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PRIVATE EQUITYSTRATEGY SHIFT FOR A CHANGING MARKETPLACE




According to Marc Nachman, Asset Management Chief at Goldman Sachs in a January 2024 Financial Times Article, he writes: “Private equity can no longer rely on borrowing cheap money to fuel returns and will have to go back to its roots of sourcing good deals and making operational improvements. Private equity will look different over the next 10 years than it looked over the past 10 years. Over the past 10 years you could rely on lots of leverage, cheap cost of capital and multiple expansion”.  So, what has changed? US interest rates have peaked after the biggest rise in decades and are likely to remain high for some time.  Nachman warns that “private equity [will] need a different modus operandi from the one it had thrived on in the past decade.”  


Nachman goes onto say “even as higher interest rates cause shifts through the economy; private equity managers are expected to continue to be able to generate attractive returns. [However], leverage and multiple expansion are unlikely to add much to value creation as they have previously. Thus, operational initiatives, revenue growth and margin expansion are poised to become the main determinants of success in the new regime.”


The due diligence, pre-acquisition process will vary from one target to another dependent on such considerations as industry, competitive landscape… That said, a key constant amongst every deal is the reliability and accuracy of the financial data. Even for the best of companies getting their arms around their financials is very often more time-consuming and complex than most CFOs would care to admit. A PE firm’s validation of the financials is a key lynch pin in the go -no- go decision process. The focus of this Article is on post-acquisition financial transparency, accuracy, and speed to produce accurate reporting for intelligent decision making and in preparation for an exit.


THE CHALLENGES


The three pillars of operational improvements are, and remain People, Process, and Technology. The question is how and where within an organization private equity can synthesize them rapidly enough to gain operational efficiencies in the shortest time, while maximizing its ROI.  The starting point is gaining rapid transparency in both operational accounting and financial management.  When referring to operational accounting we are referencing work streams such as req-to-check and order-to-cash, whereas financial management addresses such functions as budgeting, planning, forecasting, close and consolidation and reporting. The reason for this starting point is quite simple, financial data is the best barometer to determine if a company is thriving or struggling. All too often the retrieval and management of this data is plagued with excessive costs, operational inefficiencies and is overly laborious to produce. Assuming accurate data, the faster a private equity investor can get a handle on the financials the better, but as we all know that is easier said than done. 


One challenge linked to operational improvements is “Margin Expansion/Contraction.” James Gelfer CFA at Goldman Sachs opines “Margin expansion could be challenging. With elevated (though moderating) inflation and labor costs near the forefront of macroeconomic risks, margin expansion and indeed the threat of margin contraction is receiving increased attention. For some a focus on margins may represent a shift in mindset from prioritizing growth to now focusing on efficiency, as the cost of capital has risen. Margin enhancement is likely to rely on optimizing processes, enhancing supply chains, and rationalizing the workforce to be prepared for technological challenges and opportunities.” Once again People, Process and Technology are center stage and so the question is how to maximize the contribution of each for purposes of increasing margin?  To positively impact, and improve margins, operational improvements must at minimum address a myriad of finance and accounting issues (see Table 1) These issues are some of the “Resisters” to margin growth.


Table 1: Resisters to Margin Improvement


Poor data quality / Accuracy

Financial close takes too long

Fragmented systems / Point solutions

Disparate Processes

Manual processing-Excel Driven

Siloed processing

Integration issues

Lack of agility in reporting

Redundancy / Repetitive data entry

Weak internal controls



So how do most Organizations try to solve these challenges? They do not, but instead apply the best band aid/s they can find. We call this “Modeling Toolkit Chaos,” the use of many point solutions to do the job of what should and can be solved by a Holistic Solution. One which creates speed to attainment of valuable and sustainable benefits not a proliferation of Margin Resisters. Benefits we will detail later in this article.


BROKEN PROCESSES & INEFFICIENT USE OF RESOURCES 


Corporate Performance Management (CPM) is the domain that facilitates transparent, accurate and timely financial data and is the vehicle which addresses the margin resisters for better financial management.  Many CPM modeling and planning toolkits, such as Anaplan, Board or Oracle Essbase tout flexibility and speed for departmental needs, however these toolkits are not designed to unify connected planning processes across the enterprise. Why? Because rather than leveraging a unified extensible architecture, these type of CPM modeling toolkits instead rely on a series of individual planning models the must be “connected” together. Having disparate models creates data latency, risk and chaos and makes the planning process maintenance-intensive, difficult to access, slow to consolidate and inconsistent. Not to mention this type of point solutions strategy is prone to user errors and comes with a high cost for data movement. So why do these toolkits and processes exist? Three reasons:


1.       To help FP & A teams ensure consistent data collection

2.       To aggregate disconnected data

3.       To input the data into yet another planning model for analysis


The reality is that far too much time is spent creating and maintaining these models and often misused. That misuse results in even more time spent fixing and compiling the data, just ask anyone in Finance.   The most common compliant is too much time collecting and synthesizing data and not enough time analyzing it resulting in rushed decision making, and worst yet decisions based on faulty data.


