In the firing line

Private equity continue to pump massive amounts of investment in to UK companies. Ambitious managers find it harder than ever to resist the lure of a PE-backed business, too. Not only are there substantial financial rewards for management teams that deliver results for their PE investors, but for quoted company boards, the removal of a huge regulatory burden is a massive bonus.
But how do they make sure they're meeting the needs of those investors? And, given the high casualty rate for finance function leaders in PE-backed businesses, how do FDs and their FCs ensure they're delivering to the backer's satisfaction?

The answer, according to an exclusive survey of top private equity managers conducted on behalf of specialist recruiters EquityFC and EquityFD, isn't creativity or great leadership skills. The secret to surviving the 'dragon's den' is for the FD and their team to play with an incredibly straight bat.

What does a good equity FD or FC look like?

We asked the PE players what they considered to be essential attributes of financial executives in investee companies. The top two answers were accuracy in financial forecasting and openness with investors – in both cases, 88 per cent of respondents said they were vital attributes. IT skills, leadership qualities and flexibility all scored poorly. 'This doesn't surprise me at all,' says Sarah Hunt, MD of EquityFD. 'The advice we give our candidates is, yes embrace the business, its goals and capital gain opportunities – but first and foremost you are the FD and you will stand or fall on the quality of the information you provide; and, on a personal level, how reliable and open you are as an individual.'

'Trust and communication are paramount,' one PE manager told us. 'They must have a robust, detailed approach.' Another put it more succinctly still: 'They need to be on top of the numbers.' (Interestingly, given that this was a fairly common view, by far the most popular qualification for an investee FD to have was from the ICAEW; an MBA, often talked about as the qualification FDs of the future will need, didn't get any votes.)
Not all the respondents were quite so stark in their assessments. 'I like to see a focus on KPIs and accurate reporting,' said one. 'But the FD and FC also need to have a good understanding of what drives the business in order to make corrections if things go wrong. They need to be adaptable in case the strategy changes – they have to be able to cope with growth, cost cutting, maybe a turnaround situation. And they must be a good communicator when dealing with leverage bankers – these guys are the equivalent of equity analysts following publicly listed companies.' That's certainly more like the rounded FD role that most financial managers aspire to.

PE-backed FDs also need to appreciate which side their bread is buttered. 'They need to understand the detail behind the numbers – and be challenging to the other members of the management,' said another PE manager. 'I want them to be open and honest with the investors, especially when there is bad news to deliver.' Another said they wanted the FD to be a 'countervailing force' to the MD. If that means grassing on the management team, in other words, so be it: 'They must be able to challenge strategically at board meetings,' said one respondent. Another added, a little more diplomatically: 'The list runs independence, being a good custodian of the company's capital, accurate projections – and no surprises.'

Tips for success

Some of the respondents gave us specific pieces of advice to pass on to financial managers at investee companies. They're a mix of focus on the numbers and calls for adaptability, with a heavy dose of caution – get it wrong, and you'll be on the wrong side of those MBO FD casualty figures. In short, a PE-backed financial manager has to be quick on their feet.

'Be commercial. Don't just report 'what', link it to 'why' and come up with 'how can we make it better' output. Be visible in the business – you can't understand it if you're not.'
'Understand the detail behind the numbers and be challenging to the other members of the management. And produce information in the required timescales with no excuses.'
'Delegate, but also keep control. Be a genuine voice on the board. Have a can-do, must-do attitude.'
'Ideally you should understand price elasticity/volume impacts of strategy changes. Good, clear, solid, reliable communication skills are a must. And while they don't need to know the answer to every question, they should be able to find the answers quickly.'
'Deliver a crisp, clear and timely (at least 24hrs before the board meeting) management pack that focuses on forecasts rather than historics and includes an integrated set of non financial KPIs. You need to provide a 12-month cashflow projection and covenant tests. Finally, give us an annual review of shareholder value creation (ie, the anticipated proceeds from an exit).'

'Above all, do not go into a private equity backed situation unless you understand exactly what is going to be asked of you,' says Hunt. 'There's nowhere to hide and no-one to hide behind, with resources often paired back and timescales shortened. It is not the time for a half-hearted approach. You have to want to drive the business and ultimately, hopefully, do yourself out of a job on exit.'

The status of the finance leader

Whether it's an FD or (in a smaller backed business, perhaps) an FC, many of the PE managers who completed the survey said they looked for a degree of 'status' from the finance leader of the teams in which they're investing. That's simply a practical approach – as one respondent put it, 'The critical issue is dealing with the demands of a leveraged structure post deal, so they need gravitas in front of the bank.'

