What Makes an Ideal Private Equity CFO?

A recruiter gives deep detail on the thought processes of P.E. firms looking to hire a finance chief within their portfolio.
Claude ShawJuly 24, 2017
What Makes an Ideal Private Equity CFO?

As private equity firms look to maximize the value of their holdings, they are increasingly bringing in new CFOs early in the lifespan of their investments.

The ideal private equity CFO is both strategic and operational, serving as a thought partner across various functional and divisional aspects of the business while implementing the systems and processes to help the company get to an exit.

A strategic CFO will be growth-oriented and look at the business “through the windshield,” rather than the rearview mirror, as controllers most often do. An operational CFO will often oversee multiple functions beyond finance, most notably information technology, but also legal, human resources, real estate, and supply chain.

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In private equity-backed companies, the CFO is often viewed as the conduit of information to the financial sponsor — communicating financial results, working through capital structure issues or M&A opportunities, and generally speaking the parties’ common language of finance. Therefore, private equity firms tend to be quite influential in the CFO selection process, even though the ultimate decision typically resides with the portfolio-company CEO.

The CFO selection may also be driven by the underlying investment thesis for the company. If growth will come largely from M&A, then a CFO who is experienced in acquiring and integrating companies will be invaluable. If the exit strategy points to an IPO, then a CFO with public company and/or capital markets experience will be important.

Background and Skills

While most CFOs have a well-rounded skill set, typically they excel in one of three areas: accounting/controllership, business/operational finance, and capital markets/treasury. Those who excel in accounting and controllership typically begin their careers in public accounting. Those who excel in business and operational finance will have honed their skills in divisional finance or financial planning and analysis. Former bankers tend to spike in the capital markets/treasury area.

All three areas of focus are important, but we argue that business/operational finance is often the most critical priority for private-equity CFO roles, given the need to provide decision support across a range of operational and strategic initiatives.

While technical accounting skills are important, the ability to manage a controller while having a good-enough grasp to ask the right questions is typically sufficient.

And despite the role leverage plays in a private equity context, capital markets experience is usually a “nice to have” rather than a “must have,” as the sponsor can step in to lend a hand. A notable exception is a pre-IPO situation, with the capital markets challenges it brings.

Sitting CFO vs. Divisional CFO

More often than not, private equity firms seek to fill portfolio CFO roles with executives who have enterprise-level CFO experience. They will have had full ownership of the finance organization across all functions (audit, tax, treasury, FP&A, etc.) and will have interfaced with a board of directors on strategic matters.

Conversely, a divisional CFO may have relied on a shared-services infrastructure to manage other finance areas. Additionally, a divisional CFO may have managed his/her business to only a certain level of profitability, focusing on, say, gross profit rather than operating income or cash flow.

That said, there are situations in which a divisional CFO can offer just as compelling a skill set as an enterprise CFO. For instance, divisional CFOs from certain large corporations have operated their businesses with a similar level of accountability as that of an independent company.

Additionally, divisional CFOs from best-in-class organizations often bring a highly strategic and operational approach to the finance function, which is integral in partnering with the business to drive growth and profitability. From a practical perspective, divisional finance chiefs may also be easier to attract, given the opportunity to assume a top CFO role for the first time.

Large Company vs. Small Company

Conventional wisdom holds that an incoming CFO should have worked in an environment that is at least as large and complex as the envisioned future state of the portfolio company at the time of exit. For example, if a private equity firm is hiring a CFO for a $500 million company, whose investment thesis calls for doubling revenue through international expansion, it wants a CFO who has managed a business with at least $1 billion in revenue and the complexities of international operations.

Still, bigger is not always better. While the CFO of a multibillion-dollar business will bring more than enough scale, scope, and credibility to the role, he or she will likely be accustomed to working in an environment with far more resources. The CFO may have cut his/her teeth in an environment where the infrastructure was already in place and the need to roll up one’s sleeves and tackle the challenges of, say, an ERP implementation were not part of the role.

In fact, the ideal portfolio-company CFO combines a knowledge of “what good looks like” from having worked in a larger organization with the entrepreneurial gumption required to be successful in a smaller environment.

Not every CFO candidate combines both categories of experience, but for those who have worked only at larger companies, the nature of their progressive roles can offer evidence of entrepreneurship. For example, many finance executives who have rotated through emerging-market regions of large multinationals have worked in low-resource environments, where the abilities to adapt and take a hands-on approach are keys to success in the role.

