“The single most important thing is to make sure you have the right leadership for the business. In a world economy that remains prone to macro shocks, the firms we work for are looking for expertise and a successful record, but equally important, CEOs who really want to make a difference transforming a company.”
— Hugh MacArthur, Head of Bain’s Global Private Equity Practice, author of Bain’s 5th Annual Private Equity Report, February 2014.
One of the top concerns in private equity right now is top talent recruitment. Ideally firms are proactively creating a bench of people that can be called on for the C Suite or the boardroom either before the deal or post-deal. It can take months to conduct a traditional search for experienced executives, so private equity firms that have a ready bench of top leadership talent have a real advantage over firms that do not.
Generally, PE firms will utilize any of the following three value creation methods to grow their investments:
In all of these methods, the right talent plays an integral role.
In operational engineering, private equity firms develop industry and operating expertise that they put in place to give guidance and add value to a particular portfolio companies.
In governance engineering, private equity investors use the boards of their portfolio companies to guide more actively than their public company counterparts. Private equity managers often adjust incentive compensation to better align incentives of management by increasing managerial equity ownership.
Private equity investors use financial engineering to provide lucrative equity incentives to the management teams of those portfolio companies. These first two require strong talent selection for C Suite leadership, Operating Partners and boards. Getting the right fit matters.
According to a Harvard Business School study on firm valuation, capital structure, governance and value creation, 70% of private equity investors will keep the existing management team before the investment. However, post-deal, about half of PE firms will recruit their own senior management team. If you combine investors who recruit their own teams before, after or both before and after investing, the study found 58% of investors are recruiting for top spots within their portfolio companies. This illustrates how an “on demand” bench could help expedite operational and governance engineering efforts.
To build a bench that is deep in the expertise needed to lead private equity portfolio companies, we need to look at how to define the parameters for top talent recruitment.
The ideal profile of a CEO in a private equity portfolio company is situational – highly dependent on the investment type. Value creation in a turnaround is markedly different with a more stable company looking to expand via new markets, products or M&A versus an add-on acquisition shaping into a roll-up.
The size of the company also impacts which engineering skill set can yield the best results. Larger companies, especially those with sizable production costs, would likely benefit from an executive with a track record of producing significant cost savings to drive profit — whether through product line focus, process re-engineering, or lean/six sigma.
The most successful CEOs foster a results-oriented mindset within the company and measure the core areas that drive real value. These CEOs are aligned with the private equity sponsors — they think and act like an owner. In addition to robust equity compensation tied to their efforts to meet financial metrics, they have a personal ownership position in the company. This is an effective level for maintaining a sharp focus on achievement of the value creation plan.
In some cases, fund leadership and their past investment targets can provide clues toward industry and engineering preferences for value creation.
Has the existing culture worked well for the portfolio company? Or is there a need for a culture transformation in order to achieve targets? A misalignment on culture prevents the new executive from the necessary advocates and buy-in to move growth initiatives forward and sets them up for failure. The answer to these questions will help round out executive requirements and help determine the relative weight each should have to meet a company’s unique situation.
One soft skill that is useful for board members to possess is the ability to use culture assessments to keep companies on track. For example, the Heidrick & Struggles’ board study looks at how board members that are able to judiciously assess culture are better equipped to uncover if the degree of risk taking that leaders perceive to exist in a company is in line with the board’s tolerance for risk. This type of focused governance oversight helps reveal any behaviors that signal a problem with accountability or integrity before they cause serious financial or public relations damage.
Almost 6 in 10 private equity firms are recruiting for the top positions in their portfolio companies. That means they need to build a deep bench to tap into. To do so they need to assess the C suite skill set that aligns with their needs. Also, they must determine whether the existing culture is working well or if leadership will need to transform the culture. Understanding cultural needs helps to define executive requirements. Also, private equity firms are best served seeking board members who have the ability to assess a culture because they are better able to provide the necessary governance oversight.