Private equity Chief Financial Officers face a myriad of challenges. They are usually responsible for a wide variety of company operations, including accounting and finance, human resources, risk management, health, safety and environmental, procurement, tax, and a maybe even commercial operations.
Adding to this broad list is the compressed timeline of the private equity world. Investors expect a high on their investment in short order, resulting in a potentially stressful, chaotic, messy, and volatile environment.
The experienced and well-supported CFO can bring all this together to manage external expectations, managers, and line employees to support a profitable exit by the investors.
If, however, the CFO makes some critical errors along the way, they may not survive long enough to see the elusive and hopefully lucrative exit of the private equity investment..
Without further ado, here are the six quickest ways for a private equity CFO to make sure they don’t live long in their role:
1. Focus and report on irrelevant metrics.
A common error made especially by Chief Financial Officers new to the private equity game is an over-reliance on the skills that may have gotten them there, especially an intimate understanding of accounting and financial reporting. Typical accounting results presented in accordance with local Generally Accepted Accounting Practices (GAAP), in many cases, are woefully inadequate to help steer an agile private equity-backed company.
Things change very quickly, and require near-time monitoring of company health. A sole reliance on GAAP financial results won’t meet the organization’s needs. At best, those numbers are available after the end of the month, and relate to what happened up to four weeks prior.
Instead, non-GAAP measures rule the day. And, the more closely those metrics relate to cash generation, the more interesting they become. Metrics such as cost per unit of production, weekly cash forecasts, backlogs, order intakes, sales pipelines, and open purchase commitments, are all critical to measure on a weekly, if not daily, basis.
As the CFO considers what’s important, they should pay attention to the informal conversations around the organization. The things that employees are focused on are hopefully aligned with maximizing organizational value, and are therefore great candidates for measurement. Lacking this, they should consider the near- and mid-term goals of the organization that lead to maximizing enterprise value. Most times, those aren’t just last quarter’s net income.
2. Report inaccurate results.
Just as important as tracking the right metrics is getting those metrics right. This can be more challenging, because the non-GAAP metrics don’t necessarily “tie out” to anything. For instance, understanding the sales pipeline (which tracks a revenue opportunity all the way from prospect identification through order placement) requires getting to know your sales people, as there is considerable room for interpretation as any sales opportunity matures. To get the reporting right, the CFO needs to understand the customers’ buying habits, the market environment, and most importantly, the reliability of the salesman’s assessment.
Highly qualitative measures such as these result in high degrees of required interpretation and synthesis, which is a skill quite different from financial accounting. When done right, the reporting is wonderfully focusing for everyone. If not executed well, though, the organization can easily start pursuing valueless goals and create an equally valueless CFO.
3. Consistently miss near-term forecasts.
Typically, there is enormous pressure to forecast rapid near-term growth and improving financial results. This pressure can come from the private equity sponsor, who is literally banking on the achievement of favorable earnings numbers, so there’s a great temptation to tell them what they want to hear when it comes to forecasting.
Then, this pressure can manifest itself into over-optimism on the part of the entire management team. The team can convince themselves that by simply “trying harder” or “focusing more,” the financial results will come.
It’s the job of the CFO to look through this and “handicap” the projections. Over the planning horizon, it benefits precisely no one to be overly optimistic about revenue growth, cost reductions, or capital management improvements.
But, if the CFO is looking for a short-term gig, please… ask them to forecast like this, regardless of reality:
4. Don’t earn the right to have an opinion.
The lead finance resource often finds themselves in the midst of executives with immensely more industry experience. This can be challenging, as the CFO may have at least as much executive leadership experience, but their knowledge of the specific market dynamics and industry players are lacking.
To earn the right to have an opinion, the CFO needs to leverage experience and knowledge earned elsewhere and then apply that to unique situations. Then, viewpoints need to be proffered with appropriate levels of respect to the subject matter experts. Over a surprisingly short period of time, the right attitude can earn the CFO a sought-after opinion.
Or, the CFO can just pretend they know more than everyone already knows they do, and they won’t be long for the role.
5. Lose (or don’t ever earn) the support of the board, investors, and the CEO.
Similar to earning the right to have an opinion, it’s critical for the CFO to both earn and maintain the support of: (a) the board of directors, (b) key investors, and (c) the direct boss, the chief executive officer. Each of these are important individually, as they all have some level of say in filling all leadership positions, but especially the lead finance job, since they may interface with this person more than even the CEO.
As with a three-legged stool, the CFO needs the support of all three, but can survive with only two for a time. Lose support of two of these groups, and the end is near!
6. Run out of cash unexpectedly.
The unforgivable sin of financial leadership is surprising your financial backer, the private equity firm with a nearly empty bank account. The CFO job is a one-mistake affair, in case the business runs out of cash at any time other than what was communicated, ideally well ahead of time.
Private equity firms are averse to surprises, and absolutely abhor negative ones. And, the most unpleasant surprise of all is that the company they have likely sunk untold millions into is in urgent need of funding. That makes everyone look bad, including the partner assigned to tending to the portfolio company. That’s bad. As in, the-CFO-should-call-a-recruiter-right-now bad!
Of course, a lot more can go wrong than just what’s on this Top Six list. But, the successful CFO avoids these pitfalls daily, and has an opportunity not only to see the end of the investment, but also earns a reputation for being a trusted partner.