Industry Experience

It seems logical that private equity firms should source portfolio-company CFO candidates from within the same industry. As the logic goes, that person will be a more “plug-and-play” solution, bringing knowledge of the competitive landscape, relevant performance metrics, and instant credibility to internal and external stakeholders.

Highly regulated industries, such as financial services and health care, often require a CFO with knowledge of sector-specific regulatory nuances. In a world driven by internal rate of return, time is always of the essence, so the ability for an incoming CFO to get up to speed quickly is critical.

Yet, companies often look beyond their industry to recruit top finance talent, perhaps more so than with any other corporate function. When and why does that make sense?

First, a particular industry or sector may not yield strong talent within the finance function. Some sectors, such as consumer packaged goods, are renowned for breeding best-in-class finance executives, while a creatively led industry such as fashion may place less emphasis on the finance function.

Moreover, bringing a CFO from outside the industry may bring a certain level of objectivity and freshness that can be helpful in thinking about different ways of operating the business.

Finally, companies sometimes look for CFOs who understand certain operating characteristics of the business without necessarily coming from the industry. For example, a consumer manufacturing business that is struggling with supply chain issues may look to hire an industrial CFO who understands plant operations and vertical manufacturing, irrespective of consumer products experience.

Proven Private Equity Chops

How important is prior PE experience for an incoming portfolio-company CFO? The answer varies by sponsor, with some saying it’s a “nice-to-have” and others insisting it’s a requirement.

Certainly, someone who been CFO of another private equity-backed company will be familiar with dynamics such as operating in a levered environment, maintaining a relentless focus on cash flow, driving operational excellence, communicating with a private equity board, and knowing what information is needed and when.

Even better is a CFO who has not only worked in a sponsor-backed company but has also been involved in a successful exit, with a record of driving measurable value. While one can argue that a CFO learns as much, if not more, from a gritty, operationally challenged private equity situation, all else being equal sponsors always feel more comfortable with a one who has rung the bell and helped to drive a positive outcome.

Due to the nature of three-to-five-year hold periods, experienced private equity CFOs may possess the episodic career path of a journeyman, which can sometimes be viewed as a red flag. But keep in mind that depending on the nature of an exit (sale to strategic buyer, sale to a sponsor, or IPO), a private equity CFO may be victim of his/her own success and need to find a new job.

The Importance of Competencies

While industry background and technical abilities are important, to a large extent they are table stakes. What really distinguishes one candidate from another are their leadership competencies, which should be well aligned to the sponsor’s investment thesis.

First among these is performance orientation, which is, not coincidentally, one of the central business priorities of private equity investors. This competency is characterized by a high sense of urgency, a bias for rapid change and continuous improvement, and a strenuous avoidance of negative surprises. From a financial perspective, the CFO’s performance orientation manifests itself as a track record of consistently delivering significant year-over-year improvements in financial results.

However, not all results are achieved equally. Some may require deep cost cutting, and others strategic growth initiatives. While a turnaround situation will require a more surgical approach, most private equity investment theses require the company to grow and evolve.

In these instances, the successful CFO has a “build” mentality and aligns the team appropriately to drive major change management initiatives, bringing a willingness to challenge existing ideas and facilitate continuous improvement.

Successfully driving change will require the CFO to influence the firm’s decision-making process, drawing upon not only his or her functional expertise, but also demonstrated leadership, initiative, and collaboration. The ability to build relationships across the organization and position finance as a business partner will enable the CFO to provide effective decision support.

Importantly, the CFO must be able to collaborate with the CEO as a strategic thought partner, aligning around a shared vision for the organization and shaping the finance strategy in support of the company’s business objectives. A strategic CFO is creative and capable of thinking broadly about business issues — not just financial ones — in order to contribute to the bigger picture. Strategic orientation is particularly relevant when the investment thesis calls for inorganic growth.

Finally, the successful private equity CFO is a strong team leader, with a track record of building high-performance finance teams and enhancing shareholder value.

In conclusion, the ideal private equity CFO thinks like an owner, bringing entrepreneurial gumption, a hands-on approach, and a clear and timely communication style. He or she knows “what good looks like,” in the contexts of both a best-in-class finance organization and delivering value through a successful exit.

Claude Shaw is leader of the global private equity practice at leadership advisory firm Egon Zehnder.