Equity FC Blog

The customer is always…

2013-05-07T14:06:14+00:00

One of the great truisms of private equity ownership for FDs and FCs is that you need to be on the money. "On the money", in this instance, means you're exerting real discipline over cash, you have every metric covered and you can deliver the numbers - and precise explanations for variance - at the drop of a hat. This isn't some topical requirement brought about by fine margins, unpredictable markets and a tough economy. That's just what those guys demand.

But if you neglect the other stuff - often, the more interesting stuff - you might also have problems. A few months ago, a major PE house hosted a gathering for management in its portfolio companies. The focus was growth and leadership and the word that dominated the discussions wasn't cashflow or acquisitions. It was "customers".

Obviously that matters for marketing, and for ops generally. (At this point, take a moment to read Harvard Business Review's article on why marketing and finance chiefs should be intertwined...) But finance? Well, yes, for finance too. To be "on the money" you absolutely have to have a handle on customer sentiment, appetite and needs.

“I’m constantly trying to communicate better with all our stakeholders," Kevin Boyd told me a few months ago. (He's FD of FTSE 250 tech manufacturer Oxford Instruments - but the principle holds true for backed FDs.) "Finance can sometimes lapse into navel gazing, which is a huge loss because it can do so much for the rest of the organisation. The main thing is explaining what the numbers actually mean – to be interpreters, helping people within the business make better decisions - and maintain great communications with customers, suppliers and shareholders. You have to be a good storyteller, creating a narrative that gives people a context for their decisions.”

There are some other, back office, customer roles for finance, too. Take pricing: the marketing team cannot - and should not - be setting prices on their own. Bringing real rigour (which includes not just financial modelling, but increasingly some pretty nifty behavioural economics) to pricing is a great way for finance to add value. And there are lots of examples like that.

But in fast-growing companies with a highly motivated owner keen to know what's going on, a finance exec with real context for the numbers is gold dust. And that means being "front office", too.

Don't take my word for it. Adam Brown is CFO of software vendor Access Group. "As FD it’s really important to have a sense of the sales pipeline – and to understand customer sentiment," he told me recently. "That’s partly about their confidence and their intention to purchase. But also what’s important to them. That’s the real return on investment in your time [spent with customers]. You’re getting more knowledge on how to invest in the business and where it needs to develop. There are no hard and fast rules. But I would say allocating time to be involved with maybe the top 10% of revenue generators is a decent rule of thumb." Sound advice. The customer is always... well, always everything. Without them, there's no business. So finance needs to know them.

Fear or fundamentals: does it matter?

2013-04-24T06:41:06+00:00

Like much of the financial industry, private equity has been on a journey these past five years or so. Along the way, it's had to deal with a dearth of debt (although that's coming back... and not always in ways the industry would like) and re-emphasise the importance of operational transformation as a means of generating value. Is it working? According to Forbes.com, it might be. Says the magazine: "The private equity industry looked to be stuck in a rudderless recovery through the end of 2012. The global buyout market has remained flat since 2010. Sales of mature portfolio holdings were below 2011 levels. And new fund-raising improved only marginally."

And now? It cites the latest Bain & Co. report on PE to make the case for a revival. What's the cause? Sustained low interest rates. So it's cheap debt then? Ah. No. It's more about investors looking to PE as a way of bolstering portfolios currently languishing with low returns. It's as much a supply-side story as it is demand-side.

Oh, and there's an uptick in M&A (we looked at that a couple of months back) and IPO deals to help with the demand side, too. That's certainly non-trivial, and it's good news for those of you already in backed businesses as well as the PE industry, of course. If you're looking for an exit or to execute a buy-and-build strategy, deals ahoy.

But then, glancing through the agenda for this summer's symposium at the Coller Institute for Private Equity, it was hard not to see evidence of another kind of shift. The title of this year's event? "The Private Equity Model: still fit for purpose?".

I've no doubt that most of the speakers will conclude PE has a long life ahead of it. But many of the debates pick up on shifting dynamics – between investors (LPs) and PE managers (GPs); around sentiment for secondary buy-outs; and the real level of returns LPs can generate.

That obviously matters to management teams in portfolio companies. The kinds of pressures GPs are under influences their approach to financial and operational performance at investee businesses - and to their FCs and FDs. There's a deeper truth, though. PE-backed businesses need to be incredibly agile to ensure they can deliver returns these days. Backers might be genuinely fearful of making their model work, despite the good omens from the market. Being able to respond quickly to your markets, innovate and rapidly translate operational change into financial results? That's just good business in 2013, regardless of your ownership model.

