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šŸ¤¬ Investor Relations II: Are you happy now, shareholders?

Keeping shareholders happy

A word

The CFO role is in growth mode

The evolution of the CFO role is clear in the sentiment of CEOs: they're looking for their CFOs to go well beyond the balance sheet to serve as strategic partners who contribute to growth.

Check out this guide to discover the top 7 skills CEOs say they want from their financial partnersā€”and how CFOs can deliver.

Working

The devil is the details

ā€œHow does this guy always get it so wrong? We pretty much give them the numbers, donā€™t we?ā€ I asked Paul, my loyal VP of Investor Relations.

It was the third consecutive quarter this particular sell-side analyst (Toby) had wildly mis-forecasted our performance. He was working for one of the bulge bracket banks. So his reports carried weight. They could move the market.

All of the other big bank analysts were never too far away from our own models. That was no coincidence. Paul spent a lot of time with them, making sure they got to a sensible answer. Without ever quite giving them the numbers.

So, given that process, how come Toby, (or should I say ā€œToby, CFA, qualified at one of the most prestigious financial institutions in the world?ā€), managed to get his forecasts so wrong?

It hurt the credibility of his research notes. And it created noise for us in the market. He was stubbornly continuing to recommend ā€˜sellā€™ when the consensus was a ā€˜hold.ā€™ It was a clear outlier. And his numbers were being proven wrong quarter-after-quarter.

Why was this one analyst in a completely different zip code to the others on earnings outlook? What did he think he knew that they didnā€™t?

I went to see him.

He described his methodology. I was stunned by the detail he had gone into in his modeling. Well beyond what I was used to from an outside analyst.

Heā€™d clearly taken a deep interest in our particular sector. And had attempted to bottom-up build the Income Statement from first principles using detailed assumptions on the cost structure of the business.

Far beyond the level he could ever hope to accurately forecast without having access to internal company records. And it was giving him a much more volatile earnings outlook. But it was that ā€˜volatility riskā€™ that drove his lower rating.

Most analysts used high-level trends in sales growth, gross margin, and expense ratios to forecast earnings. And with a gentle hand from our IR function, would end up with roughly the right answer.

With Toby, it was the classic example of being ā€˜wrong in a great amount of detail.ā€™ Guesswork on 100 variables, when an educated steer on 6 or 7 variables would have done fine.

I decided to tackle it head-on: ā€œHey Toby. How many times are you going to have to be embarrassed by your own forecasts before you start listening to us? We pretty much hand you the forecast on a plate, but you never listen?ā€

It didnā€™t work. He still thought he knew better. Adamant that he was onto something in the fundamentals of the business (and the industry more widely) that no one had picked up.

Time proved him wrong. Eventually, his research reports (on our company at least) carried less and less weight in the market. And 3 or 4 quarters later he moved onto a different desk covering another industry.

I was glad to see the back of him.

It doesnā€™t matter how clear the facts are, someone else will always have a different view of the prospects of your business.

Deep Dive

This is the second part of a 3-part series on Investor Relations.

Are you happy now, shareholders?

Last week, we discussed some principles of investor relations and how to set ourselves up for success.

This week we will talk about managing shareholders and equity capital specifically.

Letā€™s start by defining the different types of shareholders and how their interests may differ.

Public shareholders

The hard bit with investor relations in a public company is the diversity of interests. One public shareholder does not equal another. You have:

  • Employees

  • Retail investors

  • Activists

  • Value investors

  • Dividend investors

  • Growth investors

  • Hedge funds

And itā€™s not just your actual shareholders, but prospective shareholders, sell-side research analysts, ratings agencies, etc. Rumors spread fast on Wall Street. Keeping clear and authoritative control of the fact pattern is vital.

And these groups all want different things.

If Berkshire Hathaway owns your stock, you know they are in for the long term. But if a distressed equity PM from a hedge fund invests, they are in for a quick flip. This means what they are looking for in terms of price appreciation, dividends, etc., will be very different.

Understanding the composition of your shareholders and their interests is vital for the CFO.

Investor relations have always focused on institutional shareholders. These guys do have the power individually or collectively to move your stock price and cause a whole lot of pain.

