CFOs: Hunters, not farmers

October 3, 2013 | Asian Venture Capital Journal

By Tim Burroughs, Asian Venture Capital Journal


"Many times as a CFO you are the smartest finance guy in the room," says Chris Roling, who filled the role for a number of companies before the work led him into private equity, with Terra Firma and then Aureos Capital. "The problem is once you have a PE firm as an investor you have a lot of smart finance guys so there is no room for fudging, which brings its own stresses and challenges."

The private equity executive who completed the deal and sits on the board is not the only stakeholder whose interests a CFO must look out for. LPs increasingly come in as co-investors, the board may also include independent advisors, and the PE firm might have put in an operating partner to work with management on a day-to-day basis.

These different constituencies have their own priorities and timetables. Industry participants agree it contributes to the "sense of urgency" that pervades private equity ownership and not all CFOs are suited to, or care for, the environment.

If, as is often the case, the incumbent financial officer is moved out post-transaction, the replacement comes in knowing that his tenure is likely only as long as the private equity holding period and specific goals must be met in order to deliver the desired return on exit. It means investing to generate growth while simultaneously keeping an eye on the cash pile, which might be required to pay down debt.

The ideal candidate is therefore competent in financial accounting, reporting and tax, but also sufficiently commercial and multi-faceted to grasp the business model as whole, while possessing the confidence to manage up and manage down.

Every PE owner wants a CFO with years of experience who can mind the store. However, they also demand a hunger and entrepreneurial bent that doesn't necessarily come as part of the bean-counter package.

"I can probably place as many really good PE portfolio company CFOs as I can actually find them across Asia," says Alice Au, regional private equity practice head for Spencer Stuart.

Tim Sims, co-founder and managing director of Australian GP Pacific Equity Partners, concedes that the position can be the most underestimated and least well-filled position in a company, whether private equity is involved or not. "Everyone understands the CEO role and how demanding it is - the buck stops with the CEO," he says. "The CFO role is often underestimated in terms of how much responsibility it involves and the potential for value add."

Right man, right time

The type of individual required varies according to the target company's situation and geography. In general terms, Michael Di Cicco, a partner at Heidrick & Struggles in Singapore, describes the archetypical portfolio company CFO as "more hunter than farmer," drawing a contrast with the traditional corporate CFO who is usually judged over a longer period of time.

The crux is that in a PE situation the CFO is tasked with guiding a company through a period of transformation that presents particular challenges. When the focus is on growth, the PE investor would want an individual experience in M&A and corporate finance. If the ultimate objective is an IPO, an ability to negotiate with investment bankers and interact with potential investors during the road show comes into play.

These factors impact where a PE investor or executive search firm looks for the appropriate person. According to May Tung, head of the financial services practice at DHR International, a classic sweet spot is executives with 15-20 years of experience under their belt who are looking for a final or penultimate posting.

It is not unusual for the country CFO of multinational in Asia, for example, to seek a change of direction. The motivation is not purely financial but could be tied to a desire for compensation that is more closely linked to performance: While an incoming PE portfolio company CFO may not see a significant bump in basic salary - they might even have to make sacrifices in terms of allowances - the kicker is equity participation in the business.

Comparable listed companies are an obvious port of call, but anyone who has experience relevant to the particular industry or situation could feasibly come under consideration. It also works the other way around with certain executives actively pursuing positions with PE-backed companies to fill gaps in their resumes.

Roling recalls hiring an individual for an Aureos-invested firm in Thailand because he wanted to do an IPO and regarded the experience as important as the pay day. The best person for the job is often "a CFO who wants to be more than just a CFO," he says.

A CFO might be dragged into all kinds of different functions, but if there is one common requirement it is an ability to manage cash and optimize working capital. This is especially pertinent in distress situations and a cottage industry of specialists offering interim CFO services - the likes of AlixPartners, Alvarez & Marsal (A&M) and FTI Consulting - exists to meet these needs.

For James Dubow, managing director and co-head of Asia at A&M, an interim placement with a Chinese power company in 2007 turned into a five-year permanent position. When a new PE owner arrived the incumbent CEO, CFO and business development head all unexpectedly decided to leave, so A&M was hired to stabilize the situation. The company wanted to find a more permanent candidate but no one suitable emerged, while the external environment worsened as the global financial crisis hit.

"Even when I agreed to stay on they wanted someone who was more Steady Eddie but it became apparent that the Steady Eddie period wasn't coming," says Dubow. "It was constant change and stress, whether internal or external."

The emerging Asia angle

This example serves to highlight the range of demands that can be placed on a CFO, particularly in Asia's emerging markets where target companies are often less mature and lack strong financial processes and the pool of available talent that can address this is not deep.

