of starting from scratch

Normally, the GP will negotiate terms for the parent company to continue to provide the finance department, but there are a number of downsides to this arrangement. “The carve-out is left paying a fee for these functions as their CFO or finance lead scrambles to choose systems and hire their own staff,” says Klein. “But it’s safe to say that spun out business unit will never take priority over a current unit when the accounting staff is pressed for time, and these departments aren’t built for customer service, so there can be communication snafus and delays in getting answers.”

As these hiccups arrive, the carve-out business still needs to find the best way to build that finance department from scratch. “Private equity firms know how important it is to get the finance function up and running, but it’s not among their strategic priorities. It’s another task to be done on that very long checklist after the deal is signed.”

But there are real costs to underestimating the time and skill necessary to create a finance function. “No talented CFO wants to focus on the basic tactics of a finance department, the aggregating and reporting of financial data. The longer it takes to get the department up and running, the longer it takes for that CFO to make a strategic contribution to the company.”

If the carve-out CFO is starting from scratch, building the finance team involves a lot of unforeseen roadblocks. They are going to have to tackle five key steps, and each have their own hurdles:

  1. Recruit and hire people
  2. Research and architect systems
  3. Map the processes to the system (this could be far harder than choosing a system, since a system’s capabilities might not instantly fit with the exact process needs of the business)
  4. Integrate and train users on that system
  5. Configure the system, move the data and test it

The strategic value of starting with a partner

This is where a service provider like Consero can make a real difference. They allow the carved-out business to plug directly into their outsourced finance department. This means they get to skip right to the final step of that 5-step process. “We tend to get a department up and running within thirty to sixty days, while building a finance function from the ground up can take nine to eighteen months,” says Klein.

As the deal team negotiates the terms of the carve-out, Consero can make an initial assessment of the project. “Prior to close, there are limits on the information we can access, but we take a high-level view of the business, focusing on discovering its revenue model and financial structure,” says Klein. “Once we know that, we have 80% of what we need to get started because we’ve so much experience doing this.” Contrast that with a controller that’s hired during a traditional build-out, who might have built a finance department a few times, if at all.

This isn’t to say that Consero relies on a one-size-fits-all model. “There are policies and processes unique to the business which we can tailor our systems to do, but if the accounts payable department is truly “unique” then something’s very wrong,” says Klein. “There’s no need to reinvent the wheel each and every time.”

And Consero’s institutional knowledge helps them design short cuts and best practices for fast tracking the introduction of finance teams to clients. “For example, we make a list of critical vendors, who, if aren’t paid, would cut off services or supplies critical to the business,” says Klein. “In the wake of a deal closing, invoices can get lost in the shuffle, but with this list, we know what vendors to pay, even if the bill didn’t reach the right person.”

This speed and expertise allows the GP to focus on what they do best: create value at the newly independent company through a series of strategic initiatives. But the best laid plans have little chance to succeed if the financial data they’re based on is wrong or slow to arrive. And every GP knows it’s not the plan, but the execution that drives returns.

rendered-2

The art of the roll-up, part II: Integrating acquisitions into a roll-up

As a private equity firm completes an acquisition, it’s vital that certain finance and accounting activities at the portfolio company continue uninterrupted, regardless of the distraction that a change in ownership can be.

We spoke with Consero’s Chris Hartenstein on how Consero helps ensure that portfolio companies don’t miss a step from day one.

Buyout firms never buy a company to maintain its status quo; operational improvements and growth initiatives are now standard issue elements of any investment case. They often have extensive plans for the first 100 days, but those radical changes can distract the portfolio companies from some of the basic duties that keep the lights on, particularly in the wake of the transaction closing.

That is why Consero’s Chris Hartenstein argues that private equity firms need to ensure that employees and vendors are paid on time, and that invoicing, and collections proceed as usual. This is why when Consero takes on a new client, they make sure these key priorities are addressed at the portfolio company, so that the buyout firm, and the senior management of that portfolio company can stay focused on the larger initiatives set forth in that investment case.

