Private equity companies – do you have the right leaders to deliver above market returns?
May 2015 | SPOTLIGHT | PRIVATE EQUITY
Financier Worldwide Magazine
Gone are the days when above-market investment returns can be achieved through financial engineering alone. Clearly, the financial expertise of a private equity partner can fuel the next-stage growth of a company, but today’s investors are keenly aware that operational expertise is also critical to the growth and profitability of platform companies.
Key to delivering above-market returns and one operational area where a private equity firm can excel and make a critical impact in the performance of their platform companies is in the area of talent management.
Leadership under private equity ownership is different
The acquisition of a company by a private equity firm is a seismic change for its leaders and employees. Yet private equity firms place their ‘bet’ in large part on the strength of a leadership team that has succeeded in the past.
Research shows that effective leadership is situational and there is no single effective leadership profile. Leadership skills that successfully propelled a company in the early stages of growth may not be effective when that same company matures with more scope, scale and complexity.
The wrong leadership destroys enterprise value
We all know, and have seen, that great leadership can significantly and quickly enhance stakeholder value. And, we also know how quickly bad leadership can destroy value.
Without the appropriate fiduciary oversight in place it can be difficult for private equity firms to spot when a leader is the wrong match for their platform companies. In a worst case scenario, private equity firms are surprised to find out that a CEO has carefully managed the board by controlling both the information flow and their insights into what is really going on in the organisation.
There are steps that can be taken to ensure insight at this level.
Six principles to help ensure success: a simple yet effective model for consideration
What this model proposes is that private equity firms develop standards in the ‘core areas’ of leadership talent management that are similar in principle to the standards that most firms establish for financial analysis and reporting. The key difference is that there are no GAAP/IFRS standards, bank covenants or tax authority and/or investor reporting requirements to follow. You need to develop your own.
Make talent management a top priority. For bigger private equity firms operating in the large-cap company space, this likely means hiring a chief human resources officer, perhaps with a small staff to do recruiting, consulting, etc. For those mid-size firms operating in the mid-cap to small-cap company space, this likely involves partnering with outside resources to assist in the development and execution of talent management initiatives on a consistent but ‘as needed’ and variable cost basis.
Perform pre-acquisition leadership due diligence. As part of your due diligence process and in the final stages, it is a best practice to invest in leadership assessments. Although it is possible that such work can uncover leadership dysfunction that will ‘kill’ the deal, that outcome is an exception. Skilful leadership assessment can be a critical strategic tool, sending a positive message to the leaders of the company you are about to acquire. The outcome of pre-acquisition due diligence is a baseline understanding of leadership strengths, bench strength and areas of possible concern or need for development.
Immediately clarify the private equity firm/CEO relationship. Using a consistent and formal process, invest in bringing clarity to the relationship between the CEO/president and the private equity firm. Although PE firms have different visions for what this ‘governance’ needs to look like, we recommend a formal ‘board of directors’ approach. In such an approach, the board’s role needs to be made clear in terms of both performance monitoring as well as strategic oversight. Board meetings should be regular and operate with a formal agenda.
Conduct an early leadership effectiveness audit. At the three to six month mark the honeymoon is over and there is a greater awareness on all sides as to how well the leadership/private equity ownership team is doing. It is also the critical ‘tipping point’ where great leadership will propel the organisation toward top tier private equity investment returns and less effective or bad leadership will underperform. A well designed and consistently applied leadership assessment and development process will make good teams great, and if there are issues that are too big for development, changes can be made (top executive team additions or subtractions) at a critical time in the investment lifecycle.
Own the executive recruiting process. As the private equity owner, don’t abdicate responsibility for finding the ‘right-fit’ new executive. When key leadership additions are required, think about the recruitment process strategically, not as a standalone transaction. Without a vision of what’s needed, you may just get a retread of the very executive you decided to move out. But, what is more important and not as easy to find is the leader who will bring the right new leadership behaviours into the organisation. Organisational and cultural transformation starts at the top and if left solely to the discretion of the platform company, they will be more likely to hire in their own image. As a result, we encourage our private equity clients to build a shortlist of search firms who know how to assess the current culture of a company, and what changes are believed to be necessary in order to find the best new executives. Let the platform company executive make the final selection, but insist on a ‘best practices’ process and firm.
Effectively manage executive transitions. Don’t underestimate the importance of effective executive transition management, especially when it involves a previous owner. Even if they feel they are ready to move on to a new life stage, some career or life transition support would be a good investment. It sends a positive signal to all stakeholders, including owners of future company acquisition candidates.
Leadership makes the difference
Look at any business success story from start-up to turnaround, and the prime factor in realising ROI is leadership. Effective leaders inspire employees, make bold decisions and propel good companies to greatness. Conversely, average or poor leadership puts downward pressure on results. If you’re looking to optimise your return on investment, you can’t start too early to make this assessment. Ideally, it should occur during due diligence, but if not, start now. Or else you’ll be leaving money on the table.
John Myers is a managing partner at Kensington International, Inc. He can be contacted on +1 (312) 676 7014 or by email: firstname.lastname@example.org.
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Kensington International, Inc.