September 1, 2012
Interviewed by: David Snow
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Getting the Finance Team Right

A key role in any organization is that of CFO. Picking the right CFO can put a private equity deal on the fast track to success; keeping the wrong one can put performance in a rut. In this fascinating discussion, Robert Nolan of Halyard Capital; John Brittain of Tatum; and Lewis Raibley of Castle Harlan discuss the importance of quickly and accurately assessing the finance team in a private equity portfolio company and why many firms replace the CFO in half their deals. This series also includes an expert Q&A with James Dimitriou of Tatum, the series’ sponsor.

A key role in any organization is that of CFO. Picking the right CFO can put a private equity deal on the fast track to success; keeping the wrong one can put performance in a rut. In this fascinating discussion, Robert Nolan of Halyard Capital; John Brittain of Tatum; and Lewis Raibley of Castle Harlan discuss the importance of quickly and accurately assessing the finance team in a private equity portfolio company and why many firms replace the CFO in half their deals. This series also includes an expert Q&A with James Dimitriou of Tatum, the series’ sponsor.

David Snow, Privcap: We are joined today by Bob Nolan of Halyard Capital, John Brittain of Tatum, and Lewis Raibley of Castle Harlan. Welcome everyone to Privcap today. Thank you for being here.

We are talking all about a very big important topic, that is human capital in private equity. Obviously, getting human capital right in private equity is paramount. But there are many different people and kinds of talent that are pivotal to the success of a private equity deal.

I’d like to talk about the finance team and the CFO. And I know that all of you have views about the importance of this role, and also how to get it right, and also what happens if you get it wrong.

Maybe we can start with John from Tatum. John, in helping clients  get the finance team and the CFO right in private equity deals, what are some important considerations? How important is it? And what are some ways that you can evaluate the right financial talent for a private equity investment?

John Brittain, Tatum: Thank you, David. It’s absolutely critical for private equity and going through the due diligence process of making an investment, buying a company, they’re buying into an industry that they understand, a product, a service. They’re backing a management team, a CEO.

The chief financial officer of that target company gets to be known through the diligence process. They’re providing information to data room, historical financials, information.

There is an understanding of the finance organization. But at a very high level, quite often, through the diligence process. If there any negative signs relative to order process, production of financials, business plans, historical information, the sponsors generally can get a degree of comfort from that.

But that’s only the beginning. Because once there’s the execution for the purchase of that company, the CFO on the finance organization sits at the most critical intersection. They’re the ones, and that’s the organization under the CFO, that has got to be putting together and helping execute on a new operating plan, providing timely financial information to the management team, to the CEO, to the sponsors, being able to deliver on cost efficiencies and realignment of the business.

And that’s the critical intersection. That’s the intersection in terms of driving all that value to the CEO and the management team, providing visibility into the business, to the sponsors, and the principle shareholders of the company. And that’s the value equation for the visibility, and building the bridges between those organizations.

We come in, from Tatum’s perspective, sitting in that role that really is building those bridges. It’s really building those tool sets and processes to allow the business plan to be executed effectively, and to give the proper visibility and feedback to the owners of the business.

Snow: Bob, I saw you nodding. From your perspective, where does the CFO fit into the success of one of your investments?

Robert Nolan, Haylard Capital: I think they play an enormous role. But we should first start with how we define the CFO. The CFO has a myriad of functions, as being touched on by John. They’re both external and internal constituencies they need to deal with.

The internal side draws upon their financial acumen, and their accounting skills, and tax knowledge. And then, of course, ability to manage the team itself that sits within the finance staff.

But then the external constituencies. Those would be [? faso ?] and reporting numbers appropriately, financial metrics, operating metrics. And they’re dealing with different constituencies. You have the shareholders, may have debt holders.

So I think it’s a balance act. So when you ask how important it is, it’s critical. And the right person, who also takes on a strategic role, I should add, can be an enormous asset to both the CEO and the board. So again, it’s right at the top of the list.

Lewis Raibley, Castle Harlan: A lot of times it’s the second-most important position. The CEO needs to be right, but the CFO usually is the right-hand man.

Snow: How often is it that we can talk about changing out the CEOs, and that’s often the topic that private equity people will discuss. How often and how early is it necessary to find a new leader for the entire company. But how often do you find yourself changing out CFOs or senior members of finance team?

Raibley: Almost half the time, believe it or not. A lot of times we’ll, if it’s a carve out or something, maybe we have a divisional controller that’s not quite equipped to be the CFO. We have a great example of that.

We bought a company that was a joint venture among two large public companies about six years ago, and we had a great CEO running the division. He had four great managers around the world running the businesses. But we had a divisional CFO, and he was really a corporate controller. Good guy. Really tried hard. Just wasn’t quite right.

