Essential considerations in Private Equity investment
As the saying goes, a Private Equity investment is like a marriage. There are many steps to take in order to build a strong foundation and to be aligned for the future. Private Equity investors and leaders strongly depend on one another to achieve returns and value within an agreed period of time; if the arrangement proves unsuccessful, either party might find themselves breaking bonds in pursuit of greater rewards.
When a Private Equity (PE) firm invests in or acquires a company, it needs to have a deep understanding of the company and its structure. The firm needs to know the customer landscape, the financial details, the industry, and upcoming trends and challenges.
But with whom do you finally ‘tie the knot’? Probably not with a detailed spreadsheet or a fancy product. You will say ‘I do’ to the people who will execute your vision and put your strategic plans into action. Therefore, a careful evaluation of the human assets not only during the diligence process (buy) but also post-investment (build, bind) is indispensable; without it, even the best formulated plan can fall apart even before you start creating value.
The notion of a rise in the importance of human capital in the PE industry is not new, but it is gaining traction. In August 2017, Harvard Business Review published “PE Firms are Creating a New Role: Leadership Capital Partner.” The authors outline what we see in our daily work in PE executive assessment: namely, leadership is as important as financials.
Buy – Build – Bind
Forbes estimates that half the time portfolio firms fail to achieve the return their investors expect. This is most often because the PE firm has chosen the wrong CEO or other CxO, and/or waited too long to replace these positions when things went awry. Having a positive impression and gut feeling about the leadership team during the evaluation process is certainly essential; however, thoroughly assessing the key players is critical in the buying process in order to minimize the risk of a post investment fallout. When PE firms focus solely on tangible assets, this can lead to ignoring critical decisions that need to be made on the people front. The consequence of acting in purely good faith with regard to the ‘intangibles’ is that the momentum can be easily lost.
As outlined in Bain & Company’s Global Private Equity Report 2018, Human Capital aspects such as talent management and team effectiveness nowadays require a more proactive and dynamic approach. Portfolio companies must attain a deep understanding not only on the ‘what’ and ‘how’, but also on the ‘who’ in this process in order to succeed and accelerate growth.
For example, you have created your roadmap and value creation plan and this may include a level of expectations and complexity that the team has not experienced yet. If you acquire a company that is used to a top-down leadership approach, your innovative strategy may not match the leadership culture and values. Therefore, soft factor topics have become increasingly important in the new world of PE investments, particularly when investing in SME, e.g. mid-market sized businesses whose owners or founders are connected with strong emotional ties to their ‘babies’. This issue can be addressed by either hiring an internal leadership expert or working with credible external partners and leadership coaches. These experts can not only help to build the bridge between the investor group and the leadership team, but also give valuable real-time feedback to both parties and help to create a supporting people strategy.
What questions should a PE firm ask itself in order to ensure there is a match between what you want to buy and where you want to go?
- Is the leadership team aligned with the investors and is the strategic plan fully understood?
- What leadership skills and traits are required to effectively execute this plan?
- Does the existing leadership team fulfil the requirements? Where are the gaps and how do you evaluate these?
- Has the team bought into your strategic direction and your plans and are they committed to pursue it at great lengths? How do you ensure and assess this progress?
- Is the leadership motivated and ready for change or does it require an immediate replacement?
- What is your post-investment strategy for the leadership team involved?
- What support does the team need to show exceptional performance?
- If you have identified gaps during the buying process, how will you close these?
- How do you identify and organize the talent pipeline?
- How to you continuously assess the leadership team and the organization to ensure that the strategy is on track?
- What long-term talent programs will help you to consistently work with a high performing leadership team, hence achieve great dividends for the investors?
- How do you initiate a sustainable succession planning process?
- How do you ensure the team shows the necessary stamina and remains focused even during the most challenging times?
- Have you embedded a feedback culture and how it is put to live in your organisation?
- How do you nurture your company’s culture so it binds and attracts top talent?
To summarize, we offer this outline of Top 5 critical activities that will support your human capital decisions throughout the process of buy-build-bind:
1. Be clear about the expectations and capabilities needed. The team’s current culture may not match with the investor’s vision. What are the key roles and behaviors required to build a successful company? PE investors and the leadership team should have an open dialogue in order to lay the ground for a human capital roadmap which is aligned with the overall strategic direction.
2. Thoroughly assess your key leaders in the buying process. Replace leaders in a timely manner when expectations cannot be met. Once on board, check progress regularly so you can initiate the necessary steps to build the relevant skillset and strengthen the commitment (bind) of the key players for the long term. For example: building effective teams, managing complexity, giving direction in times of ambiguity, and managing multiple stakeholders are a few critical skills of relevance which should be assessed regularly.
3. Identify and build a talent pipeline. Based on the analysis and knowledge gained during the above-mentioned phases, consider leaders for future decisions, overall enhancement of the workforce, and the company’s direction.
4. Review the strategic plan regularly. This also includes having an open and organized feedback culture so you can swiftly react when necessary (what worked, what did not?).
5. Work with leadership experts/coaches to support the team and investors. This is essential in the critical first months and beyond. From experience, working in regular intervals with a leadership coach in a safe setting is highly beneficial for the CEO not only to act as a sounding board for his/her ideas and concepts, but also to quickly remove potential roadblocks or find alternative strategies.
By focusing not only on figures but also human capital, your business will be poised to elevate and propel itself to the top ranks of the increasingly competitive landscape of the Private Equity industry.
Stanton Chase Private Equity Practice Group
Our Private Equity Practice Group is a dedicated specialist team of senior experts located around the world, working together seamlessly with a committed focus on finding, assessing and acquiring the best executive talent in the Private Equity sector. We understand the language, requirements and expectations of our private equity clients. We offer our clients in-depth technical and industry knowledge and a holistic service.
Our consultants and experts serve the full spectrum of investment companies, including Private Equity, Institutional Investors and Family Businesses, as well as their portfolio companies.
We help private equity firms make better recruitment decisions for their own investment professionals as well as for their portfolio companies. We advise on management appointments typically at the chairman, CEO and board levels, and we perform due diligence and management assessment, including succession planning within and for their portfolio companies.
For information about our services in Private Equity, visit: https://www.stantonchase.com/industry-specializations/private-equity/
For information about our services in Executive Assessment, visit: https://www.stantonchase.com/functional-specializations/executive-assessment/
Author: Susanne Sahli
Co-author: Lucas Schellenberg