The Impact of Private Equity Investment on Accounting and Reporting

A private equity investment marks the beginning of a new growth phase for an SME, bringing both funding and new demands for developing reporting practices. Every SME with growth potential should envision its future and actively plan financing solutions that enable expansion. 

Often, the desired growth and its funding come from outside the company, especially from private equity investors. These investors put money from their managed funds into carefully selected targets and expect both a return on their investment and up-to-date information about its value. 

Private equity investments are usually made as equity or debt investments and are for a fixed term. The investor brings long-term, risk-tolerant capital to the company. Unlike a bank, a private equity investor is not a passive owner. They typically take a seat on the board and offer valuable insights to the management team, in addition to capital. Attracting a private equity investor can also be about bringing expertise, not just funding. For the investor, investing in a company is also a chance to participate in its success as a new owner. 

Forms of private equity investment and funding requirements 

There are several ways to finance a company’s growth, such as share issues, capital loans, SVOP investments (equity-like investments), and loans with special terms. When choosing the form of financing, it’s important to consider changes in ownership and the costs involved. A share issue changes the ownership shares of existing owners but is often the most attractive option for an investor who believes in the company’s growth. Private equity investment refers to funding given to an unlisted company in exchange for shares. 

Other forms of financing can be part of a private equity investment, but their terms must be carefully planned to remain realistic even if growth is delayed. Private equity stands out from other funding options because it is typically unsecured. The investment is based more on the company’s future potential than its current reporting. Investors are especially interested in the company’s growth prospects, and the investment period depends on how growth materializes, but plans are usually made for a 5–7 year timeframe. When the period ends, the company is sold and the investor’s funds are returned with any profits. 

Attracting a private equity investor requires thorough preparation. The company should consider: 

• Whether its core business is fundable 

• Its growth potential 

• The intended use of the funding 

• The terms of the investment 

• Management’s commitment to growth 

These factors determine whether an investor is willing to get involved. 

Preparing for funding negotiations 

Before private equity negotiations, the company’s management and financial administration need a careful review. Accounting must be accurate and timely, with all income and expenses properly allocated and reports produced regularly. Ongoing bookkeeping should not differ from year-end accounting principles, and financial reports must give a realistic picture of the company’s situation. Receivables and liabilities should be critically assessed, and all relevant items must be included in the accounts. The finance team’s expertise must also meet the needs of a growing company. 

It’s wise to clear up any unfinished business in the accounts, such as unclear provisions or irrelevant items. Cash flow from sales and payments to suppliers should be optimised, and general expenses and inventory levels reviewed for efficiency. A solid foundation for negotiations is built when management understands the details of profit and balance sheet items, and reporting is familiar to them. Close cooperation between the accountant and management is crucial, as private equity investors often ask follow-up questions and request clarifications during negotiations. 

During negotiations, it’s important to respond and report quickly on events affecting the company’s solvency and profitability. The board prepares a business plan or similar document outlining growth targets, possible obstacles, and solutions. The finance team’s view on revenue and costs supports the plan, which should include a broad numerical forecast for at least the next three years. 

Changes in reporting after private equity investment 

A private equity investment appears in the accounts as an equity item, usually under unrestricted equity, based on the share issue decision and payment. Documents should clearly show the new shareholder’s details, purchased shares, and subscription price—information also needed for financial statements, so it’s important to attach these to the accounting records. 

Financial reporting practices may change significantly after a private equity investment. Monthly reporting starts to resemble year-end reporting, and to assess profitability, accruals, salary provisions, and inventory valuation are monitored more closely. Key figures like profitability, solvency, and liquidity become more important. The investor may also require that reporting is done by business segment or cost center, as well as combining financial and operational data. Good preparation can minimise these changes, as you’ll be ready for the necessary adjustments. 

Bringing in an investor generally increases the workload in accounting and financial management. Monitoring and forecasting cash flow and the balance sheet become even more important. Monthly forecasting helps react quickly to deviations, while forecasting too far ahead can lead to large gaps between actual and projected figures. Critical review of receivables and liabilities is also essential to keep the balance sheet reliable. Doubtful receivables should be written off as bad debts if necessary. Liabilities should also be reviewed critically. Revenues and expenses should be recorded on an accrual basis, and cost center reporting is always on the investor’s list of requirements. 

Unusual business expenses aren’t always predictable, so it may make sense to set up a separate cost center for them in the accounts. These exceptional items can significantly affect the company’s financial figures, so it’s important to report transparently to the investor. 

Good corporate governance 

Private equity investors are interested not only in the company’s profitability and solvency but also in its ability to manage operations according to its values. Professional management, employee satisfaction, and skill levels can be key factors in investment decisions. Ethical and environmental values are increasingly influencing investment choices too. Good governance clarifies management roles and boosts competitiveness. It’s mandatory for listed companies but recommended for growing businesses as well. 

Checklist for companies negotiating private equity investment 

Ultimately, the board is responsible for financial reporting to investors, but in practice, cooperation between the finance team and management is crucial. Outsourced financial management requires a high-quality partner to ensure reporting meets investor requirements. It’s also wise to involve other experts, such as lawyers and advisors, in negotiations if needed. Private equity investment brings security and allows the company to focus on growth, but it also requires a broad commitment to financial management and reporting. 

Checklist for companies negotiating private equity investment: 

• Only clear and real items in the balance sheet 

• All accrual-based items included in profit 

• Necessary accruals recorded 

• Accounting system can handle reporting changes 

• Cooperation between management and finance works 

• Staff have the skills for extensive reporting 

• Reliable external partners selected 

• Finance team prepared for broad changes and possible new reporting systems 

 The private equity process requires careful preparation from the company but offers the chance for significant growth and increased value. Investing broadly in the company’s future pays off, making it worthwhile to go through the process in the coming years.