Adaptability for the new normal

2013-03-13T09:49:02+00:00

A simple question: what's better, the ability to more accurately predict the future? Or faster reflexes to adapt to sudden change? I recently interviewed several experts in "foresight" (the art and science of predicting what might happen) and pretty much the one thing they all agree on is that while planning for the future is sensible, fixed forecasts and rigid plans are not a smart idea.

The problem for finance execs in backed businesses is that private equity investors want a bit of both. They're looking at that five-year horizon and want a clear idea of how the exit's going to happen. But they also know that going off plan is pretty much part of the script. So all that detail you put into your financial forecasts is almost certainly going to be wrong by the first update.

Or, as economist Paul Ormerod explained, "Yes, forecasting is hard, but you still need to form a view at some point, then act on it. But even at that point, you still don’t need to put all your eggs in one basket. For organisations today, it’s about being more agile in your ability to react – and being prepared to change your mind."

For FDs and management teams capable of explaining shifts in strategy or circumstances to their backers, that's fine. (It helps if the backers are open-minded, too.) But we all know that the casualty rate for finance people in those companies is very high. A survey of 283 exec and non-exec directors who’d worked within private equity, conducted by Grant Thornton and Directorbank in early 2008, found FDs had a 28 per cent chance of being replaced, although anecdotal evidence more recently suggests that could be more like 50%. Simply put, it's easier to fire the FD when things go off course than the CEO.

Perhaps there's a middle way. One way for the finance function to become more adaptable - particularly when there's a discontinuity in the market or the business that introduces something new to the mix - is to hire in specialist support. Interim finance execs can bring a completely different (often complementary) skill-set to a situation, guide the incumbent finance team through any change that's required - and ensure that the experience and knowledge of the sitting FD stays inside the business.

One of the many features of the new normal for business is exactly this kind of flexibility. But it needn't be at the cost of stability. And if the number of seasoned FDs I know going into the interim world is any indication, it needn't be at the cost of quality, either.

M&A buzz: is the FD ready?

2013-02-18T12:22:00+00:00

What just happened in the M&A market? The corporate newswires were abuzz last week as two massive deals hit the slate (although they were far from being the only newsworthy deals recently). And guess what? Both are massive private equity plays.

First up, Dell, where founder Michael Dell is teaming up with Microsoft and PE firm Silver Lake to take the PC maker private with a $24bn offer. It's not going to be plain sailing - shareholders, as ever, sniff more upside. But it shows appetite for LBOs is back: Dell's debt is likely to rise from around $8bn to $24bn post-deal.

Then Warren Buffett announced he's teaming up with PE firm 3G to buy HJ Heinz for $28bn. Again, there's $7bn of debt built into the offer, which will pump the company's borrowing to $12bn.

So is this a return to the old days of financial engineering? We've been talking for five years about how PE is changing, putting the emphasis on operational improvement rather than squeezing cash to pay down debt. (Although, obviously, cash is always a number one PE concern.) That shift was critical to finance executives in portfolio firms - it shapes your approach to the business and your relationship with your backers.

Perhaps. But this isn't just a return to confidence. First, look at those two mega-deals. Michael Dell clearly needs to reshape a business that's being revolutionised by cloud and mobile technologies. He can do so much more easily out of the public glare. Heinz is a classic Buffett play - reliable, unsexy, cash generative. He sees more value in the business than the public markets do.

There's something else. Corporates with fat balance sheets need to use their money somehow - and strategic buys to gain market share are a good hedge against uncertainty and pricing pressure. PE firms also need to spend - but for different reasons.

This year sees the beginning of the end for many funds raised in the boom years between 2006 and 2008. PE firms with uncommitted capital will have to start paying it back… and how. As Bloomberg reports: "About 28 percent of the money raised from 2006 to 2008 has been paid back to investors, according to Cambridge Associates LLC, a Boston-based research and consulting firm. More than $100 billion, or 14 percent, of the $702 billion raised, is yet-to-be invested dry powder that firms must use or lose by the end of 2013, according to Triago. That’s a record for dry powder set to expire in a single year."

The good ones manage this flow of funds carefully and offer compelling logic to investors. Take Jon Moulton's Better Capital, which is returning £14.1m to investors as it pauses to look for new deals. But plenty of others will want to jump on the M&A bandwagon, either for fresh deals or to ignite a buy-and-build strategy at existing portfolio companies. In other words, not only do PE houses look like they're back in the debt business (upping the focus on cash) - further down the food chain, they will be expecting ongoing operational excellence to be paired with strategic acquisitions and merger integration. Those are yet more skills an FD and their team will need to polish.

