CEOs in Private Equity – Getting the Best Return on Investment
By Mark Benbow
The outlook for the UK private equity industry is an interesting topic for debate. With annual returns from existing investments continuing to outperform the FTSE All-Share Index, many would argue the industry is showing strength and resilience, despite the uncertainty surrounding the UK market. Others would suggest these returns are lag indicators and the decline in transactions is cause for concern. Though 2017 showed renewed levels of confidence, activity for the first half of 2018 has been lower again. A continued lack of clarity regarding Brexit makes it difficult for firms to identify sound investment opportunities and, when they do, the level of competition is significant – recently we worked with a tech business looking for PE backing who had 64 different equity houses vying for investment.
Whichever of these views is closer to the truth, the fact remains that PE firms need to maximise returns from their deals. Critical to this, is ensuring a leadership team in each portfolio business that can deliver on the value creation plan. Investment teams need to conduct a delicate dance with each potential opportunity. They must ensure a critical eye when analysing the leaders of a business, but they equally need to ‘woo’ these management teams who are often sceptical about a change of ownership. Moreover, the competition surrounding each business means the natural tendency is to value relationship building over objective review of leadership strength.
The risk, of course, is that a three to five-year cycle begins with a leadership team in place that lacks the experience, capability or mindset to ensure performance against the investment thesis. Research suggests this is already an issue, with a Bain & Co study reporting that CEOs were changed in nearly half the portfolio companies they looked at. Only 40% of those changes were planned at the start and the majority of CEOs were not replaced until after the first year of ownership. To avoid lost momentum such as this and to maximise value creation, it is critical to understand what differentiates high performing CEOs in PE backed businesses.
Private equity is a unique environment, and for management teams, it can be a very different experience to working in a PLC. What then makes the context so different, and how does this impact leadership success?
- The Board is typically much more hands on, especially earlier in the cycle or at times when business performance is below target. Compared to PLC Boards, engagement will be less formal, more frequent and more granular. The stance from investors on the Board will be aligned, which can also create a less independent dynamic.
- With the business strategy largely being defined at the outset of the investment, the impetus will be on strategic implementation rather than strategic thinking. This creates a sharp focus on delivery in relation to the targets that have been set out. With this comes a greater level of scrutiny, where the need for transparency, collaboration and operational grip are heightened.
- Aligned to this is an accelerated pace of play and a desire for action ‘now’ rather than ‘tomorrow’. This offers the reward of seeing real impact faster than one may see in a PLC, but also brings the relentless demands of urgency and prioritisation.
With this in mind, leaders who can demonstrate a track record of success in private equity are at an advantage and highly valued by PE firms. Nonetheless, investment strategies are diverse and so digging deeper to assess the relevance of an individual’s track record is key. An operational or sales leader who has delivered success in similar investment strategy may well offer more valuable experience than an existing CEO. Nevertheless, every leader needs to prove themselves for a first time in PE and it would be naive to discount a candidate on a lack of PE experience alone. Relevant track record can manifest in many ways and a leader may bring a wealth of situational experience (such as leading a turnaround) that can support a successful transition.
Whilst a proven track record is highly beneficial, it is not always a feasible option and, clearly, successful CEOs in private equity are not solely defined by the previous experience they bring. What other indicators then should we use to identify those who can deliver success within a specific timeframe, where the strategy is pre-defined and enhancing operational effectiveness is key? Through assessing leaders during the due diligence process for many PE firms, we have observed several traits that differentiate successful CEOs in this context:
- Significant intellectual horsepower – they conduct rapid analysis and they are all over the detail, often to the point of obsession
- Operationally savvy – they know how to get stuff done and they also know how to scale
- Heightened financial skill – they have a grip on cash and tight cost controls
- Urgency and adaptability – they like pace and are comfortable with change and ambiguity
- Entrepreneurial and willing to take calculated risk – they have courage and self-belief
- Flexible, robust and humble – they are willing to roll their sleeves up and get stuff done
- Problem solvers not dream weavers – more operational than strategic
- Galvanise and bring focus – they understand the value of teams and good people
Many of these traits align with the PE environment described earlier in this article, yet they are not context dependent and there are many ways in which leaders might evidence strength in relation to them. Building trust and exploring capability in these areas will help PE houses identify leaders with strong potential to succeed.
In summary, investment teams can benefit from asking three questions of potential leaders for each portfolio business:
- Where have they delivered success before and is it replicable in this context?
- If they have not done it in private equity before, what elements of their track record will support a successful transition?
- What evidence do they demonstrate against the eight traits outlined above?
Without doubt, the reduction in deal frequency and the competitive landscape will place greater pressure on investment teams to ‘sell’ their proposition to each business they see potential in. However, it will be crucial not to lose sight of ensuring high quality leadership that can bring the investment thesis to fruition. Knowledge is power and through identifying any gaps or risks in the leadership personnel, investment teams can define any changes or support required at the very outset of the investment lifecycle, giving the best chance of optimum value creation.
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