We were able to bring somebody in that could do it. They had international skills, they had foreign currency skills. They had all the skills we were looking for, as well as the managerial skills. And we were able to reposition this gentleman underneath of him. Worked out pretty well. But you need the right guy.

What we do in due diligence is– I may be unusual in a private equity firm. I came from a financial background. I used to be a CFO. I used to be a controller, and I joined Castle Harlan seven years ago to help with financial operations expanded to general operations.

But what I’ll do during due diligence is go in and, not only to know the CFO, but the controller, and maybe some of the people under them as well. We’ll have the accountants go in that we hired, and they’ll do all the checks and the balances and make sure that the numbers are right, and the quality of earnings is appropriate and we understand what it is we’re buying.

I’ll go in and I’ll just sit down with the CFO and say, show me how you run the business. What reports are you using? And oftentimes, the good ones will actually, they’ll be able to tell you everything themselves. But they’ll also bring their people in.

And that tells you something about the individual, and how well they delegate, and how controlling they are. If they bring three or four people in and they can all talk about what they do and tell you about the company, you start feeling pretty good about this team. Because, as you’ve both said, this is a critical role, and it’s our window into the company. The finance department needs to be right, or our window’s– it’s not going to be open.

Snow: What are some signs, when you’ve already acquired a company or you’ve invested in a company, that the finance function is not going as planned, or not going as hoped, or that the senior leadership of the finance team is perhaps not the right person?

Nolan: I think there’s one real telltale sign, which is timely reporting. Because if you’re not timely reporting, you know there’s a serious issue at stake. And of course, as was touched on, we live by timely reporting. We have to report ourselves to our institutional investors. So we have our requirement.

Now, it can be caused by a myriad of forces. But the reality is, as in any function, the CFO should give clear guidance, if there’s ever going to be an issue with time on reporting.

Now, getting beneath the covers and finding out exactly why that is so, there’s usually an interesting element.

Brittain: It’s timely reporting and it’s repetitive process. Because you’ve got to see is there a routine, is it a process, is it established, is it timely, and is it done repetitively in a process-oriented role. And those are good signs when you have problems there.

Raibley: And we oftentimes increase the reporting requirements. We ask to see things in a certain way from all of our companies on a monthly basis. Some people think it’s an onerous process. Some people say, well, I can’t do that. Well, the guy that says I can’t do that, that’s a red flag, because all we’re asking you to do is take information you should be using to run the business and package it up differently for us.

Another thing that we look for is we look for weekly information. We get a weekly dashboard from each of our portfolio companies. And it’s hopefully not, again, an onerous ask on the part of the CEO.

Nolan: Well, how deep is the dashboard, I’m just curious.

Raibley: It varies by company. I’ll say the deepest one is 10, 12 pages. But that’s a company where they’re selling into a retail market, so they want to look like it– they have some big box distributors, and we want to look at their sales. So it’s not things the company’s really doing.

I’d say typically we look at one to four pages of information the company’s actually preparing. And it’s the right stuff. We tell them how we’d like to see the monthly financial statements. Plus tell us what’s right to be looking for for your business.

The weekly dashboard we basically say, you tell us. Tell us what’s important for this business. And we have an idea what we’re looking for, but generally you get some pretty good stuff from management.

Nolan: That’s actually a good way to approach it. Because you’ll get a better story. You’ll get the truth.

Raibley: Yeah, you’ll get the truth. And we actually use that. We ask people to send them in Friday evening, and we have our investment team meeting every Monday morning. And each project manager has to talk about their company, what’s going on. And part of what they talk about is just what they learned on Friday.

Snow: I’m glad you mentioned the dashboard because I’m interested in hearing, one, what is the trend in private equity generally, and maybe John, you can help with this, in the sponsoring firm plugging into all the underlying portfolio companies, and not only providing resources to them, but expecting information back that they’ve been, I guess analyzed at a higher level.

So what’s driving that trend?

Brittain: What’s driving it is what Lew was talking about before, is that the sponsors are looking for standard reporting. So you really, let’s get down to we’re implementing an operating business plan, and there are basic metrics relative to growth, revenues, profitability, cash flow, balance sheet, other metrics.

There are standard processes in reporting. And many private equity firms are standardizing that reporting and what they expect to see, 17, 18 pages standard approach. And every finance organization and report for the company should be able to produce that information on a monthly basis. And that’s integral to the operating plan, driving the business planning function, the visibility into the business.

Quarterly, there may be more strategic reviews for board meetings, different information. That’s different. That’s not necessarily standardized. We’re also seeing all portfolio companies having some sort of flash reporting or dashboard reporting of timely information, it can be revenue sales cycle, periodic information, weekly, biweekly. That’s critical.

