CFO Search for Private Equity Firms: Eyeing the Exit

For private equity (PE) firms, picking the right CFO is key when acquiring a company. What are they looking for in a candidate?

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Many PE investments are looked at over a three-to-five-year horizon. So selecting a CFO who turns out to be a bad fit could put that hold period at risk and negatively impact the Internal Rate of Return (IRR) that PE firms are seeking.

The quality PE firms value most in potential candidates for this role is prior experience as a CFO in a PE portfolio company, ideally underlined by a successful exit. The risks resulting from a wrong pick, on the other hand, should not be underestimated.

As an example, I remember several instances of doing diligence on a target and learning that the CFO of that company was not adequately suited to what my company expected from the financial leaders in our divisions.

This meant we had to build in the cost of hiring a new financial leader for the target, which changed the ongoing EBITDA of that business. This step then had to be factored into the decision on whether to move forward with that deal at the negotiated price.

I’ve been blessed to have had three quite successful exits and to have worked for three high-quality middle market PE firms, Odyssey Investment Partners, The Jordan Company and AEA Investors. Here’s what I picked up on along the way.

Helping the CEO Navigate Unfamiliar Territory

Top-notch PE firms view the CFO as a true partner to the CEO, a role that becomes especially important with a CEO who is navigating the PE environment for the first time.

This commonly happens when the CEO is the seller who sells his company to the PE firm but stays on to run the business, but it also can be the case when a CEO is brought in because of his or her industry experience, perhaps from a larger publicly traded company.

PE firms rely on the CFO to be the CEO’s copilot and interpreter in the PE world. What impact will this or this decision have on our covenants? Is it likely to generate a payback that the next buyer will value?

The PE Mantra: Cash. Covenants. EBITDA.

On the topic of covenants… - the only things that I cared about to make the numbers work as CFO of a PE-owned company were those with a direct business impact - cash, covenants, or EBITDA.

This may be a bit of an exaggeration, but it has served me well as my business mantra in that role. I’m not exaggerating when I say that 4 out of 5 discussions I have had as CFO with our Private Equity owners involved one of these three items.

Cash, covenants, EBITDA - PE firms care about them. A lot. And they expect “their” CFO to keep that in mind:

  • Why cash? Because cash is the lifeblood of the organization - see my remarks in this previous blog post. While there are creative - if not unscrupulous - ways to "generate" EBITDA by liberally interpreting a company's credit agreement and adding back some "squishy" items to enhance EBITDA, it is impossible to enhance an organization’s reporting of cash without crossing the line. Cash, and particularly cash generated from operations, is among the best measurements of how a business is performing.

  • Why covenants? Because many PE portfolio companies are highly leveraged. It is not unusual for a mid-market company to have debt equal to five, six or even seven times of their EBITDA. PE firms prefer CFOs that feel comfortable working under these conditions. Not everyone does. The CFO who’s not acutely aware of all of the covenants in the Credit Agreement could be akin to someone sleeping on the job. The result could be waking up to extremely unpleasant conditions. One typical scenario is that a CFO suddenly becomes aware, after two or three lackluster quarters, that business is now bumping up against its covenants. PEs expect the CFO to foresee developments like this, alert other leaders in the company, and suggest a course of corrective action.

  • Why EBITDA? As the most common metric to determine a company's value, EBITDA often also serves as the starting point for any M&A related discussion. Because successful PE firms always analyze and plan with the optimal exit in mind, they expect the same focus from the CFO.

No Prior PE Track Record? Tips for CFO Candidates:

What if you’re looking to shift your career to this niche, but your resume doesn’t include a tour or two as CFO of a PE portfolio company already?

Provided you have other relevant industry or M&A experience, this should not be an insurmountable hurdle. Not every CFO in a PE portfolio company has had previous PE-CFO experience.

So what can you do to improve your chances?

Previous success in a similar role in a non-PE owned business, especially if it was a business of considerable size, would be most important. In addition, executive search consultants who have specialized in this niche are looking for one or more of the following attributes in potential candidates:

  • proven expertise in dealing with lenders, leverage, covenants,
  • industry experience, and/or
  • intricate first-hand familiarity with the process of buying or selling a business.

How can you identify the right opportunities with PE portfolio companies? In my personal experience, networking works best, followed closely by using executive search firms. Globally operating recruiters also have specialized PE CFO search practices.

Private Equity firms, whether they get referrals through their network or retain executive search consultants, want finance and accounting leaders in their portfolio companies who have experience in their field (or at a minimum in the respective industry) and who have had at least one successful exit.

The PE worldview is different from that of public companies or family-owned businesses. To be considered for a CFO role, a candidate must know how they think, and how they view the world.

Do you have experience as CFO for a PE portfolio company? If so, feel free to share your thoughts and insights in the comment section below this post on my LinkedIn profile.

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