And when we asked what experiences PE firms considered essential in investee FDs, only the fact that they'd previously headed up a finance function scored significantly in the 'critical' category. Experience of the role in a similarly sized company was the next most important factor, followed by experience of private equity situations (although only four per cent considered this a critical factor, 52 per cent agreed it was 'important'). Worryingly for incumbent FDs and FCs in MBO situations, experience in the actual business being backed is the least significant factor.

'We look for adaptable, commercial and qualified finance directors,' said one respondent. 'Their personal attributes and communication skills are often better indicators of their likely performance rather than prior industry or company experience. Previous PE experience is helpful – but really we need people who understand the importance of cash management, and how to control it.'

'This absolutely backs up our experience,' says Robert Draper of EquityFC. 'Cash, rather than sector, is king in nine out of ten briefs we are given. The board is often already sector-heavy anyway, and an FD or FC from outside the sector can add a good dose of commonsense – and be able to question an approach from a fresh angle.'

The finance function

The FD or FC in a backed business rarely work alone. So EquityFC/FD asked PE managers what their priorities were in terms of the whole finance function. An ability to generate hard numbers was of paramount importance – softer measures and internal control were far less interesting.

Bang up to date reports and sound financial systems (to deliver reliable numbers) were the top two criteria. Security was also considered 'critical' by 41 per cent of respondents. But no-one thought an internal audit function was essential, and only one PE manager said that a succession plan for the FD was critical (reinforcing the vulnerability of finance execs in PE-backed situations).

The other low scorer was staff training: none of the respondents ranked it as 'critical' and only 32 per cent as 'preferable'. The message seems clear: during the relatively short a private equity backer is involved with a company, long-term investment in a business support function such as finance is a waste of cash – and for the critical control and analysis roles, if the skills aren't there, you buy them in as quick as possible rather than patiently train up staff. 'They have to hit the ground running immediately post-MBO, driving through the 100-day plan,' said one respondent. 'A decent finance function may not be in place on day one, which places even more pressure on the FD to recruit the right team and deliver. We ask: can they produce numbers on request, as well as slicing and dicing this information as required for the business to measure performance?'

What information?

The feedback from the PE managers also gave us an insight into the key deliverables for an equity FD. 'Information needs to be relevant and concise,' said one. 'The team needs to be proactive and honest. We expect a regular dialogue and for them to be up front with issues rather than hide them away.' So we also asked them to rank ten metrics that are routinely produced by the finance functions for their importance to a PE backer.

The result? It's all about income. The cash forecast was deemed essential by every respondent; and ninety-five per cent of the respondents rated the actual cash position, sales and sales forecast in the 'essential' category, too.

At the other end of the scale, staff costs were only an essential metric for a quarter of the respondents (although half did rate that figure a 'need to see' – so it's not like they're uninterested in the payroll!). But it looks like PE backers have even less time for softer metrics. Customer satisfaction, while it was a useful KPI for most of the respondents, was only an essential for 23 per cent. And none of the PE managers said brand valuation was a high priority – nearly half said they'd either not bother with intangibles at all, or only if they had time.

The sack race

So if FDs are replaceable and are under that much pressure from PE backers, what is it that pushes the 'dragons' to start handing out the P45s? We gave the survey participants a list of possible reasons for replacing the finance chief. Sloppy accounts and late or inaccurate reports were the most popular answers (given by seven-out-of-ten respondents in each case).

'This is a very common reason we are given for seeking a replacement,' says Hunt. 'Although where an FD is being replaced fairly soon after a deal it is often the inability to cope with a leveraged environment and the lack of fit with the new culture which is cited.' Poor communication skills were cited by 59 per cent and lack of strategic vision by 46 per cent; lack of experience ranked a little lower, at 32 per cent.
In fact the big surprise was that disagreements with fellow management or investors both scored quite low. In other words, providing you're doing a bang-up job on providing information and keeping the investment on track, it doesn't much matter whether or not you're schmoozing the PE guys – in our survey, at least, they care more about results than relationships.

Four of the PE managers we quizzed provided their own reasons for having fired finance chiefs. One was startlingly honest: 'The FD was easy to pick as a scapegoat.' But the others' reasons for making a change also offer useful guidance on the pitfalls of PE backing for finance executives:

'Inability to tackle issues quickly and effectively.'
'Resistance to change.'
'Didn't stand up to MD.'

'All in all, this is a great reminder that while excellence and integrity are the touchstones of any FD role, they're even more important when you're backed by private equity investors,' says Hunt.

For more information on EquityFD or EquityFC please call Sarah Hunt or Robert Draper on 020 7493 2703, email sarahhunt@equityfd.com or robertdraper@equityfc.com.