The Best Private Equity, VC & CFO Insights for June 2023

The Private Equity Story:

Even though years of multiple expansion are in the rear view mirror, PE valuations are still increasing - with earnings driving valuations. Deals are still down with higher interest rates and equity requirements taking the L out of LBOs and buyer-seller price mismatches stalling promising deals. Many deals that are getting done are moving downmarket (smaller chunks) as middle market offers more enticing valuation opportunities and sponsors manage risk. Meanwhile sponsors are shifting fund allocations from new deals and bolt-on acquisitions to re-invest in existing portfolio companies. On the fundraising side, CVC Capital Partners IX has secured $27-billion in commitments, the largest fund raised to date. It has yet to close. There is still $1.2-billion in dry powder waiting to be deployed.

The CFO Story:

Many CFOs are facing the first economic headwinds of their careers and are being challenged and in many cases struggling in the face of tighter customer wallets and a tougher capital fundraising environment. With more than half of CFOs believing that their investment theses will be hard to achieve, mid-cycle CFOs are selectively listening to pitches and mid-cycle portfolio companies are selectively upgrading their CFO seats (many times via their sponsors.) CFOs are asking if the comp equation still makes sense: OTE + (Expected Equity Realization*Probability of Realization*Hold Period Discount) = Comp Equation vs. other options. Sponsors who were generally lukewarm about their in-seat CFOs before the slowdown are running a similar equation on the other side, exploring the impact a new CFO could make on value creation, hold period and probability of exit. This is all happening against the backdrop of a still tight CFO market with more sponsors open to the option of hiring strong, hungry?#2s who've seen an exit.

Enjoy reading the collection of data, stories and resources for JUNE. Please DM with typos/errors. Iceland in June is pictured above.

1. INVESTMENT THESES UNDER PRESSURE

More than half (54%) of CFOs and board members ?expect it will be difficult to meet the objectives of their private equity owners’ investment thesis. At companies owned by smaller private equity funds (with under $1 billion of AUM), this number climbs to 64%.

Perhaps most interesting?in the BDO Survey ?, while both CFOs and Sponsors agree that top line growth is the answer, they differ on how to address the challenges in smaller funds with CFOs focused on OPEX and funds emphasizing cross-customer revenue opportunities.

And CFOs in large and small funds also differing with large fund portfolio company CFOs also emphasizing cross-customer revenue opportunities

2. THE TALENT ISSUE FOR PE

As noted in the above, there is still a shortage of PE CFOs with the right skillset. ?Fund managers are increasingly looking for CFOs who can handle multiple responsibilities and fill in gaps within a company's existing staff. Those roles are taking longer and longer to fill.

Finding a CFO who can do it all is challenging even in the best of times, so private-equity firms often rely on CFOs with a proven track record to provide support when needed. The most highly regarded CFOs in the eyes of private-equity managers are often those who are adept at driving company value and maintaining a strong focus on key elements. These CFOs also possess the ability to effectively communicate the company's financial position during a potential business sale.

Dan Hawkins at Summit Leadership Partners highlighted the crucial synergy between the CEO & CFO.

“As you get close to exit, there can’t be any shakiness either on the CEO or CFO role because when you start [preparing for a potential sale] A) you’ve got to have a strong CEO to present the strategy and the business, and B) you have to have a strong CFO who can really articulate the financial strength of the company.”

It's not just the CFO seat that's challenging, many CFOs in BDO's survey view their current companies as understaffed ?with the most acute pain felt in > $15 fund portfolio companies.

3. CFO TO CEO

Big companies are increasingly seeking CFOs who have the potential to become CEOs in the future. ?CEO succession is now a criterion when recruiting for some CFO roles. In North America, 17% of CEOs had previously served as CFOs, and among Fortune 500 companies in 2022, 18% of newly appointed board directors had previous CFO experience. CFO searches now often include the expectation of CEO succession potential, given the expanded strategic importance and scope of the CFO role. Data-centric industries such as financial services, telecom, and B2B technology are seen as natural environments for CFOs to transition into leading the organization"

Clem Johnson of Crist|Kolder Associates sees the best CFOs looking for more responsibility: “Often top financial officer talent is looking for broader roles than the CFO seat—CFO/COO or CFO-plus roles or roles that would position them for CEO - We absolutely see a spike in the number of finance executives who will not contemplate making a move unless there is a CEO succession element to the opportunity,”

And some interesting fodder on when and how a CFO makes a good CEO

4. PROFILE OF THE ALL-STAR CFO

A16Z has an informative take on hiring for the CFO role. ?They argue any all-star CFO should:

• Move an organization toward more strategic financial planning
• Maintain frugality while investing in the areas necessary to grow
• Define business strategy and where/how to invest capital or slow spending
• Share insight and analysis across the management team and down into the organization, so that decisions are made using sound financial data
• Secure capital from the right investors at the right price
• Improve returns from real estate, technology, and infrastructure investments

They also argue there are 4 archetypes of CFOs:

• The career finance executive is a traditional CFO with experience in investment banking or private equity. They excel in strategic financial planning and leading finance groups.
• The broad-based operator CFO comes from capital-intensive companies or private equity firms, with a broader view of industry and operations.
• The M&A and capital markets expert CFO specializes in raising capital and completing M&A deals.
• The career accountant CFO has a strong technical background as a CPA and expertise in regulatory issues and risk management. They often join hardware-focused companies with complex accounting processes.

