A Private Function

For many businesses, 2008 is shaping up to be a difficult year: commodity prices are through the roof; growth has slowed to a crawl; and for the first time in a generation people are casting very nervous glances at the banking sector.

So what does this mean for private equity-backed business, until recently the darlings of the business press, and more specifically for their finance directors? After all, isn’t it when times get tough the FD can really earn his corn?

Sarah Hunt runs an agency dedicated to placing finance directors into private equity backed-businesses. She says that although the economic climate has got more changeable of late, certain virtues will always shine through. "The key thing that they’re looking for is as always – previous experience," she says. "That’s always been the case, and probably won’t change. Having that hands on, real-time, bottom line cash generating role is crucial for an FD within a PE business." Indeed, it’s fair to say that the relationship between the large private equity backers and their portfolio companies is becoming that much closer as belts begin to tighten.

Simon Burt is FD at 2e2, a pan-European IT managed services provider. He’s been at the helm for four years, in which time he says the involvement of the PE backers has increased as the credit crunch has hit. "Our funders have always been relatively hands on," Burt says. "And now the level of communication, and the amount I have to do on that front, has certainly increased. PE partners and banks are looking at more regular updates on performance than perhaps they might have historically."

It’s no surprise that those supplying finance are now bringing greater scrutiny to how it is employed. The banks, happy enough to lend at higher leverage multiples until recently, are now placing far greater control on the deals they underwrite. Andrew Golding, banking partner at 3i, believes the private equity world is being forced to come to terms with the brave new world of bank prudence. "There are several constraints, ultimately the deal size, because in today’s market it’s unlikely that any bank will underwrite aggressively," he explains. "The reality is finding individual bank underwriting above €250m can be difficult." This is borne out by the figures, which show a continued healthy run of small deals, with larger deals over €100m scarcer than this time last year.

ON THE SPOT

All this of course means that the FD’s role within the PE-backed firm will become even more crucial in the next cycle. While previously many FDs were confined to largely hitting the banking covenants and providing timely management reports for the PE backers, the communication and oversight job for today’s finance director has multiplied. 2e2’s Burt acknowledges this, and says that the days of lighter touch reporting requirements are over.

"The banks, internally at least, are expected to be more up to date on their portfolio companies and I’ve certainly noticed they’ve been more proactive in finding out what was going on."

It’s fair to say that the finance director in this type of market takes on a new level of responsibility. Ensuring the business is in the best possible shape for any exit is now becoming paramount as the cycle turns. For the FD in challenging times, being a strong advocate of internal control is imperative. Sarah Hunt says her clients will want an FD capable of fighting their corner: "Think about it – on the first day of the new company after a deal has been done, and the CEO is thinking about winning new business in China, the FD needs to be focused on something as mundane as putting a new financials system in.

"He’ll need to push that less sexy side of the business through. Something like adopting the right IFRS, even though the company isn’t listed. Chances are the guys who have just done a deal want to grow the business, and won’t want another bean-counter looking at the dull side, but you’ve got to have the confidence and experience to be able to say, ‘look, when we get the offers in, or the auction begins, then we’ve got to have this stuff done because we want all the possible options open to us when we come to exit’. And in particular, in a market that’s a little unpredictable, shall we say, then you’ve got to have this stuff in place."

Despite the need for clear oversight, is there a danger that the FD of what is by necessity a growth-driven business can be slowed down by his backers and the bank demanding more detailed information? Dale Christilaw is FD at European shoe and luxury goods retailer Kurt Geiger. He’s been involved in the company since Barclays Private Equity backed a buyout from Harrods seven years ago. The company went through a secondary buyout last month. He believes he’s got the balance right in involving the backers as well as driving the business forward.

"They know that you know your business," he says. "And I think it’s easier once you’ve done a deal before. The PE backers will be confident of your ability if you’ve got experience. And they actually realise the light touch works in a number of ways."

Kurt Geiger’s FD is more than happy to have the funders, in his case Graphite, contributing to strategy as and when they feel it adds value.

"Obviously it’s good as far as financing and debt but from their perspective they can look at businesses and see value where perhaps the incumbent management team can’t," Christilaw explains. "And you’ll often hear things like ‘we’ve worked with this ex-partner at such and such a firm so let’s all get together and talk about it."

As in any private equity the management has a big stake and that’s a great motivator and it helps to focus the mind and you do things probably quicker than you might ordinarily.

However, with the availability of easy credit seemingly on the way out, some PE businesses inevitably fear that a central plank of their growth strategy will disappear. Simon Burt has taken 2e2 into the top ten of the fastest growing IT companies in the UK. Organic growth has been strong, but the FD says a sensible acquisition strategy, aggressively backed by bank finance has been the main driver. So how is he finding the current climate?

"Our strategy has partly been built around acquisitive growth, and I do think that that will be a lot harder to achieve in the short term," he admits. "We need to be more realistic about what we can secure in terms of funding from the banks. So of course that will affect what we can pay for those companies we might have targeted."

If such an acquisitive company is admitting limited bank debt will affect its short-term prospects, then it’s clear that many midmarket PE-backed businesses will find life hard. "If we’re not able to make those deals than perhaps we’ll see a correction in prices to reflect the credit crunch," Burt says. "And it may be that the large trade buyer finds its old competitive advantage returning and able to source finance and do deals."

THE ART OF THE FD

So while deal volume is slowing and banks and funds are expecting more reassurance over internal controls and financial oversight, does that represent an opportunity for the FD to really prove his value? Sarah Hunt thinks so. "In times like these, the FD will bring in different skills like managing the banks and managing the relationship with the VC," she says. "Essentially what the FD is doing in these deals is steering the deal towards the exit. And also bringing along the other members of the management team."

Of course, it may well be true that many executive teams in private equity-backed businesses are encountering the first turbulence after a benign period characterised by easy access to debt. "This is where the experience comes in," says Hunt.

"That can make such a difference, especially if the other members of the management team haven’t been through a leveraged deal with lots of debt."

For Dale Christilaw, the current squeeze does bring his role into sharper focus. Though he does qualify that by saying that the FD of a private equity business should also be focused on one key area: growth. "That hasn’t changed too much, really," he says. "In the same way that the FD can’t be just a number cruncher, you’ve got to be commercial. I’m sure there are still guys out there who still just focused on the numbers, but virtually all the FDs I’ve come across in PE certainly have a genuine interest in the commercial aspects of the business and want to make an impact on the strategy and drive the growth."

And ultimately, as all FDs know, growth is what will ensure his survival in the world of private equity.