“You’ve got to protect your cash position,” says Chris Hartenstein. “And while that sounds obvious, in the flurry of due diligence and other closing activities, key tasks can get put off long enough to threaten cash flow.”

Consero Global acts as a company’s accounting and finance department, allowing a portfolio company to leverage their expertise and experience. And that experience includes understanding what the core priorities are from day one of the private equity’s ownership of that new company.

Consistency matters (so make sure people are paid)

“One of the first questions we ask is how do we make sure the employees continue to get paid?” says Hartenstein. “What needs to happen to get their payments out on the 15th and the 30th? Because if there’s any delay, employees will be quick to complain about the new owners, at a time when morale is vital to drive change.”

Even if the process of paying employees is changing, Hartenstein makes certain his staff understands what needs to happen, including who needs to approve the payments, so that employees are paid on time.

Identify the business-critical vendors (and pay them)

Another critical task is paying vendors. But Hartenstein says that given the sheer volume of things to do after the deal closes, they need to determine what vendors get paid first. “Typically, we’ll identify the top ten to fifteen vendors that are business critical,” says Hartenstein. “This could include contractors in the midst of a special project, web hosting services or the internet providers that would disrupt the business if they cut off service.”

Once those vendors are identified, Hartenstein and his team determine when they are typically paid, when they were last paid, and if any are already past due. And then they go about making sure those issues are addressed.

Much like a late paycheck, if the internet goes down or a contractor halts work, these interruptions can give the portfolio company doubts as to the competence of the new owners.

How can the GP say they’re here to make the business even better, when the business can’t do what it used to do without a hitch? That can be an unfair assessment, especially given the slew of extra work that comes with due diligence, closing the transaction, and getting the new owners up to speed.

Cashflow is king (so send out those invoices)

Companies in the lower middle market can really struggle to handle their usual responsibilities with such legitimate distractions, and that means sometimes invoices fail to be sent out, and accounts receivables stall.

After all, few customers are clamoring to pay bills they haven’t gotten yet. “No private equity firm wants to discover a few months into their ownership that cashflow has slowed simply because invoices were too far down the finance and accounting department’s to-do list.”

So Hartenstein’s team looks at the initial customer aging report. “Sometimes these reports aren’t in great shape because the accounting team has had so many other things to do,” says Hartenstein. “But we work to get that in order, identifying customers that need to be invoiced and what invoices haven’t been paid, and start to get the company back up to speed.”

Even with these priorities in hand, there is still a transition period, as Hartenstein works closely with the existing staff, collaborating for thirty, sixty or ninety days, depending on the size of the enterprise. Consero knows the current finance and accounting team is a brain trust of sorts, to be tapped so the transition is as smooth as possible.

Multiple tasks are mission critical

As much as making clear priorities is crucial, some things need to get done simultaneously. Sometimes the portfolio company’s books need to be cleaned up and updated, but the company can’t ignore paying employees or vendors or tackling accounts receivables until that’s done. “That’s why we have separate teams for implementation, delivery and clean-up, so they can be done concurrently,” says Hartenstein. “One person or one group doesn’t need to do it all.”

There are so many moving pieces to onboarding a new business into a private equity firm’s portfolio, that delegating the core finance activities to a service provider like Consero can free up both the buyout firm and senior management team to focus on those initiatives, the initiatives that actually improve the business and live up to that ambitious investment case.

Back Office Holding Back 3

How private equity investors can get the most from their CFO

GPs may be eager to leverage the talents of portfolio company CFOs, but managing the tactical responsibilities of the finance department can interfere with the CFO’s ability to develop larger strategic initiatives. Consero Global’s Natalie Townsend suggests how PE firms can make the most of their Chief Finance Officer’s real skills.

PE fundraising may be booming these days, but that’s also creating sticker shock for assets. So GPs have to drastically improve a business to warrant the price, putting pressure on the portfolio company’s senior management team to make major strides. And the CFO plays a big role.

But for a lot of middle market businesses, running the finance department is a full-time task and leaves little room for that CFO to work closely with the CEO to restructure, or more to the point, revolutionize that business. That is why some GPs have begun outsourcing the accounting and finance function to Consero, so that CFOs can move beyond the day-to day duties and focus on bigger strategic initiatives.

