As 2019 winds down, private equity investors face a significant challenge. With a collective $1.7 trillion at funds' disposal, they must determine how to deploy this excess capital. 2019 has been a slowing down of private equity investment globally; the previous year saw an investment of $569 billion across 3,817 buyouts, while the present year has decelerated through three quarters. Only $394.7 billion has been deployed across 2,491 deals, according to a comprehensive report published by Dechert LLP.
Because of this overabundance of capital and the slowing of investments, CFOs of both the private equity funds and those companies the funds are looking to invest in should be prepared to parlay.
Dechert attorney Markus Bolsinger spoke to CFO Dive about what role private equity CFOs play within the fund, and what CFOs of target companies should know about private equity acquisition process.
"If you’re a company that is looking to be potentially sold to a private equity investor, and you have a financially savvy CFO, I think that can make a huge difference before you go out to market," Bolsinger said.
"Smart smaller companies where a CFO isn’t as strong, or doesn’t have as much help as they need, hire outside accountants to get the company ready for a sale. [Those accountants] help the owners, before they sell, focus on and track the financial metrics, and prepare to have them in advance,” Bolsinger said.
The process, on the private equity side, can be much more pre-planned, Bolsinger said, with the firm performing due diligence on potential investment opportunities.
"Private equity firms almost always bring in their own financial advisor, performing financial due diligence on the target company for the private equity shops." These firms too rely on the CFO role to help prepare to make investments, but not all CFOs perform the same function.
"There are two different kinds of CFOs at private equity funds," Bolsinger said. "Some of them are solely responsible for accounting, bookkeeping, compliance, etc. Then there are those CFOs who also get involved, especially in the smaller funds, in helping the investment teams to structure their investment into portfolio companies."
Even with private equity firms' due diligence, they rely on potential sellers' advance preparation for consideration.
"Having audited financials is extremely helpful. So if you don’t have them, you should consider getting your financials audited. Not having audited financials will not disqualify your company, but it’s an issue, particularly for the lenders who are financing the acquisition. Some of the lenders will walk away, others will lend on less favorable terms, because there’s a perceived uncertainty or risk," Bolsinger said.
When private equity firms approach acquisition targets, even with the best preparation, tension between the former’s expectations and the latter company’s CFO’s expectations may arise. When the two executive teams’ respective expectations and objectives are not aligned, trouble can similarly follow.
The question is raised; which side bears the onus on building rapport to make sure both sets of expectations are met?
"That’s a tough one — unless it is a proprietary deal, which is the exception, there isn’t much time to build a relationship before the consummation of the transaction," Bolsinger said. "The vast majority of the time, there’s an auction, which does not leave a lot of time for deep relationship building. Generally, [there’s] one dinner with management and the investment bankers in connection with the management presentation. There you can establish some rapport with the attendees, including the CFO. At that point, as a buyer you already have seen the confidential information memorandum and the financial statements."
But does the private equity firm bear responsibility, as the investing company, to meet the target company halfway? Bolsinger notes an acquisition shouldn’t be seen as a compromise, but as a satisfaction of parties receiving what they are looking for in the transaction.
"I don’t think there really is a meeting halfway," Bolsinger said. "The company will have to meet whatever requirements the private equity firms and its financial advisors have. The private equity investment team has to present the acquisition to their investment committee and there are certain [financial] metrics they need to be able to have and show.
"What is helpful in this exercise is the private equity firm educating the seller and its CFO of its needs and obtaining that information in a professional, courteous and respectful manner," he said. "The private equity firms recognize that the smaller the company, the more resource-constrained they generally are. They will often offer to additional resources available to the target to be able to provide the financial data that will be required to get a deal done.”
Regardless of which side of the business transaction you’re on, some basic tenets hold true.
"Every company benefits from having a strong CFO who helps prepare the company for a sale, whether to a private equity firm or otherwise," Bolsinger said.
"A private equity investor is ultimately a financially motivated investor. As a founder, getting a strong CFO in order to prepare for a sale of his or her business would be a very smart move."