Private equity is a fairly complex industry, but described very simply: They find a company, they buy the company, they add and create value to this company, and then they sell it. One of the biggest hurdles many middle market private equity firms face is during the phase of creating and adding value.
Financial Reporting: Going from Good to Great
To more effectively – and quickly – create and add value there needs to be a robust financial reporting function, which many portfolio companies lack. Their finance functions are good, but they’re just not great. They’ve got a lot committed, they’ve invested a lot of money into portfolio companies alongside their investors, and the stakes are high for the private equity companies and for the portfolio companies to show a path to success. The scrutiny can be very intense.
Private equity industries are extremely data driven, and a QuickBooks report isn’t going to cut it. It’s important to have cash flow models in place, to have variance analysis, budgeting, forecasting, and other deep-dive metrics.
Meaningful Metrics for Private Equity and Portfolio Companies
We can look at some of these metrics and reporting from both sides – the private equity company and the portfolio companies involved.
For the private equity company, they have outside investors or limited partners that need to be keep up to speed. A key metric here is IRR – Internal Rate of Return, which helps clarify the multiple on the investment. They’re additionally interested in minimum acceptable return on their investment
On the portfolio company side, there’s usually a standard of information that private equity companies are looking for. These can include cash flows, liquidity, EBITDA (earnings before interest, taxes, depreciation, and amortization), and expenses. Additionally important is timing – PE companies might want to review different reports quarterly, monthly, or weekly. They’ll want to understand expenditures, budgeting, and results.
The Role of the CFO in Private Equity
This is a lot to manage practically – producing the data and meaningful reports – but also conceptually. What is all the data saying? What does it all mean?
For the portfolio company, the CFO can be a bridge to the private equity sponsors, acting as a liaison to their CEO, founder, or other leadership. The CFO can provide real time support, information flow and guidance.
Private Equity firms need to be confident in projections, in the goals they’re setting, and in investment strategies. Here the CFO can align strategic support with executing on the many financial reports that must be scrutinized.
With the right interim, fractional, or part-time CFO, management teams are supported, and experience and expertise is available to support the financial functions of both the private equity and portfolio companies involved, taking them from good to great.