A PE fund makes most of its investment returns by selling portfolio companies at a profit. Most portfolio firms are then sold to sophisticated buyers (strategic buyers like corporations wanting to add a new unit) who could be expected to shun the market if the target firm was destined to fail. That’s why the private equity fund must thoroughly think through every investment decision, which is where there’s no place for mistakes in the finance department.
For several years now, the private equity industry has been flourishing – with growing fundraising, valuations, and transaction volumes. Therefore, leaders of private equity portfolio companies will find this list of common mistakes to avoid quite valuable. Let’s take a look at those common pitfalls and ways to resolve them so your finance function can begin providing more value to your organization.
Common Finance Mistakes Made by Private Equity Portfolio Companies
- Finance function processes that cannot scale
Having centralized finance data brings the opportunity to automate and standardize their processes. When your staff spends most of their time manually performing administrative tasks, they cannot contribute more to growing the company. This scenario often inhibits growth, and the PE Operating Partner will see that the portfolio’s team doesn’t have the tools, processes, and people required to meet the established goals.
Expensive finance and accounting department
The cost of finance and accounting becomes increasingly problematic when inefficiencies in the department continue to grow. Private Equity firms expect that finance and accounting cost 1% of the revenue (or less) as the organization scales up to $100 million in sales.
Inefficient business processes
There is no room for manual business processes in a high-growth company. As the company gets set to grow, these processes must be automated and all systems connected. Otherwise, growth will be limited. Efficient companies are built on well-defined workflows and standardized practices that drive business processes across functions and departments. Automation must be implemented to reduce human errors and costs wherever possible and achieve standardization of processes. Once that is achieved, Artificial Intelligence and business software can drive many business processes.
- Reinventing/optimizing the F&A function
Time is the most critical factor for any portfolio company. Once the PE makes an investment, they expect the F&A function to be optimized within approximately 100 days. Optimizing the finance and accounting function may include optimizing processes and upgrading software systems. It often happens that middle-market companies realize their F&A systems present an obstacle to growth. The CFO shouldn’t find it challenging to decipher the KPIs of their business.
For example, if your business is using QuickBooks, there are a few common problems that high-growth companies might experience:
- The absence of certain functions essential for fundraising (e.g., reporting functions)
- Data and user limits
- Bottlenecks within finance and accounting departments that come as a result of lack of automation
These outdated or incomplete systems need to be re-build, and too many firms waste their time on that. When tasked with implementing financial management systems and hiring accountants and controllers, CFOs spend their time building and “reinventing” instead of optimizing current systems.
Points of failure
When portfolio companies choose to build their F&A foundation, there are many points of failure, such as:
Reporting. Producing accurate reports to verify that all business transactions have been appropriately processed and assure that audit and tax compliance needs are met.
Finding and implementing the right software solutions. Finding the right software is only the beginning. Implementation, training, and integration of disparate systems take time.
Hiring. Finding the right people, hiring, and training them quickly.
The abundance of F&A software options
When it comes to F&A software, CFOs have so many options to choose from. To make the right decision, he or she must answer some crucial questions, such as:
- What features of an Expense Management tool are vital for my business?
- Which General Ledger for record-keeping is best for a services business vs. a software business? Do all of them integrate with my business’ CRM?
It takes between 9 and 18 months to build the whole F&A foundation, but the question is – will the F&A department be optimized at the end of that period? The teams in an optimized F&A function should be able to scale with digitized and automated processes and systems, deliver forward-looking metrics and standardized KPIs, and close the books in 5-10 business days and be ready for an audit.
- Hiring a CFO with the wrong skill set
Private Equity portfolio companies often hire a CFO to establish a fundamental financial structure and build an F&A team. However, the CFO must have strategic skills that will ensure the vital factors that drive the company are understood and communicated to the organization’s C-suite.
Hiring the right CFO – builders vs. maintainers
There are two categories in which most CFOs fall into – builders and maintainers.
Builders are known as strategic CFOs. These are financial leaders who can take hold of a chaotic situation and find a way to help their company thrive. They often come from a background of business process design or system implementer, and they like to clean things up. As for the maintainers, these financial leaders thrive at the repeatable functional aspects of F&A management. They don’t excel in high-volatility environments that experience frequent, high-levels of change but are well organized. Maintainers often come to this position from the rank of a controller or accountant.
The common pitfall for many high-growth businesses is hiring an operational CFO (maintainer) and expecting them to bring strategic skills to the table. Maintainers are expected to build the F&A function and provide strategic guidance. Still, without a strategic skillset, maintainers cannot present the financial data that leaders require to identify opportunities and cope with current roadblocks.
On the other hand, a strategic CFO (builder) knows which questions to ask and provide the right insights to leaders, so they know when to say yes and when to speak no (in order to stay focused on the most crucial initiatives). Such CFO is able to envision the finance function and design its processes.
- Not having access to timely information
The information that leaders and managers need in order to be able to bring the right decisions must be timely and forward-looking. The CFO shouldn’t be the one who has all the answers and to whom executives go to whenever they have a question. Such a system puts the business at risk.
Decision-makers don’t need their financial information buried in finance and accounting, which is another reason why organizations need centralized finance data. With disparate business management systems, CFOs spend their time formatting, validating, and exporting spreadsheets. They also have to complete and review reports to investors, regulators, auditors, and other external audiences. The reporting process eats up much of their time, so CFOs are left with no time to focus on providing strategic guidance.
Without visibility into financial data and a firm understanding of the company’s financial health, accurately measuring and monitoring performance becomes impossible. For example, the PE fund manager won’t be able to calculate EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), which is an essential metric used by private equity fund managers that allows investment evaluations and decisions to be made while excluding the effects of certain F&A decisions.
- Disparate F&A systems
Having multiple disconnected systems can make F&A operations especially costly, complex, and clumsy. Yet, not many companies define best practices and strategies to unify and harmonize these systems. There are silos of data resulting from the proliferation of specialized point solutions (such as expense, payroll, accounts payable, and billing solutions). Data from all of the disparate systems then needs to be imported into the general ledger, but transactional detail gets lost along the way.
With all the disconnected data spread across different company departments, accountants have to spend much of their time creating spreadsheets that combine the information required to create reports for the decision-makers. Since this process is manual, it carries a lot of room for omissions and errors. Furthermore, the company cannot process automation or standardize workflows without centralized, connected systems.
Consero Helps Avoid Common Finance Pitfalls
By pairing with a FaaS (Finance as a Service) provider, Private Equity portfolio companies can modernize and optimize their finance function. Consero is a FaaS provider that can help you take advantage of AI to gain efficiencies and integrate all your financial systems to unify your data. The benefits of teaming up with a FaaS provider include:
- Building the foundation for scalability into your financial management systems
- Gaining insight through AI and connected data
- Automating manual processes to drive efficiencies
From the moment a PE fund buys a private company, the game changes. PE investors, financial leaders, PE executives, and their management teams must adapt their processes and be aware of the common finance mistakes made by private equity portfolio companies. It’s time to engage in the right financial modeling and partner up with the right consulting firm that will make sense of each private equity investment you make. The key for PE firms has evolved from the ability to increase the leverage and improve the capital structure to also encompass enhancements in value creation and operational efficiency.
We can help you lead your portfolio companies to a clean balance sheet, better cash flow, and accurate business valuation. With Consero and our FaaS solution, Private Equity firms and their portfolio companies will get a unique, out-of-the-box F&A department and accelerate their acquisitions’ ROI. We provide on-demand finance experts that can help engineer new software and process enhancements to meet a growing portfolio’s requirements.
For more information on Consero and our FaaS solution, feel free to contact us today.