"In the US or Australia, you have a range of issues you face when you go in as a financial controller from A to F," says Jim Tao, managing director at China-focused CITIC Capital Partners, where he is responsible for the portfolio operating group. "In China it's A to Z. Something that is taken for granted in the West isn't done at all in China. Some companies are so rudimentary."

Issues range from irregular practices - companies have been known to run their finances through personal bank accounts - to outright fraud. In situations untainted by malfeasance, there is still a need to introduce better reporting channels and budgetary processes.

When CITIC Capital and Warburg Pincus took a majority position in Harbin Pharmaceuticals in 2005, they found a company that was spending four times its annual net income on television commercials and investing in a portfolio of 100-plus products, many of which didn't make any money at all. Furthermore, each subsidiary maintained its own finances, which meant that profit-making businesses were receiving low interest returns on bank deposits while loss-making units paid heavy premiums to borrow money.

Centralizing Harbin Pharmaceuticals' financial structure meant facing down resistance from managers desperate to hold on to power. This kind of change is difficult to bring about without full operational control, which often means having a CFO on the ground. If CITIC Capital finds a situation that can't be remedied in this way, it may simply pull out of the deal.

"We looked at an agricultural deal based in a fifth-tier city and it was run entirely on cash transactions. Even if we have 100% control, how could we find someone we trust, with international standards, to live among the farmers? If you only fly in every other week then you don't have full control," says Tao. "We had it on paper but we didn't have it in reality."

Roling experienced similar challenges when placing CFOs with Aureos portfolio companies. The GP was making minority investments throughout the region, often in less developed markets, and insisted on the right to appoint the CFO or at least veto the majority shareholder's choice. The tendency was to send in locals who could broach language and cultural issues, but there was no guarantee of acceptance.

"If you are majority you have a more of a mandate and a bigger stick, if required. With a minority position you might not have all the decision-making ability," he says. "At Aureos half the companies were family-owned so it was a question of whether the CFO would fit in and become part of the inner circle."

One of the difficulties is finding an individual who can bridge between family ownership and institutional ownership from a skills perspective. The premise of a private equity firm's investment is often achieving exponential revenue growth and scale, but it requires a CFO willing to get his hands dirty fixing the accounts and then support strategic expansion. An executive has to be comfortable building a small company into a big one, and the equity-based portion of compensation packages rewards that.

With this in mind, private equity executives routinely cite their own networks when asked where they first look for a CFO. Someone who is has been an effective portfolio company CFO in the past would likely be so again.

The CFO of Harbin Pharmaceuticals was with another CITIC Capital portfolio company before her current posting and an operating partner with the firm before that. I.S. Lin, who served as CFO at Australia-based auto parts firm Exego before Unitas Capital exited the business earlier this year, previously performed the same role at South Korean retailer Buy the Way, another former Unitas portfolio company.

Heidrick & Struggles' Di Cicco notes that there is increased demand not just for CFO-type work but for operating partners who come in pre-investment and participate in planning and due diligence, which may lead to a formal posting with the portfolio company in question.

Those with the resources, meanwhile, simply take on more expertise in house. After selling Exego, Unitas hired Lin as an operating partner with a specific brief to help develop portfolio company CFOs.

"Even if there is a strong CFO at an existing portfolio company, they might not be experienced in working with PE firms or have experience supporting significant operational changes," says Eugene Suh, Unitas' chief investment officer. "Having an in-house CFO who has done this before can help mentor these CFOs and help them to better support operational transformations."

Incremental improvement?

When asked why CFOs frequently change when a private equity investor comes on board, industry participants say they need to be certain that a company is being run in a transparent and efficient manner and complying with international standards and best practice. Yet the implication is that the incumbent officers are generally not up to the job.

One buyout fund manager puts it more bluntly: "You may conclude from the relatively high turnover rate with private equity that it's difficult being a portfolio company CFO. The truth is the system cannot afford not to have a competent CFO and the existing ones often don't have that level of competence."

While the ideal specimen remains hard to come by and a degree of compromise is inevitable, recruitment is becoming slightly easier as Asia's talent pool fills out.

CITIC Capital's Tao targets candidates who have spent 10 years with a multinational and 10 years with state-owned or private enterprises in China because this means they have experienced the transitions the PE firm's portfolio companies tend to go through. It might be difficult to persuade an individual to relocate to a third-tier city in the country's far west but foreign companies have now been operating in China for more than two decades so appropriate people are out there.

Nevertheless, private equity firms will continue to return to known acquaintances simply because of the comfort of familiarity. A&M looks for people with similar qualities to the identikit private equity CFO and Dubow recalls hiring an executive last year who came into a company once A&M's interim remit expired. The executive spent 3-4 months in the job before the company was sold.

"We had been able to watch him at work and we liked what we saw. It's very hard to pick someone out at interview," Dubow says. "You need someone who can come in and be a leader in a room full of bankers, executives or private equity and have a view. That is really the personality part and it is hard to find this type of CFO in some parts of Asia."

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