As the former CFO of ECI, a leading manufacturer of electrical wires and harnesses, Mitch Leonard is no stranger to the challenges that many finance executives face.
The pressures of the recession coupled with several acquisitions have taught Leonard the importance of diversifying your financial toolbox.
After participating in one of our recent webinars, we wanted to learn more about Mitch’s experience and invited him to participate in our Working Capital Insider interview series.
In your experience, what are some of the unique challenges that private equity (PE) backed companies face?
The biggest challenge is creating value and continuing to deliver returns to limited partners. This has become more difficult over the last few years. The influx of private equity capital and more PE firms in the marketplace means deal competition is high and firms are paying more for deals. Having gone through the sell process in 2006, then again in 2014 and 2018, the list of PE firms we courted grew tremendously – at least double the size. So, when it comes to value creation and meeting those targets, companies are starting out behind compared to what it was like five years ago.
Would you say the finance function in a PE-backed company is more or less challenging than it was a decade ago? Why?
It’s without a doubt far more challenging. Heightened competition across the PE arena has forced everyone on all sides to step up their game. On the PE side, the quality of talent in these organizations and the depth of analysis they perform are very impressive. There’s always been a considerable emphasis to avoid mistakes in the due diligence phase, but now firms have a breadth of resources that can look into areas they perhaps didn’t analyze so closely in the past.
Financial analysis and modeling has really evolved over the last 10 years. It’s far more advanced. Firms now have the resources to recreate financials and dig into scenarios and variability in a way they haven’t before. They know how to get into the meat of the data really fast and identify fluctuations, and then highlight areas of risk that could reduce purchase price.
The same goes for the operational side of the analysis. More firms are employing really smart operational teams with deep knowledge of inventory, production, etc. They now understand the business better, the operational efficiencies and deficiencies, and they better understand what to pay and what not to pay than they did a decade ago.
So with that, as a CFO, the questions that come to you are different. There’s more scrutiny.
It’s been said that the CFO is the “key conduit” between the business and the PE firm, and that relationship can be intense. Would you agree or disagree, and why?
As a CFO, you are the conduit – especially during an acquisition or other major initiative. You’re most likely having daily contact with the PE firm’s VPs, who are channeling questions up and down the chain. They’ll call you at night. They know who your kids are. And that’s a good thing. It helps CFOs learn more about what the PE firms are looking for and stay in tune with their exit strategy.
As for intensity, I think it depends on the firm and the timing. I’ve been involved with PE firms where it’s been extremely intense and with others where it hasn’t been as intense. A lot of it has to do with how well the business is performing and the time-to-exit, and how focused they are in terms of meeting specific goals for value creation aligned with that timeframe.
Regardless, though, the scrutiny is certainly heightened. The CFO is a key ingredient to the PE firm’s success, so there has to be a lot of trust between the two. They have to know the CFO is competent.
Can you talk a little bit about what it’s like being CFO at a PE-owned company?
From day one, the focus goes right to the CFO. The CEO may ultimately be responsible, but it’s the CFO who executes the financial strategy and firm’s objectives. The pressure can be overwhelming, and you have to have a strong team underneath you. But part of that pressure comes from simply having a different set of eyes come in and look at the business from a different perspective. It’s uncomfortable and easy to feel like you have a target on your back.
But that’s what you’re there for. You’re well compensated and with the pressure comes reward. If you can’t deal with the pressure, then that’s not a fair trade-off either.
That being said, the transition period can be very difficult. The acquisition process can be any where from six to 12 months with a PE firm. During that time, you still have to run the business – and it’s tough to do both. There’s a high risk of either missing something in the due diligence phase or in running the business. More often than not, something slips and that amounts to even greater pressure and scrutiny.
How did your role and/or responsibilities change after your company was acquired?
In my case, it changed dramatically. A lot of that was because the acquisition was a carve-out (divestiture of a business unit). So I went from having a lot of corporate support to having very little. I had to completely rebuild our team and processes.
I also had to manage up. That meant knowing what our management group wanted to see, how often, what their reporting requirements were, and other changes up the chain. I had to get to know the players, their nuances, understand their hot buttons, and provide ease and comfort in the post-transaction environment.
