Positioning Your Company as a Flagship Investment Part 1: High-Quality Financial Information and Systems
By Brian Smith, Managing Partner
In the competitive landscape of private equity (PE), flagship investments stand out not just for their profitability, but for their robust financial foundations. For family and founder-owned lower middle market businesses aspiring to become flagship investments, the quality of financial information and systems is paramount. In this first part of our series, we explore the critical elements that define high-quality financial information and systems.
1. Data Integrity with Third Party Participation or Oversight
One of the cornerstones of high-quality financial information is data integrity. Ensuring the accuracy and reliability of financial data often involves third-party participation or oversight. Additionally, third-party verification helps identify and rectify discrepancies, ensuring that the financial data accurately reflects the company’s performance. External GAAP audits by reputable firms confirm that the business’s financials are compliant with GAAP. However, not only does a GAAP audit not provide the full picture, but for most lower middle market businesses, the cost and time commitment associated with a full financial/GAAP audit is not practical. More viable options include a reputable fractional CFO and a pre-process Quality of Earnings (QOE) analysis. Pre-process QOEs, which mirror the financial due diligence processes performed by buyers/PE firms, are becoming the norm for established businesses engaging in M&A activities due to their efficiency of the process, reasonable cost, and results yielded, which typically exceed the insights provided by other options.
2. Integrated Systems for Seamless Data Movement
In today’s digital age, the ability to seamlessly move data across multiple platforms is crucial. Integrated financial systems allow businesses to consolidate data from various sources, providing a holistic view of the financial landscape. This integration facilitates efficient data analysis, enhances decision-making, and supports strategic planning. Businesses with well-integrated systems can quickly adapt to changing market conditions and maintain a competitive edge. Additionally, the real or perceived costs to integrate the business with other platforms, which can create operating efficiencies for the buyer post-acquisition, will be lower with more cutting-edge, integrated systems.
3. High-Quality Financial Models
High-quality financial models are indispensable tools for flagship investments. These models provide buyers with detailed projections and scenario analyses, helping businesses anticipate future performance and make informed decisions. A robust financial model should be comprehensive, flexible, and based on realistic assumptions. It should also incorporate sensitivity analyses to evaluate how changes in key variables impact the business. High-quality financial models are critical for demonstrating the potential for growth and return on investment to PE firms.
4. Granular Source Data
Granularity in financial data allows for more precise and insightful analysis. Detailed source data enables businesses to identify trends, uncover opportunities, and address issues at their root. Granular data also enhances the accuracy of financial models and reports, providing a solid foundation for strategic decisions. For PE investors, the availability of detailed and well-organized financial data is a clear indicator of a company’s commitment to transparency and operational excellence.
5. Internal Controls
Strong internal controls are essential for safeguarding assets, ensuring the accuracy of financial records, and preventing fraud. Effective internal controls encompass a range of activities, including segregation of duties, authorization and approval processes, and regular reconciliations. Businesses with robust internal controls are better positioned to detect and address financial irregularities promptly. This not only protects the company’s assets but also enhances investor confidence.
6. Identification and Utilization of Clear KPIs
Key Performance Indicators (KPIs) are vital for measuring a company’s performance against its strategic objectives. Identifying and utilizing clear KPIs allows businesses to track progress, evaluate success, and make data-driven decisions. KPIs should be specific, measurable, achievable, relevant, and time-bound (SMART). By focusing on the right KPIs, businesses can demonstrate their operational efficiency and growth potential to PE investors.
7. Consistency of Historical Financial Reporting
Consistency in financial reporting is critical for tracking performance and identifying trends over time. Consistent reports allow businesses to compare financial data across different periods, facilitating better analysis and decision-making. For PE firms, consistent financial reports provide a reliable basis for evaluating a company’s historical performance and future prospects. It also indicates the company’s commitment to maintaining high standards in financial reporting.
8. Availability of Real-Time Financial Reporting
In the fast-paced business environment, real-time financial reporting is a significant advantage. It enables businesses to monitor financial performance continuously, make timely decisions, and respond swiftly to emerging opportunities or challenges. Real-time reporting systems provide up-to-date insights into key financial metrics, enhancing agility and strategic planning. For PE investors, real-time financial reporting demonstrates a company’s ability to maintain transparency and responsiveness.
Conclusion
Becoming a flagship investment requires more than just strong financial performance; it demands a commitment to maintaining high-quality financial information and systems. By ensuring the steps above, family and founder-owned businesses can position themselves as attractive prospects for PE investment. In the next part of our series, we will delve into the importance of operational excellence and how it differentiates flagship investments from other businesses. Stay tuned!
LCG Advisors is a leading financial advisory and consulting firm with headquarters in Tampa, FL, and Denver, CO, and services nationwide. Contact Katie Martinez, Director of Business Development, at [email protected] to find out how LCG can help make your business a flagship investment.