“A lot of PE firms we meet with are frustrated that as much as they want a more strategic CFO, most of the time these executives get mired in the details of the finance departments,” says Natalie Townsend of Consero Global. “They may hire talented folks, but they only get to use a fraction of their actual capabilities.”

“I’ve always strived to back or hire strategic CFOs,” says Scott Donaldson of CIC Partners. “But it’s hard to manage the finance and accounting functions while contributing to strategic initiatives, so they often don’t flourish as much as we’d hope in these situations.”

It might seem natural that the CFO spend time on such operational tasks as closing the books each month, generating financial reports, making sure all transactional processing is taking place and that they can get through an audit with timely and accurate information. Beyond that, they often ensure systems are scalable so if the business were to grow, accounting and finance wouldn’t slow that down. That’s not even addressing the HR component, when the CFO has to find a replacement when staff leaves.

In large companies, there might be enough resources to minimize the CFO’s role in these tasks, but on the lower end of the middle market, finance can be quite leanly staffed. “So at Consero, we take all those tasks off the CFO’s desk, so they don’t have to worry about staffing or systems upgrades,” says Townsend. “And if any of the operational tasks aren’t completed to expectations, that CFO knows they can hold us accountable.”

Tapping Consero’s Finance as a Service (FaaS) allows smaller companies to upgrade their accounting and finance teams in a fraction of the time a CFO would be able to build a new team from scratch. “The nature of private equity is to act quickly, and Consero allows the CFO to shift gears from the basics to assessing larger changes to the business, which is exactly the type of work that attracts top tier finance chiefs,” says Townsend.

She explains it’s really an alignment of interests, since the CFO gets to focus their attention on the high impact activities, while Consero leverages their expertise in providing best in class service in these tactical areas.

“Make no mistake, the tactical duties of the finance department have to be accomplished with speed, accuracy and care,” says Townsend. “Especially since poorly managed books can trip up the due diligence process when the PE firm is looking to sell the business. That’s the table stakes here.”

With the tactical side of the finance department handled, some PE firms are finding novel ways to leverage their CFO talent. “Some smaller enterprises don’t have enough truly “strategic” work to interest major talent,” says Townsend. “But that doesn’t mean those companies don’t need great ideas and someone to guide them to fruition, so they might put the CFO to work at two or three portfolio companies to create a full-time slate of work.” This way, each smaller company gets the benefit of a talent they couldn’t afford full time, and that CFO remains intellectually challenged.

There might be a CFO that actually wants to manage those tactical activities, but they may not be the ideal CFO for a PE-owned business. “If that CFO wants to devote themselves to the basics, they might be more suited to a Controller role and not the right fit for a radical improvement plan,” cautions Townsend. And there are plenty of these standard issue CFOs/Controllers at the lower end of the middle market.

This doesn’t mean that PE firms need to settle. “Consero has been really useful in upgrading the finance and accounting functions in portfolio companies, which enables higher caliber CFOs to focus deliver the investment case,” says Donaldson.

And these days, that investment case is most likely ambitious, which means that the basics need to be handled, because only real innovation and strategic thinking will deliver exits that will make the price of that asset a little less shocking.

The art of the roll-up, part I: The value of a smooth integration of the finance function

As buy and build strategies became a staple strategy for private equity firms, it’s important for firms to remember the value of a smooth roll-up of the finance function.

 

We spoke with Consero Global’s Chris Hartenstein on how Consero helps companies seamlessly bring new acquisitions into the fold.

Bain’s 2019 Private Equity Report recently found that buy and build strategies are more popular than ever. While the study admitted data on the trend can be hard to track, they cite that in 2003, only 21% of add-on acquisitions represented the fourth such acquisition for the platform company. Today, that number is nearly 30%, with 10% of those representing the tenth add-on acquisition.

The study reports there are solid rationales for that popularity. With asset prices so high at the moment, the acquisition of a platform entity may justify paying a premium, since they can acquire smaller companies at lower multiples. And naturally, the larger company hopes to enjoy reduced costs, and increased top-line growth.

