Rising interest rates, chronic inflation, and geopolitical instability have created an uncertain environment and have forced many private equity firms to consider performing more acquisitions of smaller companies to bolster their platform investments. According to a recent article from the Wall Street Journal, the number of appealing upper-middle-market and enterprise target companies is decreasing which is encouraging private-equity and private investors alike to consider acquiring smaller companies to continue growing their portfolios.

It is easy for investors to overlook the challenges that are created when typical operating practices in smaller companies meet the operating and reporting expectations of private equity. These typically become burdens on the deal team and management.

The investors who have historically focused on large buyouts know that they require considerable time, careful planning, and intensive due diligence to evaluate the finance and accounting functions of the business. For larger acquisitions, investors will spend a significant amount of time on buy-side due diligence, which covers all elements of the finance and accounting functions.

For deals that involve less earnings before interest, taxes, depreciation, and amortization (EBITDA) and lower valuations, investors rarely invest the same proportional amount of diligence. Smaller deals, however, do not mean smaller problems. Though a smaller investment carries less financial risk a thorough evaluation is just as important in these deals to avoid potential significant problems and drive value growth as quickly as possible.

Potential challenges

• After a successful growth equity investment or smaller sized buyout, investment firms often find themselves dealing with:
• Accounting records that are kept on a simple, typically cash or modified cash, basis accounting and on a less sophisticated accounting/ERP system;
• An accounting team limited to transactional support, and not accustomed to the rigor of a timely month-end close process;
• Limited investment in finance technology, low levels of automation and limited documentation of processes and procedures;
• Limited budgeting and forecasting capabilities, including weak cash flow management and little prospective reporting on liquidity and potential cash positions;
• Lack of an understanding about debt, covenant compliance, and reporting;
• Variances in how the acquiree uses data and metrics to operate;
• Financial statements that may not be GAAP compliant, especially in complex areas like revenue recognition, leasing, and equity;
• Burnout and potential turnover from introducing the acquiree’s finance and accounting team to the new reporting environment;
• Current management appointed by the investors may have to oversee the group and operate at a lower level to compensate for the skill gap.

Leveraging outsourced solutions

Deals for smaller companies make a lot of sense for investment firms, but it is important to go in with accurate expectations about the current state of their financial management and how to quickly upskill and uplevel. Partnering with a full-service outsourced solution provider can address the often unforeseen challenges in acquiring a smaller firm and can optimize the firm’s grow strategy.

A team of highly trained individuals that can provide finance and accounting support at various levels and are accustomed to working in a private-equity environment can help to mitigate some of the challenges mentioned by:

• Managing the transition from small business accounting to a private equity-level of discipline;
• Ensuring a timely and accurate month-end close, a month-end close document and providing customized solutions to enhance the process, including recommendations to improve system integrations and reduce the time to close;
• Assisting with a post transaction integration strategy to combine and document processes, policies, procedures, and the books and records;
• Providing audit support, including assistance with required policy and process documentation;
• Establishing and maintaining financial planning and analysis (FP&A) and decision support tools such as budget/actual, cash forecasting/projections, and modeling;
• Offering consolidation/reporting solutions;
• Providing resources to select or implement new systems or optimize existing systems.

As investors increasingly adopt an acquisition strategy that focuses on smaller targets, they will inevitably encounter issues that will slow their ambitious growth strategies. Citrin Cooperman’s Business Process Outsourcing Services’ team is equipped to prepare you as you acquire smaller businesses and can provide the customized services you need to stay ahead of the curve.

For more information, please contact Mike Zyborowicz at mzyborowicz@citrincooperman.com or Kieran Higgins at khiggins@citrincooperman.com.