Portfolio Company CFOs Have The Power to Define The Strength of Your Exit

What matters more to exit multiples: business fundamentals or leadership teams?

According to Russell Reynolds Associates’ recent survey of US-based investors from 30 leading private equity firms, a full 100% of PE investors said that a weak leadership team was a top factor contributing to weak exits. This was far more than those citing disappointing sales, market conditions, cost reductions or any other business factor. In other words,
PE investors believe the talent on the leadership team outweighs the fundamentals of the business when it comes to maximizing returns.

Investing time into assessing and supporting the existing leadership team—and recruiting a new one as needed—is essential to the strength of the exit.

What core competencies and skills should PE investors look for in their CFO candidates? Furthermore, given their importance, when is the right time to plan, assess and hire a CFO to maximize portfolio company value?

Our survey revealed some clear trends, as well as common misconceptions, among PE investors.

01. Moving out of the pandemic, CFOs will need to increase their focus on partnership, both within their company and with their sponsor – but should not lose sight of building high-performing finance teams

When asked about the most critical leadership traits for portfolio company CFOs in the next two to three years, PE investors put the emphasis on portfolio company CFOs being strategic business partners and driving results within the company while also effectively partnering and communicating with the PE sponsor.

 What do you believe will be the most critical leadership traits for your portfolio company CFOs for the next 2-3 years?

% respondents who responded very to extremely important

02. Financial planning & analysis is the preferred route to the top

• Nearly every PE investor views FP&A as an important technical skill for portfolio CFOs, compared to 75% who see accounting and control experience as a top requirement. Given this, investors may want to revisit their hiring criteria for step-up candidates. CFOs who come from companies with strong rigor around financial analytics could be supported by a strong controller.
• Regardless of experience working with PE in the past, PE investors prefer someone with seated CFO experience (public/ private), with 71% seeing sitting CFO experience/proven leadership as highly important, versus only 50% for PE experience.
  
  

How important are the following technical competencies and experiences for a portfolio CFO?

% respondents who responded very to extremely important

03. Unique circumstances call for unique experience…to a point

Although proven experience correlates to predictable performance, finding candidates who fit this experience profile can quickly shrink the talent pool.

When a PE investor is contemplating an IPO, 82% see IPO experience as required for a CFO. Given the complexity of the deal and the financial gains that ride on it, this requirement is practical. The reality, though, is that only 12% of CFOs who lead IPOs have past experience doing so as a CFO. By setting IPO experience as a ‘must-have,’ the already small pool of available CFOs is further reduced.

Conversely, while PE investors see IPO situations as needing specific experience, they do not place the same level of emphasis on industry experience. Only 30% of respondents saw having industry experience as highly important to portfolio CFO success.

04. PE Investors value leadership assessments – but most run out of time to perform them robustly

While PE investors think most about the skills needed within the portfolio company leadership team during the due diligence phase, only 55% actually do a rigorous evaluation of their portfolio CFOs – with lack of time as the top reason for not doing it.

For those PE investors who do assess their leadership talent during due diligence, few used deeper assessment tools, with fewer than 20% leveraging in-depth psychometric tools and other similar methods. While the least used, these more rigorous methods provide the best information on the leader.

While faced with a lack of time and a limited selection of tools, PE investors are aware of the value that comes from doing this right. As previously noted, 100% of investors surveyed believe the right leadership team becomes the difference between a weak and strong exit.

100% of PE investors believe the leadership team makes a difference to strong exits

05. The ideal CFO replacement time is post-deal

Deeper pre-deal assessments allow PE firms to determine how the leadership team stacks up against their value creation plans. If existing leaders do not meet expectations, firms have two options:

• Promote from within and support the leaders’ development, or
• Recruit and replace the existing leader.

Most PE firms (79%) choose the latter, with 42% replacing their portfolio CFO immediately following the deal, and an additional 25% do so within two years.