But that potential upside is predicated on a savvy integration of staff and processes, not the least of which is the finance function. For platform companies, speed is of the essence, since there is often another acquisition on the way. And if the integration stumbles, or the finance staff doesn’t prove adequate, it can drain time and energy from senior management.

Chris Hartenstein has navigated many a roll-up during his time with Consero. Consero offers an outsourced financial solution for small and middle market companies, which are precisely the kind of the enterprises that private equity firms target. He suggests PE firms develop a process for rolling up the financial function of a platform company early, and ideally start by bringing the platform company in line with the standards and the systems they expect and need.

“We’ll get the call from a company usually within a month of the LOI, and start working towards being ready for day one,” says Hartenstein. “We have an acquisition playbook of 35 points we run through for the first month we’re there,” says Hartenstein. There’s only so much to be done before then, since typically the client and therefore Consero won’t have full access until the deal closes.

Their process begins with a rigorous assessment of the finance function, and then continues with the implementation of the technology stack and best practices and processes in line with the client’s preferences. Typically, it only takes Consero a month to get a company’s finance and accounting fully integrated and supported as part of the acquirer’s business. Although, for larger companies, in the range of $50 million to $100 million, that timeline might stretch to sixty or ninety days.

But after the platform company is done, Consero can work with remarkable efficiency on subsequent acquisitions. “Once the foundation is set for Company A, it’s only a matter of applying those policies, procedures, and schedules to each new acquisition.” The staff that’s already working for Company A isn’t distracted by bringing the new acquisition into the new system because Consero has a dedicated implementation team that tackle that job. Each new acquisition becomes easier since that team is working off the structure that’s already been built for Company A.

“Let’s say for Company A, we’ve identified a standard chart of accounts to utilize; when we get to Company B, we’re duplicating the chart, and we’ll map the acquisition to that. We’ll have standardized the accounts payable process, with the rules and workflow. All we need to do is plug in the appropriate approvers and payers,” says Hartenstein.

And that means the new acquisition meets the same standards as the platform company far quicker. But that also argues a PE firm should tap Consero for the platform company first, before any other acquisitions are completed.

“There’s a lot of clean-up work to be done, as the first company may not have been really consistent in generating monthly financials, or doesn’t have all the work paper schedules in order, and we have to recreate them,” says Hartenstein. And for that, Consero brings on a separate group, called the COE (“Center of Excellence) team to put things in order.

While the platform company may be tempted to hire an outside consultant for that kind of work, the difference with Consero is that as the company’s finance and accounting department is fully implemented with ongoing deliverables supported by Consero. So, they have a vested interest in making sure all accounts are reconciled and supported appropriately.

And Consero tends to stay on board with the platform company even after the private equity firm exits the investment. “We pride ourselves in providing potential buyers with accurate and timely information during the due diligence process,” says Hartenstein. And this frees the buyer to focus on the value the PE firm has helped to create, and the runway that’s left.

Buy and build strategies may be here to stay, but that doesn’t mean they’ll get any easier, which is why it’s all the more crucial to get the finance function in order and running smoothly. As any successful buyout firms learns, the most brilliant strategy doesn’t matter if the execution isn’t there, and partners like Consero are there to help get the basics in order as soon as possible.

Read “Art of the roll-up, part II”

Why private equity firms get meaningful partnerships by outsourcing

Choosing to outsource accounting and the administration role is a huge decision for every private equity fund manager. With that in mind, we are here to talk about all the benefits that a manager can get by doing so, which should give them confidence when making a decision to outsource.

 

In the last year or so, private equity (PE) has had a lot to be optimistic about, especially in the area of money as PE firms now have nearly $1 trillion at their disposal. There’s certainly a lot of investor demand, but they are still very likely to be careful with where they allocate that money.