And I want to pick up on another point we were discussing before is that the CFO on this process, as they standardize this reporting and generate it, they’re not the chief executive officer of the company, they’re not the chief operating officer of the company, but they better understand the business. They better understand exactly what’s driving the business, they better understand the revenue, the revenue growth, cost structure.

And when you get variance analysis in your monthly reporting, what you don’t need to hear is the elevator analysis. You don’t need to hear this is a percent variance month to month. What you want to hear is why. Why do these things vary? Why do we have a variance? What’s going on with that business?

That’s the CFO, that’s the finance organization, that’s the financial planning and analysis function that the portfolio company has to have in place to get that visibility and feedback to the chief executive officer, to the chief operating officer, and to the sponsors of the business.

Raibley: And to pick up on that, one of the things we try to do in cases where– not every finance organization is that sophisticated. And a lot of times if it’s a carve out, if it’s a buy off an owner, it’s not the most sophisticated finance department. But maybe you’ve got some good people. And we’ll go in and we’ll coach them on how to look at things, and how not to just give us the revenues are up and expenses are down. Well, that’s a good equation, but we really would like to understand why, because maybe you missed an accrual.

But we’ll go in and we’ll help them, and we’ll implement tools that maybe they don’t have. We’ll help them understand the revenues. What’s really driving the revenue? Do you look at product profitability? Do you look at customer profitability? What is it that you’re looking at? Are you stopping your analysis at gross margin, ignoring production variances, ignoring corporate overhead?

We find a lot of times people are fooling themselves. They’re analyzing 10 segments of their business at a contribution margin level, and there’s a lot of expenses that are happening between contribution margin and EBITDA. And we’ll help them understand how maybe those ought to be allocated out.

We have implemented these types of processes in, I’d say, pretty good finance departments and pretty good companies, and have helped management understand that product’s not doing so well, this customer’s a real opportunity, and really driven a lot of value like that.

Nolan: I’d just like to add one. I sounds like you’ve done this in your own businesses. We’ve twice positioned people into the finance staff from our own resources.

Raibley: Yes.

Brittain: Out of the fund resources, not outside people, but internal people, to sit there for a period of time to both– now we’re talking about both education coaching, getting the metrics right, making sure that we’re delivering it on a timely basis.

And of course, as I’m sure you do, as you were touching on, we lay out exactly what we want from them, both on a quarterly basis and a monthly, you touched on.

I was amused at the description because we had a CFO who’s no longer with one of our portfolio companies who was exactly that person who was reporting on the top line movements. And then what it really revealed was he was just accepting the numbers from the different divisions, and not really understanding the business. And once that’s revealed, you need to move.

Raibley: And we’ll often, to Bob’s point in putting people out there, we’ll often encounter a CFO who can think differently. And they say, yeah, I understand it, but you know what, I just don’t have the resources to do this. And what you’re asking me to do isn’t a full-time person. It’s a full-time person for about a month.

And we have junior people on all of our deals, and they’re real good with spreadsheets, they understand the businesses. We’ll ship them out, let them help the company, get them up to speed. And then we’ll say what are the real resource requirements now?

We’ll encourage our executives, and particular, our CFOs, to go out and get the right resources. Maybe you don’t have enough. Maybe you have too many. Maybe you need some different people. Just help them understand what it is they need to be effective.

John Brittain: Tatum is a full solution firm. We’re a professional services firm, specifically as it relates to the finance function. Myself and others, CFO Partners and company, have long background and experience working in private equity firms and supporting portfolio companies. We come in and we’ll do a full assessment in terms of the situation.

You may have an interim requirement, you may understand from the portfolio company’s perspective that there’s a deficiency, there’s a gap, there needs to be an immediate critical role to be filled. We can come in immediately and sit as an interim CFO in that business. We can fill specific financial reporting roles. We can fill other interim requirements of the company.

But more importantly, when we get in there and we’re sitting in those roles, we’re doing a complete assessment of the finance organization of the delivery, all services. And as a result of that, we’ll make our recommendations in terms of ongoing requirements to management and to the portfolio companies. We’ll help realign the company.

The goal here is to maximize operational efficiency and financial performance. And we come in with a full suite of services.

We are known to get phone calls on a Thursday, being told we have a problem, and we need someone on board Monday morning, and we work at that kind of speed. We’ll be in there, we’ll get on board, and we can fill those gaps and drive the ongoing requirements of the business.

We sit in a critical position where we have the experience and the background that we know how to manage those multiple constituents. It can be difficult. It’s quite a juggling act at certain points of time. We have to be supportive and develop the relationships to support the management team. The CEO of the business, be part of his resource, his team, as he’s trying to deliver his results to the new owners of business.

While at the same time, making sure the new owners of the business have the visibility, and that the results are being delivered to them and there are no surprises from their perspective.

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