On the comprehensive ocean of business, there are many different sailing vessels. Some are large; some are small. Some have a crew of hundreds; others are manned by a single person. Some are hauling cargo and valuable merchandise to bustling seaports; others are on pleasure cruises or vacation getaways.
If a traditionally-owned business is a yacht, then a private equity (PE)-sponsored company is a container ship. They are both boats that sail on the ocean, but there the similarities end, and the differences begin.
While a small business might need nothing other than a spreadsheet or perhaps QuickBooks to manage its finances, a PE-sponsored company is a much more complex entity with a complicated financial structure. There are investments from multiple entities included in the company’s funds.
In turn, private equity accounting for companies is equally complex. There is a precarious balance between managing operating efficiency, generating revenue while reducing costs, and reducing the tax burden while ensuring that the company flourishes over many years to guarantee a significant return-on-investment for the private equity firm’s investors.
What Is Private Equity Accounting?
The accounting needs of a company owned by a PE firm differ significantly from those of a traditionally-owned company. Both should work within the standards issued by the Financial Accounting Standards Board (FASB).
Whereas traditionally-owned companies are required to adhere to Generally Accepted Accounting Principles (GAAP), these principles were created before the advent of the complex accounting structures of private equity investment firms. Accordingly, they are more difficult to apply to private equity accounting.
However, private equity firms still need to follow GAAP and FASB standards as much as possible while also conducting themselves according to the best practices unique to PE entities. They are required to produce institutional-level accounting, which can mean, for example, transitioning from cash basis to accrual basis and changing how they consolidate and how they report.
Since a PE-owned company reports to investors – many of whom may not be involved in the company’s day-to-day operations – it’s necessary to keep them apprised of the health and status of their investment on a routine basis.
As per Investopedia, “The financial statements prepared for investors [vary] depending on the accounting standard. Private equity funds under U.S. GAAP follow the framework outlined in the American Institute of Certified Public Accountants (AICPA) Audit and Accounting Guide. This includes a cash flow statement, a statement of assets and liabilities, a schedule of investments, a statement of operations, notes to the financial statements, and a separate listing of financial highlights.”
What Are the Main Challenges for PE-sponsored Companies?
Some of the typical challenges for private equity-sponsored companies when it comes to managing their accounting include:
- Inability to keep up with all of their financial and operational data because spreadsheets only get bigger and more difficult to manage
- Lack of transparency into core business processes
- Difficulty expediently transitioning off of existing parent company systems in merger and acquisition scenarios
- No integration with forecasting and pipeline data
- Lack of visibility into customer behavior
- Limited reporting capabilities
- An overwhelming amount of manual data entry
- Lack of workflow sophistication
Some or all of the above challenges can cause a company to drown under its own weight if they are unable to manage their data sufficiently to conduct necessary oversight, analyze efficiency metrics, and provide the necessary information and reports to investors, government auditors, compliance investigators, or tax professionals
What Are Potential Repercussions?
If the issues listed above aren’t adequately handled, there can be undesirable consequences aside from the obvious profit loss or bankruptcy. Murky accounting practices can mask larger problems, including ethical or criminal malfeasance.
Left unaddressed, poor financial management can lead to an investigation by and possible fines and penalties from the Securities and Exchange Commission, or even criminal prosecution by the Department of Justice.
The latter is especially concerning given that the United States is cracking down on fraud in private equity firms, especially fraud related to COVID-19 relief funds. According to Bloomberg News, “In June , Ethan Davis, who was then the second-ranking official at the U.S. Department of Justice’s civil division, warned in a speech that private equity firms would be taken to task if they knowingly participated in relief fraud.”
The article continues, “Since 2013, at least 25 private equity-backed healthcare companies have paid a combined $573 million in government fraud settlements, according to a report [released] by the Private Equity Stakeholder Project, a nonprofit advocacy group that scrutinizes the industry. In only three did private equity firms agree to pay any money.”
It is imperative that PE-sponsored companies have all of their financial affairs in order, with comprehensible and transparent accounting practices, to protect the company and its investors.
My Private Equity Accounting Is a Mess – Who Can Help?
Finlyte has worked with hundreds of private equity-backed companies and investors. They understand what these companies require, why they require it, and the best way to get companies where they need to be.
They have ample knowledge and extensive experience to help with:
- Guidance with company restructuring
- Supplementing current accounting staff
- Business consolidation best practices
- Calculating pass-through costs
- Evaluating and revising allocation methodology
They can also provide professional guidance with Oracle NetSuite, the ideal platform for companies to use for private equity accounting. Oracle NetSuite offers companies and investors an easy transition from their current accounting practices, allowing them to standardize business processes and reduce risk.
With the help of the NetSuite platform, we’ll help you make sure the right policies and procedures get implemented, and we’ll provide timely, accurate financial reports to all interested parties.
To circle back to the nautical analogy, if there’s a financial storm causing the large container ship to flounder in the water, it’ll take seasoned sailors and a guiding light to bring it safely into port. If you need assistance with private equity accounting, contact Finlyte for a consultation today!