Key Takeaways:

• Finance teams should evolve from focusing solely on compliance to becoming a strategic partner that drives EBITDA growth and prepares for an eventual business exit.
• Investors should assess the finance function’s people, processes, and technology to determine whether it will contribute to value creation or pose risks during the hold cycle.
• It’s crucial to evaluate the talent within the finance function, ensuring they can support new ownership requirements, scale processes for growth, and align with business objectives.
• Assessing a target’s technology stack can reveal opportunities for automation, enhanced decision making, and risks.
• Conducting an assessment of the finance function during diligence or early in the hold period can help acquirers develop a comprehensive growth plan.

The principles of value investing that stress a strong balance sheet, cash flows, and low price-earnings multiples were abandoned decades ago. Even within private equity, where EBITDA (earnings before interest, taxes, depreciation, and amortization) reigns supreme, a fundamental strategy is to buy EBITDA at a platform company, boost EBITDA with subsequent tuck-in acquisitions, then package and sell the business to the next buyer.

The return on investment is realized through strong earnings growth and by exiting at a larger multiple than the effective blended multiple of platform plus bolt-ons.

So what can finance teams do to help an investor protect capital or implement some form of guard rails? Today’s market participant should consider the role of the finance function in playing a key role in driving EBITDA growth and preparing for an eventual exit.

Transitioning finance’s focus from compliance to strategic support

Targets for middle-market acquirers tend to have limited finance function capabilities, focused primarily on basic compliance items required to meet basic business requirements such as drafting finance reports, executing on core finance transaction processes (such as Order to Cash and Purchase to Pay), filing taxes, issuing payroll, and meeting any other reporting or compliance requirements.

Many of these firms may be unfamiliar with how the finance function can support broader business objectives and support the management team in making better business decisions.

Similarly, smaller firms may not appreciate how the finance function could impact the business’ customers, operations teams, and other stakeholders in ways that can either enhance or undermine the business.

Optimizing the finance operating model for value creation

Accordingly, how does an investor evaluate the people, process, and technology (the operating model) of the finance function of a target to determine whether it will be a source of value leakage or a potential source of value creation during the hold cycle?

The specific answer will depend on the specifics of the business, but there is tremendous value in assessing and selectively enhancing the role of the finance function as part of the broader plan for value creation. While there are many ways this can be achieved, below we highlight some learnings from our experience in working with clients through some of these challenges.

People

People are the trickiest aspect of the operating model to evaluate. Individuals at the target are often playing multiple roles, which is common for those fulfilling back-office functions (e.g., your office manager is also the Accounts Payable clerk).

In addition, we find that most of the time spent by these teams is in basic execution of the key finance process, without as much time dedicated to supporting broader initiatives.

Any assessment of a finance function needs to begin with the talent. Some key questions to ask include:

• Are there any deficiencies in the finance processes due to competency or capacity (e.g., an accounting closing process that is protracted and does not produce complete, accurate, or timely information for decision support)?
• Does the finance team understand how the processes they perform fit into the broader business processes?
• Does the finance team understand and communicate to the management team where the company is and is not making money?
• Does the finance team contribute ideas for improving the business?

An assessment should also evaluate how the finance team performs under current ownership and how prepared they are to operate with new business requirements that come from new ownership. Do they understand and can they meet investor and lender reporting requirements? Do they understand what it will take to support the growth that new owners expect?

Asking these questions will help buyers understand what investments will be required to transition to a more mature finance function, and it will help buyers be realistic about the pace of change the organization can tolerate.

Processes

Processes employed by the incoming business are generally poorly understood or concentrated in the hands of a few key individuals. Buyers do not need to commission consultants to create desktop procedures or process flows, but they do need to understand who does what process (e.g., “billing and invoicing,” “purchases and payables,” or the “accounting and reporting”) as well as how these processes affect the broader business.

Once the buyer understands the end-to-end core business processes and who does what, the buyer can begin to understand the scalability of these processes, identify critical points of failure (e.g., the inability to reconcile bank accounts if a key individual goes on vacation), begin de-risking and improving the most important business processes, and start developing a roadmap for supporting future growth.

From our experience, the finance processes of many targets are designed to meet current requirements but may not be scalable or ready to scale at the pace expected to supporting future growth needed to boost revenue growth. Any value creation plan should consider the investment needed to make finance processes scalable to support future growth.

In addition, we also see opportunities for finance functions to align better with other business functions (sales, operations, procurement) to work together to understand the cost to deliver products and services and support value creation opportunities beyond the finance function.

Technology

The final pillar for the finance function to assess and address is the technology stack. Experienced operators understand that assessing a target’s technology can help inform what investments need to be made and how quickly the company can grow and implement value creation initiatives.

Some of the issues that should be assessed include:

• How well can the organization turn around financial and operational data for decision making?
• How easily can the technology scale?
• How flexible is the technology in supporting new business requirements?
• How much is the company leveraging the capabilities of the existing systems?

Assessing the technology stack can inform buyers of opportunities and risks deriving from the target’s application of technology.

Some opportunities that can be gleaned from a technology assessment include the ability to automate financial processes, to deploy new features to enhance the client experience or operational efficiency, and to enhance the detail and quality of financial information to drive decision making.

Risks that can be identified from the assessment include:

• The need to invest in system updates/upgrades (especially if companies are using technology that is no longer supported)
• Technology-related barriers to implementing other value creation initiatives
• Basic technology risks, such as a lack of technology controls or the ability to address cybersecurity threats

Deeper insight into these areas at the front end of a transaction can strengthen negotiations and help drive more realistic expectations around the technology required to drive growth and better decision making.

Summary

Hindsight is 20/20, but many acquirers identify issues well after transaction close (i.e., during the hold period). Acquirers can assess, diagnose, remediate, stabilize, and optimize the operating model of a target either during diligence or the initial months of the hold period.

An early start in assessing the finance operating model can help acquirors develop a more comprehensive plan for growth and value creation that considers any limitation and required investment in finance people, process, and technology.

Beyond improving the core operations, a more capable finance organization can bring additional lasting benefits by being a true partner to the management and investment team, and helping drive to a successful exit.