And if your backer comes offering finance for deals? Above all else, be careful. There are some great guides to doing good deals out there (like this and this and this). Think carefully and positively - the finance function can be the difference between M&A success and acquisition gloom. But the FD and FC should be the last people caught up in the adrenaline of M&A.

New year diet, anyone?

2013-01-15T11:21:56+00:00

Thin is in for FDs. Sadly, this isn't about waistlines. It's looking like spreading yourself thin is going to be the order of the day in 2013. Because while it's true that FDs have always had a pretty diverse role and range of responsibilities, the need now is for them to be operationally active as never before.And that's on top of being hyper-disciplined about cash and forecasting as unpredictability beds in as part of the "new normal".

Evidence? Take this report from the Wall Street Journal's blog highlighting a survey of CFOs where 72% expect their role to expand this year. There's the usual stuff about pressure on admin costs and the focus on productivity (as well as some US-specific concerns around healthcare costs). But it's operational areas - talent management, growth and cultural change - that really stand out for me.

So far, so good. Most FDs I know are happy to roll up their sleeves in IT and HR and even operational areas. Yes, you run the risk of spreading yourself a bit thin - but the FD's input can be really transformative in all those areas. Then I saw a piece in Real Deals about the dearth of transformative operational nous within private equity firms themselves. Aha.

According to the RD piece, "A survey of company directors... found that 41 per cent of respondents rated the quality of private equity input as average or poor." For the PE guys, this isn't promising. Their new model is all about growth and quality of earnings (returns from a profit multiple, essentially). That means it's no good just relying on paying down debt (even if you can get it) to deliver fund returns.

There are lots of PE general partners who add masses operationally. Most PE houses will also place a premium on an expert chair or an operating partner to support that kind of operational improvement. But given that in some cases - according to the survey - PE operational expertise is lacking, the FD really does have to make sure they're delivering the goods too.

But here's an alternative to spreading yourself too thin. Perhaps the secret is to bulk up a bit - within your own team. I think this is as much about ensuring there's a great financial controller in place to handle the core finance function deliverables, while the FD offers telling contributions more broadly in the business. The secret of success in 2013 is open minds, willingness to take calculated risks - and engaging the entire finance team in exactly the right roles… even if they're not the ones you trained for.

The Special Ones

2012-12-02T16:32:34+00:00

Many Chelsea FC fans are hankering after a return of the Special One. For non-football fans, that's Jose Mourinho; their team is currently saddled with unpopular interim manager Rafa Benitez. But private equity is also hoping 2013 is something of a special one, too, as we come to the end of another year of rather depressing figures.

Examples? Take BDO's Q3 private company price index. It reveals deal volumes are still depressed - and prices actually remarkably high, a horrible combination. "Despite private equity funds having significant capital to deploy, it is becoming more and more difficult to get deals over the line due to the scarcity of quality businesses and an air of scepticism regarding market recovery," the report explains.

Or take the buy-and-build monitor published by mergermarket and Silverfleet Capital, which shows Q3 2012 saw only 50 add-ons completed in the quarter, compared with 142 H1 2012 and 85 in the same quarter last year. It's one of the weakest quarters since the nadir in mid-2009. Neil MacDougall, managing partner of Silverfleet said: “Any hopes we had of seeing an improvement in European Buy & Build activity levels in the second half of 2012 have taken a big knock from this data, which once again also reflects the weakness of the European buyout market... this looks like it has been a very weak quarter with lower activity levels in most regions of Europe and none in Spain & Portugal."

Will the numbers look at different in 2013? The underlying trends aren't encouraging. Except...

The very fact that the environment doesn't look like it's going to get any more benign could be a plus. Many PE firms are under no illusion: to bring back the magic, they need to find a different kind of special one - companies that fit an increasingly narrow set of criteria to be prime PE candidates.

That much was evident from the recent equityFD-hosted Entrepreneurial FD conference - where both FDs and PE practitioners were clear about the need to think creatively, uncover efficiencies and deliver new avenues for growth. Management teams with a bit of verve - and FDs who are great are supporting (and being) entrepreneurs - are still in demand. If you can show how you'll break out of the stagnant patterns of the economy, you'll do well.

Is this kind of special situation enough to offset the lingering death of financial engineering in the PE world? It's hard to say. But I recently wrote up the minutes from a summit of portfolio managers for a large PE house - one with a track record of delivering exceptional multiples from operational improvement.

