Interim CFO Explains Why PE Sponsors Need a Financial Risk Evaluation and Mitigation Strategy

CFO Insights

As part of Focus Search Partners’ ongoing CFO insights series, managing director, Monica Foster, discusses how interim CFOs help de-risk private equity (PE) acquisitions with Mike Grembowski, who as a CPA and experienced finance executive has been providing CFO advisory services to investors since 2015.

Mike Grembowski isn’t afraid to describe himself as an old-school accountant. After all, that’s what makes him such an important thought partner to PE sponsors when they acquire a founder-led business to build their first platform in a given space. He cut his teeth as a PwC auditor and later became CFO at various companies, including School Specialty, Inc., Reed Elsevier (now RELX), and CVS Health.

Now that Mike consults as an interim CFO, his old-school accounting background lends a unique perspective to PE sponsors, helping them more extensively evaluate and mitigate financial risks lurking underneath the surface of acquisitions. He talks with Monica Foster about why that de-risking is so critical and how he partners with investors to achieve it.

This interview has been edited for length and clarity.

MF: Tell us about your interim CFO experience with PE sponsors.

MG: Since 2015, I’ve provided CFO advisory services to PE firms, mostly when the accounting department for a company being acquired is led by a founder and little more than an electronic checkbook. No GAAP accrual-based financials. No extensive accounting department. The founder previously had no need for these things because they knew the business like the back of their hand.

MF: What do you bring to the table in this scenario?

MG: I provide financial due diligence that uncovers important details that investors can’t see from the quality of earnings review.

MF: What do you mean by that?

I’m talking old-school financial due diligence in which you dig into all the accounting from balance sheet reconciliations to policies and procedures manuals. This is something PE sponsors don’t get out of their commissioned quality of earnings review, which produces pro-forma financial statements for a steady-state business. But pro-forma isn’t GAAP and businesses don’t run in a steady state. So, when I come in and produce GAAP-compliant, accrual-based financial statements for the very first time, it reveals things that didn’t show up on the quality of earnings review.

MF: Can you share an example of something they can’t see from the quality of earnings?

MG: Sure. In the 18 to 24 months before a business is sold, smart sellers do things to position it for the sale. Not filling open positions is a prime example. In that case, a pro-forma quality of earnings review sees undercut staffing levels as the norm, even though they’re not. An accountant conducting financial due diligence would catch that.

MF: What is the risk to the PE sponsor when that isn’t caught?

MG: The buyer quickly learns that the staff is so lean and overworked that they have to add people, which impacts the financial statements and leaves the PE sponsor with a tough decision. If they hire people to get the business to where it should be, it can blow their valuation model. On the other hand, a business can’t operate materially understaffed for very long.

MF: As an interim CFO, how do you help them mitigate this risk?

MG: I help them evaluate open positions to determine what to prioritize or help them consider things like whether they truly need a VP in a certain role or if staff could handle the job. Along with looking at staffing, I check for excess in any areas. For example, in many healthcare settings, ancillary services are provided. I dig into the services’ metrics, something the quality of earnings doesn’t really do.

Especially when this is the sponsor’s first acquisition in a particular space and they’re not fully knowledgeable about the metrics, I can identify and evaluate them in order to allocate money where it’s most needed and will have the most impact. I also look for other cost savings to find money for staffing to appropriate levels.

MF: Would PE sponsors benefit from engaging an interim CFO before they buy rather than after?

MG: Absolutely.

MF: How long would it take for someone like you to uncover risks that can only be found by this extensive due diligence?

MG: Not long. Four to six weeks before the acquisition would suffice. Even if the PE sponsor can only afford three weeks, someone with my background could figure these things out pretty quickly. It’s just a matter of expanding the scope of the quality of earnings review to include someone with an extensive accounting background.

MF: Are there other times when an interim CFO can identify serious risks for PE sponsors?

MG: Yes. Sometimes PE folks, out of respect, are really hands off until they finally lose patience with a CFO who’s not communicating or performing. I’ve been brought in at that point to replace the CFO while they search for a permanent replacement and have been able to quickly assess the situation for them.

In one instance, the company had a significant cash crunch, but only the former CFO knew about it. Within two to three days, I detected this and uncovered the reason: The business had more than half a million dollars in significantly past due invoices to important vendors, which had never been entered into the system.

MF: How can PE sponsors avoid that kind of scenario in the first place?

MG: Be more hands on in the early days after an acquisition and ask basic accounting questions.

MF: How so?

MG: In my experience, larger, more mature PE firms typically have a finance director who knows what to ask. But in the case of younger and leaner PE firms without that role, there is one thing I recommend they do after they buy a founder-led business that’s never had a degreed accountant: Request to see the balance sheet reconciliations. They tell you so much about a business.

MF: How else do you help PE sponsors de-risk?

I identify the qualities and skills they need in a permanent CFO. PE sponsors are often inclined to choose a CFO profile that mirrors their own skills, i.e., the strategic CFO who can do deals and talk to the banks, all very important qualities. But they shy away from hiring an old-school accounting CFO, which is really what they need when buying a business that’s never had a degreed accountant before.

MF: Does the work you do position the permanent CFO for better success.

MG: I uncover and fix things, align processes and procedures, and start transitioning the tasks I’m doing as interim CFO to the existing A/F staff to provide a clean slate for the permanent CFO. This allows the CFO to really hit the ground running for the business and its PE sponsors because that new executive isn’t straddled with outstanding accounting issues.

MF: You recently completed an engagement through Focus Search Partners’ Interim Executive Services (IES) as an interim CFO for a PE-backed, founder-led healthcare services business. Here’s what the managing partner at the PE firm had to say about you. Mike “exceeded every expectation, from his tremendous work output to his understated gravitas, which immediately put our partners at ease and helped them transition to a PE-company mindset. Having him in place enabled our team to work with Focus Search on identifying the best full-time leader for the business long term.”

MG: That was a really fun engagement. To build a professional accounting infrastructure from scratch and to see the founder and PE sponsors’ growing excitement about the next phase of the business as a result was truly gratifying. It’s what I love about consulting as an interim CFO.

Are you making the first acquisition of your nascent platform? Contact Focus Search Partners today to locate an interim CFO to evaluate and mitigate your financial risks.