Turnaround situations are common in portfolio companies, often requiring significant changes to...
Private equity firms invest in companies with the goal of improving their performance and ultimately generating a return on investment. However, one of the challenges private equity firms face is getting timely and accurate financial information from their portfolio companies. This is largely due to the portfolio company’s financial system.
Legacy Financial Systems
Older finance and accounting systems are pervasive in small and midsize companies. They typically ‘do the job’ for the company yet are inadequate at tracking, managing, and reporting on financial information.
The cause of legacy system limitations can be traced to either the software or the initial implementation. Older or lower-end systems often do not have the functional breadth of today’s modern systems. Thus, companies add on custom or off-the-shelf software solutions to fill the gaps.
Even if the software has functional breadth, users may not be using it correctly. This could be a training issue that occurred during the initial implementation or a lack of knowledge transfer to new employees.
The Excel Band Aide
Excel has long been an accountant’s favorite tool and is often used to fill the gap of an existing financial system. For example, many companies use Excel to track and depreciate fixed assets. However, Excel does not have the inherent integrity of a financial system. There is the risk of human error. And, it has been said that more than 90% of all spreadsheets have errors.
The PE Impact
The short-term impact of an inadequate financial system is the inability to generate timely and accurate financials. This prevents financial analysis which hinders a private equity manager from monitoring performance and making informed investment decisions.
The longer-term impact is on company valuation. An outdated financial system will hamper a future buyer’s due diligence process and reduce buyer confidence. Both of which can lead to a lower valuation.
Modern Cloud-based Financial Systems to the Rescue
Timely and accurate financials typically requires implementing a new financial system. Financial systems have come a long way over the years. They are now cloud-based, not requiring hardware or data centers. They can be quickly and cost-effectively implemented. And they are much easier to use than their predecessors.
For example, Oracle offers a comprehensive Enterprise Resource Planning (ERP) system inclusive of financials. A basic implementation can be done within 12 weeks. Oracle Financials is a full solution footprint that is used to manage ALL financial data. And, it has embedded best practices to streamline the financial close enabling more timely reporting. Excel-based reporting tools can then be used to easily drill into financial data and report in multiple formats, all in real-time.
Making ERP a Priority
Cash injection into a portfolio company is often intended to strategically improve the company platform. However, a company’s historical culture of reactive behavior often continues as executives focus resources on firefighting instead of ‘working on the business’. It is up to the private equity firm to help their portfolio companies prioritize a financial system implementation. While there will be short-term pain, the investment will lead to a long-term gain in both efficiency and valuation.
Conclusion
Outdated financial systems can have a negative impact on the valuation of private equity portfolio companies. However, private equity firms can mitigate the problem by encouraging a new financial system implementation. The result is improved performance and return on investment.