How did financial expectations change post buyout?
When anyone sells a business, they put together a best-case financial model. But the buy side is looking at that model and risk adjusting to manage investor expectations. There are “numbers behind the numbers” that you never really see. But then after the transaction is complete, those sanitized numbers go away. You’re expected to deliver on those higher numbers from the best-case model you sold them on.
Those first 18 months are critical. If you meet your numbers, the pressure subsides some and you reset. But, if you miss them, you’re essentially swimming upstream and trying to get realigned with projections. You have to understand the deviations and how to get creative in improving earnings, liquidity, reducing financing costs and so on. So many things change but the expectations remain the same. You have to know how to adjust and compensate.
As a CFO of a PE-backed company, you used supply chain finance. Can you tell us more about how supply chain finance helped your business?
Our introduction to supply chain finance was as a supplier to one of our major customers. We were initially reluctant, but then we hit a recession. Our customers weren’t paying on time and liquidity wasn’t available in the marketplace during that crisis time around 2008. We were able to use supply chain finance to create millions of dollars of liquidity, and it helped us survive the downturn better. I’m sure we would have survived eventually, but this allowed us to do it better than we would have on our own.
As we continued to participate in the program, it became a simple, easy way to get paid on a consistent, predictable basis. Payments before were lumpy. If one of our AP guys was out on leave for a week, we might not get paid. Supply chain finance gave us the ability to control when payment came in (and how much) and gave us visibility into payments at a more granular level. If an invoice wasn’t loaded into the supply chain finance platform, we knew, which meant we could ask why. Was it a missed delivery or inaccurate packing slip? An error? Whatever it was, we could identify issues and discrepancies that would have otherwise turned into bad debt or collection issues.
Then, ECI decided to implement their own supply chain finance program – not just for the working capital benefit, but to be a better customer to their suppliers. There had been issues with timely payments from ECI to suppliers and that had become problematic. The supply chain finance program and the payment automation element alleviated that issue.
What are your thoughts on how supply chain finance can help other PE-backed companies increase value?
Better cash flow and access to liquidity are the obvious answers, which I just spoke about. But the value of supply chain finance goes beyond liquidity.
There’s the payment terms equalization element, which benefits both sides of the equation. Longer payment terms are good for the buyer, and when they can be offset by early payment options, it’s just as good for the supplier. Every program I’ve been associated with has been a huge win-win for the customer and the buyer. It works as a way to improve buyer/supplier relationships and benefits the balance sheets of both parties. The working capital benefit clearly outweighs any cost associated with it.
I was meeting with a customer once and there were several other supplier-side financial executives in the room. The customer was talking about supply chain finance and the response from the supplier executives was less than enthusiastic. They were apprehensive. I had to tell them “hey, you don’t know me and you have no reason to believe what I’m going to tell you, but this will be the best move you’ve ever made in terms of liquidity improvement.” Also, it’s consistent and in your control. If you want payment to come in on the first of each month and build up a cash surplus, you can. Or if you want to let that receivable grow, you can.
How do you think supply chain finance can best benefit PE-backed companies today and their CFOs?
It gives you the liquidity you need to fund strategic initiatives that will drive capital and growth. No one wants to go back to the firm and ask for equity. If the firm can retain their initial investment level, it helps with returns at exit.
What would you say to your peers in PE-backed companies that are considering supply chain finance?
Definitely look into it, whether from a supplier side or a customer side. Understand it completely. Look at what you want to accomplish and what it can potentially do. Most likely, it’s going to work for you. Your PE firm will be more than happy to back it if they understand it and its potential impact.
On a scale of 1-10, how would you rate supply chain finance’s ability to improve cash flow?
10. Every time we did it, it had a meaningful working capital benefit and improvement to the business.
With 35 years’ experience in domestic and international manufacturing operations within both the public and private sectors, Mitch Leonard is a proven financial professional with a robust understanding of private equity. Previous roles include Chief Financial Officer at both Electrical Components International and Warburton Valve Co. Inc., Director of Finance at Viasystems Group, Inc. and various other senior level positions. Mitch graduated from the University of Iowa with a BBA in Accounting.