Investors need to be confident that managers know what they’re doing, and part of the process most managers use today is focusing on the task at hand. That has led to the adoption of outsourcing. According to PwC:

  • 70% of PE firms in Europe are actively outsourcing
  • But only 30 to 40% are outsourcing in the US for now

The experts are doing the job and are helping the managers

If you partner-up with the right third-party firm, you can get a level of operational expertise for an excellent price, which is only part of the benefit. In addition to that, managers have the opportunity to have more time for other crucial matters – like focusing on their assets, i.e., the employees, which they cannot get easily and in large numbers due to their cost.

However, a manager no longer needs to hire certain people, if they opt for outsourcing the administration of their accounting and finance. Through outsourcing, they get access to a highly skilled team of experts that will do that for them by using advanced industry knowledge and the most innovative technologies.

The more help the private equity firm gets from trusted partners, the more effective they and the entire front office can be. They become more efficient in:

  • Sourcing deals
  • Generating the best performance in investor funds

Managers also get help in investor relations when dealing with:

  • Capital call letters
  • Cash flows coming and going out of the fund
  • Capital contributions

All of this gives comfort to investors and managers, but also to auditors who rarely find mistakes on financial statements they audit.

A vast majority of experts now believe outsourcing is more advantageous than keeping the admin function in-house

Outsourcing is no longer a trend; it’s becoming an established pattern for many PE firms. Investors see the benefits. They now know that, by outsourcing the admin function, the PE firm can have more time to focus on:

  • Sourcing investment opportunities
  • Evaluating potential transactions
  • Valuation monitoring
  • Management of the current portfolio
  • Establishing great lines of communication with limited partners (LPs)

However, none of this can be possible if the PE firm is not a partner with third-party vendors. They cannot be pure providers – they have to be clear partners with the managers to achieve the best operational practices. That requires trust and clear lines of communication.

A specific mindset should be developed – one that makes the administrator an extension of the manager’s team, as that helps reassure investors.

That’s crucial because investor standards are high in the current market, and you want to give them what they need. They need to see:

  • A sufficient level of expertise
  • A good ratio between cost and efficiency
  • A reassurance that you’re sending information to trusted outside parties

In essence, they want to see clear evidence that you are interactively involved with the service partners.

That’s also achieved not only by you but by the third party vendors as well. The key in the business model of Finance as a Service (FaaS) companies like Consero is transparency. Other FaaS firms and we are transparent when it comes to how we offer our service because we know that investors want to see the process if they are going to feel comfortable.

That’s why, once again, clear lines of communication are vital, as that’s the easiest way for investors to be reassured that everything is going in the way they want it to go.

Naturally, investors want to get the information they need in the format they are comfortable with.

Our finance experts are there to manage the entire finance & accounting function and provide the portfolio companies with month end financials and custom reports. We are responsible for the financial statements and all necessary communications with the investor if your portco does not have in-house financial leadership. What outsourcing achieves here is helping managers manage the finance function more efficiently and cost-effectively.

What are the key advantages of outsourcing?

There are three main advantages:

  • Finance & Accounting expertise
  • Real-time access to all financial data
  • Cost-efficiency

Most companies hiring the services of companies like Consero say that the level of expertise they get is unprecedented and is the most important advantage of outsourcing.

That goes in line with what all companies looking to outsource want to get in return for their money. They want to gain the services of an expert team that will help with the tasks they cannot complete on their own.

That expertise is complemented by the technology the company uses in the service they provide. That’s why we at Consero have ensured that our software is flexible and able to deliver everything that each specific client might need.

The upcoming trends in outsourcing within the PE space

Most companies believe in the prevalence of the following trends:

  • LP pressure
  • Regulatory compliance demands
  • Product complexity

Most feel that outsourcing will continue to rise in popularity. Some are even saying that they can barely market to investors unless they have a 3rd party finance & accounting administrator.

The huge LP demand will also continue to drive the funds to service partners. As we’ve already established, outsourcing gives managers the time they need to focus on the tasks they do best – finding great opportunities and delivering a superior product to the investors.

In the end, the rise in outsourcing popularity will continue in the US as well, and most believe that the percentages from PwC we mentioned in the beginning, are destined to rise. Outsourcing is no longer a luxury – it’s a necessity and investors demand it.