Scott Kupor , Caroline Moon contributed to this article.

5. MIDDLE MARKET ON CENTER STAGE

The size of leveraged buyouts are on the decline, with the median size of take-private deals being halved. Middle-market funds, which raise between $100 million and $5 billion, are outperforming larger funds in the private equity sector, boasting the widest gap in returns in favor of the middle market since 2016. Moreover, middle-market funds are attracting the largest share of private equity capital commitments in the past decade.

Despite a drop in deal-making activity and a slowdown in middle-market exit activity in the first quarter of 2023, fundraising for US middle-market private equity remains strong. Limited partners (LPs) are showing a preference for smaller buyout funds targeting smaller companies, as they allow for smaller commitments and offer specialization that can boost returns. The fundraising for middle-market PE has nearly doubled compared to the previous year, and the middle-market share of all US buyout funds closed in the quarter has reached its highest level in over a decade.

6. PRIVATE CREDIT DOMINATING AT THE BIG SIX

(Blackstone, KKR, Apollo, Carlyle, Ares, and TPG)

Private debt has surpassed private equity as the dominant asset class in terms of assets under management (AUM) and fundraising . Credit accounted for 45.5% of the $3 trillion AUM across the six managers and 54.5% of fundraising in the past year. The popularity of credit can be attributed to its higher yield, which appeals to wealth management channels and perpetual capital structures. Additionally, these managers have been focusing on managing long-duration insurance assets, further driving the growth of credit products.

7. 5 LEADERSHIP SHIFTS FOR A NETWORKED WORLD

McKinsey's ?Aaron De Smet ,?Arne Gast ,?Johanne Lavoie , and?Michael Lurie identified five fundamental shifts in mindsets and ways of working to lead thriving organizations in the new disruptive-networked era. These shifts include moving beyond profit to impact, beyond expectations to wholeness, beyond command to collaboration, beyond control to evolution, and beyond competition to co-creation.

The Five Roles: Visionary, Architect, Catalyst, Coach, Human

8. CFOS FOCUSING ON GROWTH

According to Gartner, 57% of CFOs are more likely to use capital to fund organic growth compared to 2022. In addition, 80% of CFOs will hold at least the same amount of or more excess cash in 2023, which, for many, is a precursor to enabling organic growth investments. 82% of respondents cited profitable growth among the top five issues that keep them up at night. Seventy-three percent of CFOs picked inflation in their top five, and 68% noted balance sheet health. “CFOs often find themselves in a balancing act between satisfying shareholder returns in the short term and building the company’s long-term resilience,” wrote Shannon Cole of Gartner .

9. DIGITAL FINANCE TALENT HARD TO COME BY

Gartner also finds that only 16% of CFOs believe their teams are proficient in digital skills and they expect that talent to be harder to come by.

Gartner also tries to define digital talent across a spectrum:

10. 5 PE LEADERSHIP CAPABILITIES FOR THE CFO

Finally, I distilled down > two dozen operating partner and PE CFO interviews to identify the leadership capabilities most mentioned.

5 important leadership capabilities for a PE CFO

1. Pattern recognition and anticipating challenges: ability to identify patterns and anticipate potential obstacles or risks. They proactively address issues before they become significant problems.

2. Catalyze growth: identify opportunities for growth, develop and execute plans to achieve growth targets, and ensure financial resources are effectively allocated to support growth initiatives.

3. People development, influence and EQ: possess excellent interpersonal and communication skills to effectively collaborate with various stakeholders, including the CEO, PE sponsors, and other executives. They should be able to build relationships, influence decision-making, and lead cross-functional teams. They take pride in developing their finance team and people across the organization.

4. Financial acumen and business contribution: CFOs must have a deep understanding of the business and its drivers, enabling them to provide strategic insights, analyze data, and translate financial information into actionable recommendations.

5. Effective data management and technology expertise: ensure accurate and timely financial information, implement improved data capture and analysis systems, and embrace technology solutions that enhance efficiency and provide meaningful insights.

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About The Private Equity CFO Collective

Soft-launching The Private Equity CFO Collective. This is a private group for performance-driven Private Equity CFOs to share best practices and anonymously crowdsource solutions to pressing company, sponsor and investor issues. All participants will held to a high-bar, absolutely no vendors or shilling of any sort will be allowed. I'll hold a monthly webinar for the top 3 issues of concern to start. At some point there will be drinks and fun.?#privateequity ?#cfo ?Click here to apply if you are an in seat CFO mid-market or higher in a portfolio company . DM me if you would like to invite a peer.