Let’s face it, investing in anything is a risk! Whether you’re considering giving a loan to a friend to start a business or moving your 401k into a real estate venture, it’s all a risk. But how about the professionals that do this for a living? By definition, a Private Equity Firm is an investment manager that makes investments in the private equity of operating companies through a variety of loosely affiliated investment strategies including leveraged buyout, venture capital, and growth. Let’s be crystal clear about this folks… they put a lot more science into their investment decisions than I did in my 401k roll-over. But, what is that science?
“Often companies have financial reports, but not at the granular level we’d really like. Companies should always be planning 5 years ahead.” — Brent Burgess, Chief Investment Officer
Over the course of 10+ years, I’ve been a part of accounting system implementations that were either prior to, during, or post the investment of a private equity firm. These experiences were just enough to make me seek a deeper understanding of “what comes first… the horse or the carriage?” Brent Burgess, Managing Director and Chief Investment Officer of Triangle Corporation, agreed to spend a few minutes with me in early July with information that small to mid-sized companies would benefit hearing.
| Q – | What is the primary risk that you find yourself faced with while considering a company to invest in? |
| A – | Fraud. (Burgess defined his use of fraud in this answer as “purposely and/or carelessly misreporting financial information”)
|
| Q – | What is the number 2 risk that you find yourself faced with during consideration of investing into a company? |
| A – | Lack of good reporting. If you sell Products A, B, and C, which is more profitable? Which ones share COGS? How could we invest in this company and then leverage the direct cost?
|
| Q – | What is the best tool to combat these top 2 issues? |
| A – | Thorough financial reporting.
|
| Q – | What makes a company more attractive to Private Equity Investors? |
| A – | Thorough financial reporting.
|
| Q – | If a prospective company doesn’t have good reporting, what do you do? |
| A – | Because of prior investment experiences, we often know where to look for possible issues or opportunities. If the prospect doesn’t have good reporting we take data extractions and do our best to analyze using our own data models.
|
| Q – | So, because of your experience and these data extractions you can eliminate the risk that would’ve been combated with good reports? |
| A – | No. We’ll minimize the risk in this process, but the reporting would have been preferred. My team would then discuss our trust in the data extractions to see if it’s enough to swallow. If not, we’ll simply tell the prospective company that we’re not comfortable enough to invest at that time.
|
| Q – | Would you agree that with better reporting you could have a decrease in audit cost? |
| A – | Yes. Though I haven’t heard of a company making a decision to change accounting systems just for that result, I can clearly see how there would be residual savings in the audit cost. However, if they had better reporting in the first place they’d likely catch problems before the auditor would anyway. Throughout our discussion I couldn’t help noticing how much of it orbited around reporting. These investors used it to identify everything in the kitchen… opportunities, threats, earnings, fraud, cost, income, loss, etc. and it appears that many potential investments (companies) lacked the mustard. Burgess went on to explain, “Smart companies should be planning five years ahead. Will we need to raise capital during the next five years? Would we care to cash in on part or all of our equity in the next five years?”
|
My final QUESTION of our discussion:
| Q – | What should companies do to make themselves more attractive to private equity firms? |
| A – | When you want to sell a car, you get it ready to show by cleaning it. You make it more presentable because you feel like it’s a good car for someone else to consider investing in. With companies… the attractiveness can easily be seen in the presentation of good reporting.” |