But the memestock phenomenon has changed how the investment community looked at retail investors. They too, now have the power to organize - via social media.

Understanding the motivations of activist investors is particularly important. They may push for changes like cost-cutting, asset sales, or leadership changes. And if not handled well, they can become a serious disruptor to business strategy.

Private equity

Private equity capital will typically have a well-tested path on what they expect from their CFOs.

They will have a board pack, monthly accounts, and weekly KPI templates they expect you to follow. These are the tools through which they monitor their investments. Donā€™t mess it up.

The reporting requirements will have a heavy focus on cash and cash flow forecasting. If their investment turns out to be a dud, the leading indicators of that will be in the cash flow forecasts.

They will also expect a relationship directly with you as the CFO. That might include telling tales on the CEO if necessary.

You will be seen as the person who provides them with their information, so prepare for all manner of last-minute requests for information in different formats.

The benefit of this is you should never be second-guessing what they expectā€”they will tell you.

The more you can build a fluid, trusting relationship with your man-mark in the PE fund, the better. They have the power to make your life easy or miserable. Some CFOs will work for the same PE fund in 5 or more portcos across their career. So the relationship is vital.

One benefit of a well-built PE-led capital structure is clear, aligned interests: the prosperity of the company in acceleration towards an exit and not running out of cash in the meantime. But not all structures are well built. Fifteen years of cheap money has led to a ton of mediocre actors in the PE space.

Bear in mind that PE investors usually have a clear exit strategyā€”whether that's a sale, an IPO, or another event. Typically, the investment horizon is between 3ā€“7 years. This will drive many of their decisions and pressures on you as CFO. Understanding their exit expectations is key to managing the relationship successfully.

Venture capital

Investor relations in a VC-backed structure depend entirely on the structure itself and how much control has been ceded to the "money people" to secure the funding needed.

This will depend on how many rounds deep you are and what the operating agreement says. The more rounds and new institutions added, the bigger the risk of differing interests.

In short, the key determining question in a VC cap structure is whether the power lies with the founding team vs. the money. If it lies with the money, what exactly are their expectations regarding investor updates, board meeting attendance, etc.?

VC funds are growth-driven, and their primary focus will often be on key growth metrics like revenue growth, customer acquisition, burn rate, and churn. These metrics drive their reinvestment decisions and whether they'll push for further rounds.

Also, donā€™t forget that many VCs come with complex terms: liquidation preferences, anti-dilution clauses, and board seat allocations. These terms can seriously impact the businessā€™s future, and understanding them inside out is essential.

Either way, maintaining good professional relationships is importantā€”you never know when youā€™ll need their help.

Make sure you understand the investors, their terms, and their objectives.

As a serial CFO to venture-backed businesses, your personal reputation with VC funds will increase your value significantly to future founders. Cultivate and accumulate them.

Family shareholders

Family-owned businesses typically have the longest time horizons of any type of equity capital. Their legacy is tied to the fortunes of the business. Whether they are the Mars family or a family that owns a small local chain of gas stationsā€”they will be proud, and most will prioritize reputation at all costs.

Dividends will be important to them to fund the family lifestyle, but they will be patient about value growth. Oftentimes, they will measure their success on what the business is worth to their children, not what it is worth tomorrow.

As a CFO, managing family shareholdings comes with its own challenges.

There are often family members working in the businessā€”in "untouchable" positions. That could be a good thing. It could be the mercurial founder or the brilliant second-generation daughter who has successfully scaled the business. Or... it could be the third-generation doofus nephew who was installed as head of marketing because he was the first family member to get an Instagram account.

In large family businesses, it's also important to understand any governance structures, such as family councils or constitutions, which can drive decision-making processes. These structures could either simplify or complicate your role depending on how they function.

If youā€™ve worked with one family-owned business, youā€™ve worked with one family-owned business.

I once tried to acquire a business from a family that had over 20 people on the cap table with the same last name. It was impossible. They couldnā€™t agree on what they wanted. We could have come with a blank checkbook to that deal, and it wouldnā€™t have gotten done. Years later, it went bust.

