Do PE-Backed SMEs Need an Internal Audit Function? A Practical View

Internal audit is one of those governance topics that tends to get deferred. The business is growing, the finance team is stretched, and internal audit feels like something that happens in large organisations with dedicated departments and three-year rolling programmes. For a 50-person or 150-person PE-backed business, it can feel like a solution to a problem you do not quite have yet.

This view is understandable but not entirely accurate. The question is not whether you need an internal audit department. It is whether your business has a proportionate, functioning process for independently assessing whether its controls are working. Those are different things, and for most PE-backed SMEs, the answer to the second question should be yes.

What internal audit is actually for

At its core, internal audit provides independent assurance that the controls an organisation relies on are actually operating as intended. It is not a police function. It is not about catching people doing things wrong. It is about giving the board and senior management confidence that the processes they believe are in place are genuinely working — and identifying, before auditors or investors do, where they are not.

For a large corporate, this requires a dedicated team operating a structured audit programme. For a growth-stage SME, it can look very different: a targeted annual review of the highest-risk control areas, conducted by someone with genuine assurance expertise who is independent of the finance function being assessed. Same principle, proportionate form.

The value of this is most clearly felt in two situations: in the period before an external audit, where an independent pre-audit review can identify and resolve control gaps before they become audit findings; and in the period before a transaction, where a clean set of controls and documented governance provides both commercial reassurance and negotiating confidence.

What investors and auditors are looking for

PE investors have a professional interest in knowing that the businesses they own are well-controlled. They are not always explicit about this, but it is implicit in the governance conversations they have with management teams, in the operational reviews conducted after investment, and in the due diligence processes that precede secondary transactions.

A management team that can demonstrate that it has independently assessed its own controls — that it does not just assume they are working but has verified that they are — is a more credible and more investable team. It signals that governance is taken seriously as an operational discipline, not just observed as a formality.

External auditors, for their part, take a positive view of businesses where there is a functioning internal audit process, however proportionate. It affects their risk assessment of the control environment and, in some cases, allows them to place reliance on internal audit work rather than repeating it themselves. That can shorten fieldwork and reduce cost — though this benefit is more reliably available in larger businesses than in SMEs.

A proportionate model for SMEs

An internal audit function does not require a team. For most PE-backed SMEs, a proportionate model involves an experienced external adviser — someone with a professional assurance background who is independent of the finance function — conducting a targeted review of two to four high-risk control areas per year. The output is a report to the board or audit committee, setting out what was tested, what was found and what management should do about it.

This model costs a fraction of a permanent internal audit function. It delivers genuine, independent assurance. It produces a documented record of governance activity that is useful in audit conversations and in transaction processes. And it can be scoped each year to focus on the areas of highest current risk — which in a growing business tend to shift as the risk profile changes.

The areas most commonly reviewed in this model for PE-backed SMEs include financial controls over the close and reporting process, IT general controls and system access, revenue recognition and contract compliance, procurement and expenditure controls, and payroll and headcount governance. Any of these, reviewed independently and honestly, is likely to surface something actionable.

When to start

The right time to introduce proportionate internal audit activity is before you think you need it. Once a significant control failure has occurred, or once an audit has produced substantive findings, the value of assurance is somewhat retrospective. The value of doing it proactively is that problems are smaller, remediation is cheaper and the governance record is clean.

For PE-backed SMEs, the natural trigger points are the period shortly after initial investment — when the investor expects governance to be formalised — the period before a significant transaction, and any year in which the business has undergone material change: a new ERP, a significant acquisition, a change in finance leadership, or rapid headcount growth.

The businesses that wait until the external auditor identifies a control problem before introducing internal assurance activity are the ones that spend the most time and money fixing it. The businesses that build proportionate internal assurance in early are the ones that external auditors comment on favourably.