The debate was far from doomish. Indeed, it was positive - and centred on reshaping businesses for global markets and delivering innovation rooted in customer needs. That can only come from open-minded management and a positive culture that prizes creativity. FDs and their teams are instrumental in delivering that approach. Yes - you can be the special one...

Cloudy with sunny intervals

2012-10-15T22:09:16+00:00

One of the features of the much-discussed “new normal” in business and finance is its sheer unpredictability. Markets are in constant flux, trends seem to break down just when they're getting established and there are far more outliers in the system – non-conventional approaches that suddenly become significant. Just take a look at two recent datapoints in the private equity world.

First, a great study from KPMG, looking at members of the National Association of Investment Companies (NAIC) – which are mostly owned by women and minorities. (The latter term seems a little pejorative in the global picture. But still.) It found the net internal rate of return (IRR) for those firms was 15.2% between 1998 and 2010 – compared to the median net IRR of US buyout houses of 6%.

Conclusion? “[The report] cites a ‘disciplined adherence to investment theses,’ ‘better entry purchase terms’ and ‘investments in opportunities tied to rapidly changing demographics reshaping the U.S. economy,’ as key drivers to the NAIC members’ success.”

In short, drive a hard bargain with people you understand – this isn’t about sex or race. But it’s a salutary lesson, too, for FDs looking at PE opportunities. Don't be afraid to test the business model where you work, be tough with the people - and look for businesses where you can make a difference beyond the numbers. Even for FDs and FCs now, this is an opportunity exploitation game.

Next, a strange contradiction. Private equity is still sitting on a mass of “dry powder” - money committed by investors but unused by PE firms. It’s less than it was (as you might expect, the peak years were after the fundraising boom in the middle of the last decade). But globally, we’re talking $360bn right now waiting to be spent.

Critically, funds raised at the end of that last boom – 2007 – need to be spent this year (or at a pinch next) if they’re to remain in play. So while M&A is in a slump (well, at least in the UK) and private equity has been priced out of many deals (“PE has, on the whole, adopted a more conservative approach to leverage, but it has also shown increased reluctance to engage in the bidding process unless there is perceived to be a good probability of success,” according to the FT), there is activity.

Leveraged buyouts are back (although not the mega-deals, according to this excellent Dealbreaker article); secondary buyouts are booming; and even in the UK, the banks are back, offering debt to fuel buyouts back to 2008 levels.

The lesson? Things are seriously patchy. But then, maybe that’s as they ought to be. At the start of the recession, a former CFO (now PE GP) suggested I start a session on coping with the downturn by asking a conference of FDs how many had seen a rise in turnover. It was almost half the room. In any community or environment, we should expect hot and cold spots - and that's true of PE as it is of business as it is of (to reach for another example) interim appointments. A long-standing turnaround interim FD I know went through a six-month lean spell last year - and is now fighting off the assignments.

The trick for smart finance execs is to find out where those hot spots might be. Understand the appetites of the people with money to invest – know the pressures on them and figure out why they sometimes focus on one type of deal and exclude others. Don’t try to understand the system as a monolithic whole – because that doesn’t make any sense now (or probably ever).

And remember: that dry powder wants discipline and focus. If the traditional City and Mayfair PE houses can get the kind of returns women and minority investors of the NAIC are getting in the US, they’ll be seriously happy. And if they can soak up more of their dry powder in your deal that offers those characteristics – they’ll be ecstatic.

Operational profits

2012-09-04T14:10:50+00:00

"You've got to want it." That was the core message of several FDs and PE folk interviewed for a recent article in Real Deals, published as part of the run-up to the Entrepreneurial FD conference in November, which is being co-hosted by EquityFD. In short, private equity ownership puts the finance director and their team in the spotlight. You have to deliver more numbers, more frequently, more accurately. If you stumble over an answer or can't contextualise decisions around the key drivers of the business - your backers are going to lose faith.

But there's more to it than that. The other side of "wanting it" is the opportunity. Jeff van der Eems, CFO-turned-COO of PE-owned United Biscuits put it best: “Successful CFOs in PE tend to like being operational. They get excited by business decisions and facing less bureaucracy. Under PE ownership, it’s much easier to take risks – that’s certainly been a big plus for me personally.”

His point is that good finance execs are always looking for the profit potential. Yes, they must be able to provide all the answers - which means knowing the business inside out. But once you have that depth of operational knowledge, it's hard not to contribute to value creation.

A few years ago, before GDP started flat-lining and we had to get used to a "new normal" in terms of the economy, that was less important for every business. In PE, so long as you were paying down the debt and riding your valuation, the leverage did all the hard work for investors and management. Now? Not so much. So that operational side isn't just what keeps you in our job as an FD - it's also what makes sure your equity pays out too. The operational FD is the "new normal" too.

