Private equity firms embarking on buy and build strategies should have a plan to effectively scale the finance function, says Consero Global’s President, Bill Klein.
Imagine the ideal roll-up scenario. A GP acquires a platform company at a discount, then guided it through an acquisition spree, eventually consolidating a huge swath of the market into a single industry leader. Sellers are now lining up to make their bid, only to discover inconsistencies with how the revenue was recognized at some of the underlying entities.
That’s hardly a deal breaker, but it changes the tenor of the negotiations, and might shave some points off the price. Now before we judge this imaginary GP too harshly, it’s crucial to appreciate the challenges in managing the finance function during a roll-up process. Bill Klein, the President of Consero Global, identifies three core issues that PE firms need to address in scaling the finance function in these situations.
“First, there’s a question of personnel,” says Klein. He explains that these smaller entities often will have staff that isn’t the right fit for larger institutions with their more rigorous processes, and there’s always a matter of turnover, especially among junior staff. “Second, there’s often inefficient processes, that were adequate for a smaller enterprise, but can hinder the consistency and quality of the financial reporting.” And finally, Klein notes that the very nature of buy and build strategies involves merging siloed and disparate data and systems.
“But if they can develop a process to quickly align the right people, processes, and systems, as soon as they complete an acquisition, GPs can move quickly to making the most of that latest acquisition,” says Klein. Naturally, that’s a tall order as a platform company onboards one entity after another. Klein advises focusing on four key building blocks* to prioritize when looking to tackle the finance function.
The right software stack
Small businesses can cobble together what they need from various desktop accounting applications, but as the platform company grows in size and complexity, that won’t be sufficient. “We’ve seen some platform companies struggle as they try to use Excel, but that can get complicated and even dangerous when it comes to stating revenue,” says Klein. He suggests making sure all the software solutions are integrated and extensible, so it can synch with CRM systems and grow as the Company does.
F&A staff with a range of skillsets
Klein explains that upgrading staff involves appreciating that finance and accounting talent varies. These roll-up strategies require a mix of skills, including “maintainers,” who focus more on transactions, and “builders” who can dive deeper into accounting matters, manage integration issues with the new entities, and implement additional software capabilities. “Without the full range of skill sets, a CFO can be distracted with the core functions of the finance unit, and not be able to think strategically about that next acquisition or making the most of what’s just been acquired,” says Klein.
The right kind of reporting
It’s obvious that any business needs consistent and timely reported data, but with roll-ups, they need both GAAP-compliant financials, and another set of books that exclude expenses related to the acquisition, so that the business leaders and the GP can examine the actual performance of a given entity or a product line.
So much of a private equity firm’s investment case is built on finding synergies, getting rid of inefficiencies and knowing what deserves more resources, which are all driven by the financial data. “So there needs to be a financial system that can manage those two sets of books, and if it’s just spreadsheets, that could lead to trouble,” says Klein.
“Say you have a business of urgent care centers, spread across the country,” says Klein. “The GP will want to review the financials not just by each center, but by each service, say a particular kind of blood test, and view the performance across all locations. And for that, they’ll need reporting that can do that.”
Centralize, standardize, automate
Synergies are baked into the investment case of every buy-and-build strategy, but they need to be earned with discipline and a deliberate process. In the case of the finance function, Klein highlights three key phases: centralization, standardization and automation.
First, processes need to be centralized, as trying to standardize tasks over a distributed org structure can be difficult. “We had a chain of yoga centers and they were relatively close geographically, but were still decentralized, so that every change in process, even as small as how an expense was coded, had to be introduced to each location separately,” says Klein. “So we first had to centralize certain tasks to remove that burden.”
Once processes are centralized, they can be standardized, so that as new entities are brought aboard, those processes remain consistent across the platform. And once there are standard practices, then the enterprise can find what tasks can be automated. “AI-enabled software can be powerful, but they have to be directed at the right repeatable tasks to deliver a healthy ROI,” says Klein.
A checklist is just the beginning
Klein knows that just because a process can be distilled to four easy steps, doesn’t mean it’s easy. Each step requires time, attention and judgement. “Private equity firms will often tap a more experienced CFO to run that platform business, but what good is that high-level strategic talent if they spend all their time just trying to get basic financial reporting right?” asks Klein. He stresses that Consero can step into a new company and accomplish all four steps in one to two months. “But that’s only because we’ve done this countless times before, across a range of industries,” says Klein.
It’s true, that over time, as roll-up strategies become more common in private equity, there will be in-house experience to guide the process, but even here, GPs might prefer to expend their intellectual capital finding the best ways to identify and integrate potential targets in a roll-up strategy, rather than how best to scale the finance function. Either way, the scaling of the finance function will have to be addressed or that ideal roll-up strategy can turn into something that no LP or GP wants to dream about.