“As the term would suggest, the ‘annual audit’ does not often get much attention early on in the deals of financial investors,” Ulrich Störk, Private Equity Audit Leader at PwC, observes time and again. Wrongly so, says the expert for audits of private equity (PE)-financed portfolio companies. The equity story, with which the PE firms want to make a case upon their exit, should be prepared from the first day together with the auditor. Ulrich Störk speaks about this and other features of the audit in the private equity segment.
After the game is before the game, as German footballers say. You claim that this also applies to the private equity industry?
Störk: Financial investors would likewise say: After the deal is before the deal – because a profitable exit, an exit from an investment in a portfolio company after a certain holding time is part of the business model as far as financial investors are concerned. It is well advised to work this scenario out early with the auditor and then develop it in an integrated audit approach across the entire investment cycle.
Why do you make the case – for holding times of four to six, sometimes even up to ten years – for such an early planning of the exit together with the auditor?
Störk: Well, for one, there are very practical reasons: In the due diligence of the financial investor, a variety of audit-relevant issues are typically examined. The intelligent transfer of this knowledge to the audit team is an important component for effectively carrying out an audit. For this reason, it is often useful to include colleagues with audit and accounting experience in the due diligence team. In addition, the motivation for a financial investor often lies in the rapid implementation of a growth strategy. For this, however, not only does the financing have to be right, but also the structure of the company. Process specialists from the audit team, which was also involved in the due diligence, can highlight for management how efficiency gains can be achieved long term. And finally, with a view to the exit, it is important to implement effective control as early as possible.
In which areas do you see opportunities for control?
Störk: With IPO candidates, one point is certainly developing the equity story – the earlier in the portfolio company the right ratios are correctly developed and thereafter used for control purposes, the more convincing the arguments on exit are. But relatively common things are also not to be overlooked: In the 16 years during which I have been supporting corporate deals, I have often heard statements like: “In terms of the credit covenants, if we had made adjustments years ago then we would not have any problems now.” In many cases, it should be noted that the ratios and key performance indicators evolve differently than planned and are not sufficiently tailored to the covenants.
Why do some things in the portfolio companies not go completely as wished for by financial investors?
Störk: Private equity firms and portfolio companies are connected by a unique partnership: The investors have clear ideas about what they want to achieve with their investment, and in the portfolio company it sometimes takes time to get used to these ideas. It has often been our experience that we as auditors, with our overarching view of the portfolio company and our understanding of the mind-set of the investor, were adept at facilitating and could thus act a permanent sparring partner in order to ensure a productive outcome.
Is distrust of financial investors in your view justified?
Störk: Quite the contrary – only when the portfolio company is growing healthily can the financial investor realise a lucrative exit. However, the rapid growth process that portfolio companies undertake following the entry of a private equity firm can very quickly strain their systems. Here it has once again proved valuable to work with an auditor who practices a risk- and process-oriented audit approach.
Partner, PE Leader Germany & EMEA, PwC Germany
Tel: +49 69 9585-1950