Be ready to change as PE adapts to a new world

2012-08-07T13:32:04+00:00

Is private equity dying? I've had three conversations with backed FDs recently and all suggested it might be in danger of doing so. “The big problem for these guys is that their model is broken and they’re not moving fast enough to fix it,” said the one – echoing, more or less word-for-word, what the second said a week later.

Their concern is that PE managers haven’t adapted to the slower growth, multi-polar, high-risk world that we now live in. More worryingly, they haven’t adapted to the way debt markets have changed.

Yes, there are still lots of firms that focus on operational change as a source of value, especially in the venture capital and middle market arenas. But too many have come to rely on debt as a crutch to make the numbers work.

The third, an FD who’s now inside the PE industry, cited the number of funds in run-off – that are raising no new money and selling investments to pay out to investors – as a sign that many in the business have lost their way.

Even at the venture end of the market – which is less reliant on debt – serious question are being asked. In May, the Ewing Marion Kauffman Foundation, “an organization that promotes entrepreneurship by investing in venture-capital funds”, issued a report showing that poor investor returns for VC funds, no better than the public markets, were a sign of real sickness. In the last 15 years, it says, venture-capital funds haven't even been able to return to investors the cash they've invested.

Defenders of VC quibble about this. Invest in a top quartile performer and the returns are stellar. And the VC industry still plays a crucial role – and the backers of fast-growth, high-tech and start-up businesses need FDs desperately if they’re to engineer those kinds of returns.

And outside venture? Some point to the continued influx of money into private equity as a sign of its health. According to Prequin, global assets in PE hit $3,000bn last year, up 9.7% and a new high.

But behind those numbers lie the fact that big PE houses are attracting more of the money – often from investors lacking any serious options in this low-returns environment. And exits are still incredibly tough – meaning funds are holding onto investments longer, bumping up the numbers.

Evidence? Dow Jones VentureSource says that even at the venture end, fewer deals are consuming more investment cash. Because funds aren’t exiting, they’re often pumping higher levels of money into existing portfolio companies to take them to the next level.

So what does all this mean for FDs and FCs? “Your expectations have to change,” one of the FDs I spoke to told me. “You might have gone into a deal expecting to be cashed out in four years. But whether it’s follow-on funding or even a secondary deal, there’s now much more pressure to stay put in the business – a business that’s possibly changing quite radically.”

That last point is critical. Whether you join a young business starting out, a turnaround, a company looking to expand… you might find you’re having to run the numbers for a very different beast a few years down the track. That means keeping on your toes professionally and strategically – and being clear about how your other life choices are affected, too. None of the PE-hardened FDs I spoke to recently - nor many that I've interviewed over the years - lack for positive things to say about being in business with the right backers. But like so much these days, things change - and you have to be able to change with them.

Why private equity needs financial discipline

2012-04-26T08:26:58+00:00

Private equity firms - and the industry as a whole - are a little obsessed with overall returns. In particular, they like to be able to show their investors that they're doing better with their money than, say, one of the highly liquid quoted indices; or property. The problem is, in recent years, that hasn't always been the case. But rather than inferring a problem purely with the model or with the environment for PE investment, I think at least part of the problem is the need for disciplined financial management in their portfolios.

Let's look at some evidence. A recent study by legendary economist Steve Kaplan shows US VCs, for example, have performed poorly compared to the S&P 500 since the dotcom crash. Now you could say this was too much money chasing too few deals. Perhaps it's the lure of mega-returns from backing the next Google which suckers firms in. But I prefer to look at the fundamentals. The dotcom era was characterised by an abandonment of sound financial management on the basis that the business models were so new, conventional investment appraisal, say, was meaningless. As for cash management? Forget it.

In fact, the numbers for larger PE buyout firms, investing at a later stage, in the new study were much better. In aggregate, funds outperformed the public markets by about 3% a year through the 1990s and 2000s. Again, many factors deliver this result - but the ability to apply sound financial disciplines and strategies as a means of engineering returns is surely one of them.

We shouldn't big up the FD's and FC's role too much. After all, for buyout firms, the effects of debt, particularly on tax levels, is a huge factor. But in an environment where big finance is harder to come by and earnings growth is often hampered by economic sluggishness, the ability of PE firms to put great financial management into portfolio companies shouldn't be underestimated either.

* PS: the exact differences between plc boards and PE-backed ones is always interesting. This (slightly old) study makes interesting reading if you're trying to work out what it is...