Upgrade the finance function to assure private equity value creation

This is one of seven private equity value creation strategies we have compiled into our new guidebook. Download the entire guidebook here.

Most private equity firms understand that when they begin integrating an acquisition, they’ll need to make some improvements to the seller’s finance and reporting capabilities in order to add value creation. In our experience, the degree of upgrading that’s required isn’t always fully appreciated — and may even come as a surprise, especially for smaller, family-owned acquisitions. There are three areas where private equity firms should be focusing their efforts in order to begin building value.To get a handle on the state of an acquisition’s internal controls and determine what kind of structure is appropriate, a thorough assessment is in order.

Create a robust internal control framework

Many private equity acquisitions have a relatively limited internal control structure, if any. Certainly very few can meet the rigorous reporting requirements of their buyer, nor have they gone through an external audit with a major, or even a regional, accounting firm. The level of information that management needs to gather, and the reports they have to compile, can be bewildering — and the buyer may not realize the extent to which the acquired company is unprepared.
To get a handle on the state of an acquisition’s internal controls and determine what kind of structure is appropriate, a thorough assessment is in order.

An assessment will reveal potential improvement opportunities such as ways to:

• Improve the 13-week cash flow forecast
• Allocate costs
• Expedite the financial reporting process
• Efficiently manage inventory

The timeline for completing an assessment may depend on the time of the next reporting period and how quickly the seller needs to be ready for an external audit. It could also depend on the private equity firm’s specific needs in adequately addressing the reporting requirements.

Improve the efficiency and timeliness of financial reporting

The highly metrics-driven focus of private equity firms, as well as their specific reporting methodologies, can create a challenging environment for management of the acquired organization. Smaller companies, in particular, often don’t have the ability to track financials at a truly granular level or to compile accurate reporting on such items as net revenue, cash flow, and selling, general and administrative expenses on a weekly or even a daily basis. Arriving at this level of proficiency takes both time and resources, so the earlier the process starts, the faster the finance function can begin adding value.

The optimal approach for improving financial reporting will also depend on the owner’s overall integration strategy. For example: Does the new company have multiple business units that need to be organized within a single controls and reporting framework? Or, are there opportunities to leverage systems and frameworks from other portfolio companies?There are several ways private equity firms can get an acquisition’s finance staff firing on all cylinders to ensure post-acquisition value creation.

Upskill or upgrade the finance talent pool

An acquired company often has a relatively unsophisticated finance team that is more focused on bookkeeping than on pulling together monthly reconciliation reports. Yet, many private equity firms are surprised by how unprepared their acquisition’s finance staff actually is when faced with a new set of demands and responsibilities. There are several ways private equity firms can get an acquisition’s finance staff firing on all cylinders to ensure post-acquisition value creation.

If the current team is fairly knowledgeable, then staff can be trained on the finer points of the reporting requirements, such as:

• Improving the efficiency and timeliness of the financial close
• Monthly reconciliations and financial statement preparation
• 13-week cash flow forecasting and cost analysis
• Preparation of accurate budgets
• Purchase agreement compliance

Alternatively, they may need to replace staff or bring in reinforcements, either from within their organization — if they maintain a finance “SWAT team” — or by enlisting third-party experts. A strong finance team will not only guide efforts to streamline financial reporting; it will also be better positioned to extract value-adding insights from the data gathered.

Achieving a robust level of financial reporting proficiency for a new acquisition is often harder than it looks — but, it is critical during the first few months after the transaction closes. An accurate picture of the new company’s financial performance will help the private equity firm implement an optimal path to integration and value creation.