Leadership in Private Equity Portfolio Companies

Leadership in Private Equity portfolio companies

For private equity (PE) portfolio companies, leadership is an important determinant of success. Portfolio companies often lack strong inhouse leadership development capacities. That means they need to bring in leaders from outside. Unfortunately, research shows that the quality of executive selection procedures in portfolio companies remains low, with the result that goals are achieved too slowly, or not achieved at all. Career Openers Executive search regularly works with PE portfolio companies, and here we will share some of our insights into which candidates make the best leaders in these companies.

From Rationalization to Transformation

Attractive financing, above-average market returns, and growing portfolios have contributed to the substantial growth of PE in the Netherlands. PE investments continue to growing rapidly, and a 2020 report from BCG suggests they will grow faster still in the years to come. As the sector grows, its approach is changing. Whereas PE firms in the past often focused on rationalizing – think cost cutting and financial optimization – transforming is now a priority. PE firms are acquiring companies with the aim of implementing intensive transformations; making radical changes to their market proposition, digitalization, and culture.

The Importance of Leadership

As PE firms aim to realize more complex transformations, the importance of understanding how to manage transformation effectively increases. Research from Bain shows that one driver of success stands head and shoulders above the rest: leadership. They found that the impact of leadership on market value of portfolio companies has been shown to be as high as 25-30%.

Leadership can also reduce “hold times” for investors. The “hold time” is the period that a PE firm maintains its stake in a company, and is used to set goals for growth and development. The right leadership choices can reduce “hold time” by as much as half, according to research by Dave Ulrich of the University of Michigan (Harvard Business Review, 2017).

Despite the potential gains, Bain’s research shows that PE firms often select the wrong leaders, and don’t recognize the mistake until the opportunity to build momentum for transformation has already passed. It can be difficult to recover from this position because, when the results of transformation projects are disappointing, developing internal support becomes a challenge.

Why Portfolio Companies are Different

The results of a study by McKinsey confirm the idea that PE portfolio companies are differnt. Executives with board experience in both corporates and PE were asked to compare the quality of management in the two contexts. PE companies scored higher overall. The most significant difference mentioned, which we at Career Openers Executive Search also recognize, is the intensity of the performance management culture in PE portfolio companies. KPIs are not only more explicit, they are also more time-sensitive and more closely monitored.

On the other hand, portfolio companies scored lower on two metrics compared to coporates. The first was leadership development: they did not show a capacity to train and promote leaders from within their workforce. The second was governance: Leaders at PE portfolio companies often score lower on governance. In a corporate environment, the field of stakeholders is often less clear and more complex, which drives these companies to set up extensive, formal structures to address governance questions. In contrast, PE portfolio companies often rely on less formal processes in their governance.

Conclusions

So, what are the underlying causes of the differences between leadership in PE holdings and corporates? Two main points stand out in the research. First, the balance between value creation and risk avoidance. While each of these skills has its role in both contexts, PE portfolio companies generally display a relatively greater focus on value creation, and consequently more appetite for risk taking. Second, the leaders of portfolio companies tend to be much more hands-on. Directors in PE firms spend more than 7 (!) times as much time on “the shop floor” as their corporate counterparts. That means a willingness to deal with ad hoc meetings, to answer calls and e-mails from people across the organization, and to spend more time and energy on the informal side of leadership.

Selecting Leaders for PE firms

At Career Openers Executive Search, we regularly work with PE firms and their portfolio companies to identify and recruit the right leaders. As the research would suggest, we find that ideal candidates for portfolio positions differ from ideal corporate candidates. Comparatively high risk and limited time create a more pressured environment; while the smaller talent pool in the organization and more limited systems and processes demand greater self-reliance.

We identified six attributes which, alongside relevant skills and experience, play an important role in how we select leaders for portfolio companies. A good search partner should challenge PE investors if they focus too much on candidates with narrowly corporate experience, who don’t score well on these elements. For candidates with management ambitions in portfolio companies, we believe these elements can guide their leadership development:

• Strong intrinsic motivation to take on hefty challenges in a strict timeframe.
• Hands-on mentality, executive strength and reluctance to delegate.
• Decisive leadership style with drive for performance.
• Adaptive approach to different phases of the hold period.
• Exceptional level of self-knowledge, self-confidence and resilience.
• Strong focus on value creation, cash, data, and problem solving.

From Corporate Leader to Portfolio Leader

On average, candidates with a corporate background score lower on the above criteria. Our PE clients are often reluctant to consider a candidates who are making such a step for the first time, especially for the most senior positions. They see a high risk in a candidate who is unprepared for the environment.

A candidate who had moved from a corporate environment into a small or large medium enterprise (SME) and delivered a good performance there, will be seen as more likely to possess the right attributes. Someone who can combine strong performance at an SME with the foundation in leadership best-practices that corporates offer, will often prove the most promising candidates.