HIDDEN COSTS OF A POINT SOLUTIONS STRATEGY

Table 2.0

Endless design possibilities and flexibility appear attractive but usually lead to ongoing, endless costs and fixes

Significant effort and IT expenses are both required when trying to extract/transform/load (ETL),

synchronized models and data repositories due to technical deficiencies that do not adhere to enterprise standards

Data Hubs which are costly and created due to a lack of unified platform

 

Extensive money is spent to have FTEs to monitor and repair the connections

Data inconsistencies and constant data validation are required across connected data models

Multiple environments and data movement are necessary which increases the cost of third-party apps and data integrations

 



All of the above increase what is known as “Technical Debt” (too many point solutions and the costs to maintain them all). The irony is that technology, but the right technology, along with best-practices, and the more efficient use of labor will position private equity with accurate financial data for faster, more intelligent decision making while concurrently reducing costs and risks. 


For a graphical look at the challenges described above and what can be done about them.


Figure 3.0 Point Solutions Strategy Model




 Let us take a quick look at the weaknesses of the Point Solution Strategy.  We will examine the two primary layers in this model.

 

1. The bottom layer is common amongst all companies, Enterprise Resource Management (ERP) systems such as Oracle, SAP, and MS Dynamics…  These are the transactional systems which collect and manage all the transactional data within an organization. The problem is they were not designed to provide what Organizations need and require for financial management. They are transaction processors which need to be customized, which are costly and carry high risks to meet financial management and analytical needs.

 

2. The middle layer is where problems start and compound!

a.    Point solutions are costly to maintain and only solve for a sliver of the challenges and worse of all cannot easily share information between and among each other without significant technical and manual effort, and

b.    The end result is piecing together a puzzle of disparate data with varying degrees of reliability which makes decision making time consuming and challenging, fraught with issues as found in table 1.0 above.

 

THE SOLUTION


What does the solution look like that addresses the margin resisters, reduces technical debt, and provides best in class financial management? The solution must address the 3 pillars Mr. Gelfer referred to (1) People (2) Process and (3) Technology; they must be properly incorporated to deliver consistent, accurate, timely and transparent financial and operational data for management reporting, regulatory reporting, and analytics to enable decision making which improves margins and business growth.


The information age in which we live is a double-edged sword in that the answers are often available, but difficult to find in a sea of overwhelming amounts of information. Companies like Gartner and Forrester make it easier, but if you do not understand exactly what you are solving for and what you would ideally want/need in a solution you are just throwing darts at a dart board, and in part, how point solutions became so popular in the first place.


First, you will need a resource whether internal or external with the functional knowledge of what you need from your Financial Data, Processes, Reporting and Analytics. Moreover, these folks should have the experience and depth of knowledge to help formulate an efficient future state and be able to address your present state impediments to getting there.


Once you have properly dimensioned the challenges, selecting the right technology must address all three pillars with embedded change management and strongly supported by Senior Management.


The characteristics of the solution which address the margin resisters, reduces operating costs, helps reduce risk, and provides consistent, accurate and timely financial and operational data for analytics and decision making are many.  Here is a list of the key elements:


  • One unified application for financial consolidation, reporting, budgeting, planning, forecasting, analysis, and data quality

  • Deep functionality and scalability capable of use from the simplest of environments to the complex

  • Deployed on Premise or in cloud with rigorous compliance and security certifications

  • Enable Business Units to report and plan at a lower level of granularity without impacting corporate standards

  • Relational Blending allowing for relational and cube data to coexist in a single application, with the ability to report and drill back to the details

  • Guided Workflows for simplifying the processes and tasks, providing ease of use, and allowing users to focus on data quality and results, instead of system mechanics

  • Integrated financial and operational data to ensure confidence in financial and operating results


Benefits PE Firms as well as numerous other companies HAVE realized from deploying this solution model are:


  • Improved speed and accuracy of reports and forecasts to stakeholders, improved decision making

  • Increased business agility-respond quickly to changes, gaining completive advantage

  • Aligned financial and operational plans and forecasts

  • Improved finance team productivity-doing more with existing FTEs, more focus on value-added analysis of the business and less time compiling and preparing data

  • Reduced costs of ownership vs legacy solutions

  • A Future-proofed investment with functionality and scalability to meet your needs today and into the future

  • Platform based not module based like point solutions reducing time to implement

 

SUMMARY


As the market dynamics change and PE Firms look to secure gains through operational efficiencies and margin improvement, they have choices in the tools and approaches they use to enhance their portfolio investments. We have explored two approaches.  One which is costly and does not deal with margin resisters and one which eliminates margin resisters and enables best in class management, reporting and analysis for financial data.

 

About the Author

 

Mr. Marinelli has more than 25 years’ experience in both Industry and Consulting, where he

has worked for such leading companies as The Walt Disney Company, Verizon Communication, Deutsche Bank A.G., Siemens A.G., and Guardian Life Insurance Co in

various management roles at both the divisional and “C” levels. Mr. Marinelli specializes in

expense management, back-office re-restructuring and modernization, vendor management and out-sourcing services. He has worked on nearly all aspects of operational management and organizational re-structuring which included systems and process improvement.

 

Mr. Marinelli has been a keynote speaker at trade and research events during his career and holds a JD from Seton Hall University School of Law.

and leads the firm’s Client Relationship Program.

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