What public company CFOs can learn from private equity leaders right now, according to McKinsey
In times of economic difficulties, rising interest rates, and market challenges, public company CFOs need to take a proactive approach to value creation, and they should take a nod from private equity portfolio company CFOs who “don’t play wait and see,” according to McKinsey and Company.
Ankur Agrawal, a partner at McKinsey, is a co-author of a new report highlighting what private equity (PE) portfolio company CFOs can teach public company finance chiefs. However, PE firms have a reputation for slashing and burning, cost-cutting, and layoffs, and not necessarily a focus on long-term investments. So I asked him about that.
“Despite the terrible personal and emotional impact on employees, we are seeing an increasing number of both private and public companies reducing costs and conducting layoffs to prepare for slower growth or to better align their cost structures,” Agrawal says.
What McKinsey’s research highlights is that from the moment a PE fund acquires a company, they’re on the clock, and they have to act fast, he says. That means it’s typically just a five-to-seven-year period in which a PE CFO has to create and manage through “a value creation plan and holding firm along the execution milestones each year,” he says. “This contrasts with the quarterly earnings guidance and annual resource allocation cycles in a public company.”
PE-backed companies usually develop a 100-day plan that outlines the key execution points to achieve the investment goals, according to the report. Then a road map is created to align priorities and resources in the short term, and set the pace for the organization.
‘Ambitious but achievable targets’
Often public company CFOs pull back and see their primary job as risk avoidance, but PE CFOs live daily with the risk of falling short of achieving double-digit returns, so they’re bold, McKinsey finds. Public CFOs should “define and incent ambitious but achievable targets.”
Does that mean public CFOs should be willing to take more risks? “No,” Agrawal responded. “What we are suggesting is ensuring the targets have an element of ‘stretch’ and ‘base’ which enables entrepreneurial idea generation, more individual and team ownership, and puts execution front and center.” The stretch goals should be market-based, and not arbitrary, he says. It should include “a view on external market context and not default to averages which is sometimes the case,” Agrawal says. “It is even more true in the face of macroeconomic uncertainty that the focus should be on the range of outcomes instead of a base goal.”
Since PE portfolio company CFOs have to work quickly, they “scrupulously mind ROIs” and “zealously” monitor how resources are allotted for every function, authors found. “Typically PE portfolio company CFOs have greater debt leverage and therefore tend to have a lower margin of error,” Agrawal explains.
McKinsey offers the example of a PE-acquired company, (not named) in which the new CFO dug into marketing’s spending that stayed relatively constant and unnoticed for years. The CFO and chief marketing officer then codified and prioritized marketing projects based on effectiveness. “Ultimately, the CFO reallocated more than 40% of the marketing budget, increased ROI, developed a common language (using financial metrics) for operational decisions,” according to the report.
Hiring and retaining talent is a major concern for CFOs. “Some PE portfolio companies have recognized the need to put high performing talent in key roles, especially roles that align with the largest value drivers for the company’s value creation thesis,” Agrawal explains. “Within the finance teams, the ingredients of a healthy talent development culture at PE portfolio companies include the openness to hiring less tenured talent, providing cross-functional project-based opportunities, stretch assignments, and active engagement of PE owners or operating partners in financial reporting.”
Adopting an investor mindset can be helpful for all finance chiefs during these uncertain times, McKinsey finds. PE-backed CFOs are “more vigilant in asking hard questions, shaping strategy, and redeploying resources,” according to the report. That skillset will come in handy as “the PE wheel keeps spinning, and will continue to do so in 2023,” a recent Bloomberg Law analysis states.
“Today, it’s essential for CFOs to use a ‘zoom in and zoom out’ mindset and communicate with investors about how the company is navigating the macroeconomic uncertainty,” Agrawal says. Perhaps public company CFOs can use this time as an opportunity to build a bold edge on insights, commitment, and execution.
See you tomorrow.
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