As CFO, understanding the specific charter (operating agreement) and the rules of engagement is vital. What are their goals? Value growth? Dividends? A quiet life? Their name on the local course?

That will inform how you interact with them.

Individual shareholder(s)

Working with one or a small number of individual shareholders will depend entirely on the individuals you are working with. What are their personalities? Is this their only thing? Their main thing? One of many things? Are they dependent on it for an income?

The key here is to understand each shareholder, their needs, their personalities, and the dynamics between them. And again, you must understand the operating agreement. Who calls the shots if they canā€™t agree?

That will inform how best to engage them.

If you have multiple individual shareholders, watch out for potential conflicts of interestā€”especially if one holds a controlling stake while others do not. This can create tensions, especially around dividend policies, reinvestment, or growth strategies.

Comparing the groups & their priorities

Itā€™s worth remembering that shareholders are high maintenance because they donā€™t actually have that many statutory rights. Their core statutory rights (beyond receiving certain information and anything in the operating agreement) are:

  1. Their voting rights

  2. Their right to earn dividends

  3. Their right to receive a share of proceeds in the event of winding up

The more those voting rights are concentrated into a small number of hands, the more they control the business by proxy. This is the core M.O. for PE funds.

Common principles

There are a few principles for good shareholder management that hold regardless of the capital structure:

  1. Be precise: Talk in facts. Donā€™t guess. Once youā€™ve said it, you canā€™t unsay it. And never make it up. You should answer questions with ā€œI donā€™t know, but Iā€™ll find outā€ before you answer them with ā€œI think the answer is ā€¦ā€

  2. Build trust: Especially with the key power brokers in your capital structure

  3. Check your work: Review before you publish. Then review it again. Then give it to someone else to check. Nothing undermines a CFO faster than a CFO who got their numbers wrong. Beware late changes.

  4. No surprises: If an investor is surprised by something, the questions they will ask are:

    1. Did that CFO know this was going to happen?

    2. If not, why not?

    3. If so, why didnā€™t they tell me?

  5. Tell a story: Build a story that fits the numbers. And I donā€™t mean story = fiction. I mean story = engaging way of sharing the facts.

  6. Keep it simple: Any investor will take no more 3 big things away from an IR interaction. Make sure you are clear on what those 3 things are. And repeat them. Just because you are bored of them, doesnā€™t mean they are.

Results communications

For public companies, the quarterly earnings release (and associated call) is the way you communicate the results of the business to shareholders. I broke down my preparation for an earnings call here:

But this process can be easily adapted to a private company. Your monthly accounts and quarterly/monthly board meetings serve the same purpose (with fewer legal and logistical hoops to jump through).

That said, if you're running a public company, itā€™s crucial to be aware of regulations such as Regulation FD (Fair Disclosure) in the U.S. This prohibits selective disclosure of material information to investors without disclosing it to the public. In other words, you must ensure that everyone gets the same information at the same timeā€”no tipping off large shareholders or analysts with privileged data. Similar rules exist in other markets, and being compliant with these regulations is critical to avoid penalties and lawsuits. This is not the sort of thing you want to make a mistake on. Get a lawyer you trust in your corner.

Recent past performance is important to shareholders, but your shareholders will care even more about where performance is heading in the future. Thatā€™s where ā€˜guidanceā€™ comes inā€¦

Guidance

As a CFO, guiding shareholders to expected results is part of your job. Even if you donā€™t give them formal guidance, that is still guidance.

In a private company, you might be delivering that guidance via a formal forecast model.

In public companies, the process tends to be more formalized, and documented through press releases and earnings calls (though formal guidance is not mandatory). 

When providing guidance, ensure that it complies with applicable regulations. For example, in the U.S., forward-looking statements are regulated by the SEC, and companies are required to include disclaimers about risks and uncertainties. Misleading or overly optimistic guidance can lead to legal repercussions and damage shareholder trust.

One thing is for sure, having a solid FP&A cycle makes managing your investors so much easier.

Other proactive contact

As we said last week, having a proactive communication schedule with your key investors is vital. The frequency and format should be determined by their importance to the business. And to you.

And that is the CFO Secrets guide to managing shareholders. There is so much more to say here, so we will return to this topic in different ways in the future.

