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Leadership in Private Equity Portfolio Companies

RAINIER BEELEN

For private equity (PE) portfolio companies, leadership is an increasingly important determinant of success. Because these companies are generally not strong in leadership development themselves, there is a strong need for outside leaders, which creates an important selection challenge. Unfortunately, research shows that the quality of this selection of leaders is still often inadequate, with the result that shared goals are not achieved or are achieved later. We would like to share some insights that may help to avoid this situation.

From rationalization to transformation
Attractive financing, above-average market returns, and growing portfolios have, among other things, contributed to the substantial growth of private equity. PE investments are growing fast, and experts say they are going to grow significantly faster still (BCG, 2020). Whereas PE firms in the past often focused on rationalizing – think cost reductions and financial optimization – their portfolio companies, transforming is now a priority. PE portfolio companies are increasingly being acquired with the aim of implementing an intensive transformation. This then involves, for example, radical changes in market proposition, digitalization and culture.

The importance of Leadership
Successful transformation is therefore increasingly central for PE portfolio companies, so it is important to understand how to manage this transformation effectively. Research from Bain shows that one success driver in particular stands out head and shoulders above the rest: leadership.

The impact of leadership on market value has been shown to be as high as 25-30%, and “hold times” (the period during which the PE likes to hold its stake and achieve set goals) can be reduced by as much as half through correct leadership choices, according to research by Prof. Dave Ulrich (Harvard Business Review, 2017). But Bain’s research shows that PE firms often select the wrong leaders to manage their portfolio companies, and that this is often not realized until the opportunity to build momentum for participation transformation has already passed. Selection decisions are often unintentionally made with too little care, and the impact of the decisions leaders make only becomes apparent with some delay. This is particularly unfortunate because above-average returns to the investee company increasingly demand sweeping changes, and when results are disappointing, developing internal support also becomes a tough challenge.

Unique to leadership in PE companies

The results of a study by McKinsey confirm this idea. Executives with board experience in both corporates and PE firms were asked about the quality of management in both contexts (they could compare). PE holdings scored significantly 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, there is also more focus on the timelines within which they must be met and they are also monitored more intensely. However, there are also two elements where PE holdings scored lower: (a) leadership development. PE firms are not very strong in developing their own leaders, and: (b) governance. Leaders in PE participations score lower on governance. The playing field of stakeholders for leaders in a corporate is often much less clear, so there should be much more attention to (formal and informal) interests and their complex management. PE firms often have less formal processes to manage governance. Both require a different style.

So what are the underlying causes of the differences between leadership in PE holdings and corporates? Two main things were said about this: First, the balance between value creation and risk avoidance. While both are obviously important in both contexts, you see a relatively greater focus on value creation in PE holdings. Second, the extent to which leaders spend time on “the shop floor.” An interesting observation is, for example, that directors in PE firms spend more than 7 (!) times as much time on informal hands-on matters, such as ad hoc meetings, phone calls and e-mails, than their corporate colleagues.

Selecting Leaders for PE firms

At Career Openers Executive Search, we select candidates for leadership roles within PE holdings. In our practice, we find that profiles of ideal candidates for these positions often differ from corporate profiles. In the PE contexts we encounter, there is often relatively high risk and pressure, limited time, less talent throughout the organization, and fewer systems and processes to support. Among other things, we recommend that the following six elements play an important role in the selection of leaders in PE. For candidates with management ambitions in PE participations, we believe these elements can guide their leadership development:

  1. Huge intrinsic motivation to take on hefty challenges in a strict timeframe;
  2. Hands-on mentality, executive strength and reluctance to delegate;
  3. Decisive leadership from courage and with drive for performance;
  4. Able to demonstrate adapted style for the different phases of the hold period;
  5. Exceptional level of self-knowledge, self-confidence and resilience;
  6. Strong focus on value creation, cash, data and problem solving.

On average, candidates who only have a corporate background score lower on the above criteria. This is the main reason why our PE clients are reluctant to let such a candidate make such a step immediately. They find the risk of detriment (too) high. If a candidate from a corporate environment has previously made the step to a small or large medium enterprise and has been successful there, she or he has proven to score well on the above 6 elements. The combination of such a move with a solid leadership foundation in a corporate then becomes all the more attractive. Incidentally, a good agency should challenge its PE client if it wants to propose a candidate with only corporate experience who does score well on the above elements.

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