Private equity firms have a reputation. Like most investors, they want to make money. When they buy a company, they often cut costs, lay off employees and hire new managers. So when you’re the CFO, and a private equity firm buys your company, what should you expect?
The answer may depend on the health of your company. Paul Sherman, CFO of contact lens distributor ABB Optical, has worked for several private-equity-owned companies and says he has had positive experiences with all of them. PE firm New Mountain Capital bought ABB Optical in 2012. “In our case, we were a growing, profitable, very successful company that New Mountain [was] choosing to invest in because of our growth and because of the management team,” Sherman say. “So it’s been a fantastic relationship.” But “it’s very different if a private equity firm is buying a struggling turnaround, because, obviously, then they have to strongly consider the management team and maybe bring in different people,” he says.
Whether or not your company is in high-growth mode, working for a private-equity-owned firm will likely be an adjustment. CFOs are used to steering the finance department without much interference, and PE firms may get more involved in day-to-day decisions than a finance chief would expect.
CFOs of private-equity-owned companies should make peace with the fact that the PE firm is going to be involved in the budgeting. “There’s a very rigorous budgeting process that private equity firms ask management to do,” says John Pennett, partner-in-charge of the life sciences and technology groups at EisnerAmper, an accounting firm. “If you need to spend money on marketing and R&D or product development, the private equity firm has to buy into that, because it’s their money.” Finance chiefs should be ready to communicate a well-thought-out plan with the private equity firm, just like they would with the board of directors. “You have to convince them that if we invest in these areas, we will get some sort of a return that we’re expecting,” Pennett says.
It’s not enough to allow PE firms a hand in the planning process. CFOs also need to perform up to the standards of the plan, Pennett says. If the management team convinces the PE firm to spend money so the company can grow 20 percent in international markets, the CFO should provide regular performance metrics that show the company is on track. “You put a lot of your personal capital on the line to get your budget created and approved,” he says. “If the company is struggling to execute against that, you’re going to give up some of that personal capital with the private equity firms.” Private equity firms may also control compensation, linking management incentives to whether or not the firm hits its sales growth goals, for instance.
These changes are all part of the deal. “It’s sort of like you’re getting married, in a sense,” Pennett says. “You have to get buy-in on many different levels.”
A private equity firm may expect this level of oversight even if it hired the CFO itself. Scott Kantor is the former CFO at Advanced Health Media, a regulatory-compliance-management-system provider. In 2011, Arlington Capital Partners hired him to replace AHM’s previous finance chief. (In 2013, he left AHM to become finance chief of Picturehouse, a film production and distribution company owned by marketing and distribution executive Bob Berney. Kantor has since left Picturehouse.)
When Kantor became CFO at AHM, he learned that “the previous management team wasn’t providing the type of information on a regular basis that the PE firm, which was in essence the board, required,” he says. Representatives of the owners regularly asked him for metrics he was not used to sharing outside the C-suite. “They were asking for stuff that management needs to manage the company, not what the board needs to provide oversight and governance,” he says. At quarterly board meetings, the firm wanted to see 30 or 40 slides showing metrics that management used to make decisions.
“I’ve been the CFO of public companies, private/founder-run companies, private-equity-owned companies, and one public company where the founder was still the CEO,” Kantor says. “I’ve run the gamut of types of ownership. And I have never seen this level of detail discussed at a board level. We were literally going through metrics page by page.”
Kantor says he doesn’t blame Arlington Capital Partners for its diligence and that he liked working for the firm. But the experience taught him a few lessons. The first: set a threshold at which management should run decisions by the board. In AHM’s case, that was $250,000. The other was to be forthcoming, especially about bad news. “Their requirements grew less and less onerous as time went on, because they knew if something went wrong, I was going to tell them,” Kantor says. “When something came up, we would communicate that to them. So we earned their respect along the way.”
Still, Arlington Capital Partners interviewed and hired Kantor. The relationship between private equity owners and management might be more tenuous if a CFO was on board when a PE firm bought the company. Can CFOs of struggling turnaround expect to keep their jobs if a private equity firm takes over? Maybe, but there’s a good chance they won’t. “It’s usually that a private equity firm is coming in because the company is in a certain part of their life cycle,” Pennett says. “So it’s a turnaround and they want to bring in a turnaround guy or it’s a growth story and we’re gonna bring in a guy who knows the markets better.”
The CFO can also end up being the “fall guy,” Pennett says. “It’s like what you see in sports sometimes. We can’t fire the general manager of the baseball or football team. That’s like the CEO, who is oftentimes one of the original founders of the company. And everyone is wearing jerseys of their favorite Buffalo Bills players, so I can’t fire all 53 players [employees]. But CFOs tend to be more like the coach. I could fire the coach.”
CFOs may also be a target because they have to deliver the bad news, saying “‘we missed the mark,’ ‘we need more money,’ ‘we didn’t meet our bank covenants,’ or ‘we don’t have any money to make distributions,’” Pennett says.
There’s no hard-and-fast rule for the length of time finance chiefs have to prove their worth, but the most important metric for proving themselves is EBITDA, Pennett says. “If there’s cash flow that’s being generated, that means the private equity firm is entitled to have some portion of their debt repaid,” he says. “They want to be able to see the company is healthy and that they don’t have to put up any more money to [keep] the ship from sinking.”