In the meantime, next week it's onto managing banks for the final part of the series.

Bottom
Bottom Line SCFO

  1. Know your shareholder make up and why they are invested. What are they trying to achieve?

  2. Have a clear, consistent format for communicating results with shareholders. Build trust through consistency.

  3. Get a strong process for guiding investors to future results. Backed by a solid FP&A cycle.

Office

Phil from Atlanta asked:

First, I love the content you provide. I have been a long-time reader. You often emphasize the importance of the CEO/CFO relationship, and I wanted to try to get your opinion on my situation.

Two months ago, I took a risk by changing industries and companies and made the jump to a ā€œCFOā€ (VP title but there is no CFO and I report to the CEO) role. This is my first time running an entire finance organization.

I am +15 years younger than all other leaders and am brand new to the industry. It has been a challenge to change the mindsets of small business owners. Forecasting and strategic thinking have been challenging concepts for the team. Communication! We have no C-level ongoing meetings ā€“ Iā€™ve tried to book meetings but always get pushback (the CEO only likes to do one-on-one phone calls).

Some details on the situation:

  • Recently PE-backed (6 businesses merged this year)

  • $20-25m in revenue 10m profit

  • Family-owned businesses we bought ā€“ and all leadership that I work with bought businesses from their Dad ~15-20 years ago

Should I go blow up processes and force change? Take it slow and continue to earn respect with my work (current process)? Focus on the investor relationship first (PE/Board) and worry about the CEO/ops leadership down the road?

Phil, thanks for the question, and congratulations on the new role.

Youā€™ve picked a difficult one. A CFO role is defined by its:

  1. Level

  2. Industry

  3. Scope

  4. Situation (Growth, Exit prep, Turnaround, Maintain, Transformation, etc.)

  5. Company size

  6. Geography

  7. Cap Structure (VC, PE, Public, Private, etc)

I would typically only recommend changing 1-2 of these (max) when changing roles and moving companies, especially when stepping up. Sounds like youā€™ve changed about 5 at once. This comes with a price, a longer curve to establish your credibility.

On top of that, you have to convince a bunch of small business nepo-CEOs to give up their autonomy to a new overlordā€¦ in a newly minted roll-up. Ouch, thatā€™s hard.

There is clearly a bunch of change to drive. Change starts with a burning platform. If you donā€™t have one, make one up. Creating some uncertainty is fertile ground for delivering change.

The relationship with the CEO concerns me. A CEO who only communicates via 1 on 1 phone calls doesnā€™t sound like much of a CEO to me. It sounds like some C-Suite strategy/alignment work is important.

The lens you can approach this through is value creation. I would assume all six folks running the business have taken stock in the combined business. The CEO will be on stock comp, as I assume are you. So the common ground should be the desire to create value.

I also would assume the PE house that put this deal together did so because they think they can knock some additional value out through synergies. All of which creates shareholder value which is good for everyone.

So start thereā€¦ and get the CEO on board first. Show them the money. How much value can they create through your intentions, and how much of that will land in their pocket on exit? Iā€™ve always found explaining to a CEO precisely how much money a particular action will net them, to be an effective lever. Who knew?!

You absolutely should get close to the PE house/operating partner. The CEO may or may not last, and the small business owners will get sick of having a boss quickly, so will leave once their lock-in expires. But the owner is going nowhere, not for a while at least. So get close.

Finally, if you cannot get things moving, sounds like it could be a difficult place to work. You should put a time limit on that. Set yourself some targets, and give it your best. If you arenā€™t able to deliver what you hoped within 12 months, write it off to the personal P&L against the ā€˜experienceā€™ GL code and go find a different job. One where you are set up to win.

If you would like to submit a question, please fill out this form.

Footnotes

Footnotes

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And Finally

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Stay crispy,

The Secret CFO

Disclaimer: I am not your accountant, investment advisor, tax advisor, lawyer, CFO, director, or friend. Well, maybe Iā€™m your friend, but I am not any of those other things. Everything I publish represents my opinions only, not advice. And certainly is not investment advice. Running the finances for a company is serious business, and you should take the proper advice you need.

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