2nd October 2023

Is Private Equity experience a vital component of successful leadership teams in PE backed businesses?

Proven management teams that successfully deliver for their private equity owners often have common attributes and a unique set of skills.  They are also a rare commodity.  Whether or not private equity (PE) experience is a key component in an effective leadership team has been a point of industry contention for years.

Many investors insist on it when appointing senior leaders, but I often work with clients who will place more weight on other factors. Getting it right is arguably more important than ever – industry deal volumes fell by more than a quarter last year, so squeezing as much as possible out of new investments and existing portfolio companies makes all the difference.

During the past four weeks, we asked twenty PE firms for their views on the importance of PE experience in senior leadership teams. While we set out to answer that narrow question, the responses enabled us to form a much broader picture of the methods used by successful companies to build lasting value. Those themes included:

  • Executives without PE experience must demonstrate their ability to be hands on, entrepreneurial, comfortable with ambiguity and balance sheet focussed.
  • The size of the deal and scenario the business is facing must be assessed when deciding whether prior PE experience is important.
  • CFOs must be able to manage debt (often leveraged), handle covenants, manage cash flow, and successfully decide where to best invest capital if they want to survive and thrive.
  • PE is diverse, and the style of the fund will impact the type of leader able to take a business to a successful exit.
  • The best PE execs know how to prepare a business for sale and will be focussed on value creation from the first day.

Using the responses we received, we’re able to highlight seven key questions boards should consider when making senior appointments. The names of respondents have been left out, but we’ve included details of the size and scope of various firms where it was relevant to the question. If you’re interested in exploring these issues in more detail, please drop me a line on nickhart@mcleanpartnership.com or 07961 918 416.

What Experience Does Your Existing Team Have?

Building the right team requires a diverse skill set. Businesses need leadership teams that are strong financially, operationally, and commercially, with expertise spanning strategy, technology, data and other areas tailored to the specific business type. When forming a management team or filling new roles, businesses typically evaluate their strengths and weaknesses, seeking to address any capability gaps. This doesn’t necessarily mean they need PE experience.

However, in scenarios where a business is acquiring private capital for the first time—perhaps through a sale by the founder or a management buyout— it’s often beneficial to augment a management team with no prior PE experience – with a Chair, CEO, or other senior leader that have some PE track record. If the investor’s goal is to prepare the company for sale within five years, transitioning from single-digit EBITDA to something in the 20s, then that often requires someone that has been through the process before.

Another critical consideration for businesses and investors is the diversity of the management team. Research consistently shows that diversity of people, thought and backgrounds drives profits and builds resilient businesses – as my colleague Zoe outlined here. Higher levels of gender diversity of FTSE350 boards, for example, positively correlate with better future financial performance as measured by EBITDA margin. Getting this mix can be just as important as previous PE experience.

How Big Is The Business?

The size of the business in question holds significance, too. An operating partner experienced in mega cap deals told me that the largest deals often don’t necessitate private equity experience. Instead, it’s the mid-cap deals that demand a closer attention to elements like cash flow and covenant management.

A partner from a consumer-focused PE firm, operating in the lower mid-cap space, found challenges hiring CEOs from larger corporates to lead smaller businesses. He believes that those roles demand individuals with hands-on expertise, accustomed to operating at a comparable scale.

One Operating Partner cited an example of a CEO from a multi-billion-dollar US business transitioning from a corporate setting to an early-stage company. This CEO’s success was largely driven by their passion for the product the business was offering. “A lot depends on the person,” he remarked. “Motivation is key, as is having someone to guide the CEO on what they’re committing to.”

Another Operating Partner emphasized the intricacies of integrating a new acquisition into a smaller business. “When hiring an Ops leader for a smaller scale, you’re essentially questioning their capacity for genuine integration and project management.” He noted that individuals from vast corporates often falter in smaller settings due to the absence of extensive teams – “they can struggle to be hands-on and proactive”.

What Scenario Is The Business Facing?

Different scenarios, whether they’re about turnaround, transformation, growth, or stabilisation, demand distinct leadership attributes. Understanding the challenges your team has previously faced can be invaluable in guiding the value creation journey.

A Partner from a large cap firm who recently onboarded a Chief Digital Officer for a major industrial company told me that their primary criterion was someone with experience in a digital transformation journey in a similarly scaled legacy business; Private Equity experience wasn’t a priority.

A deal partner from a mid to large cap firm emphasized the importance of ‘scenario experience’ especially when “things have gone south”, notably for interim positions. He shared an instance where they acquired a business that found itself in financial turmoil. Their response was to appoint an interim CEO and CFO with deep restructuring knowledge, sidelining the need for PE experience. “You’re essentially drawing on scenario expertise. Depending on the nature of the issues, PE experience isn’t always necessary,” he said. If a business is “cash negative or has negative EBITDA, perhaps a candidate from a similar industry or a competitor would fit… Questions like ‘Can they handle Chapter 11, restructuring, insolvency, or a turnaround?’ are pivotal. Such expertise doesn’t implicitly require PE experience.”

A recurring theme among all respondents was the importance of having a team with experience in positioning a business for a successful exit, and having done so at similar scale.

Are There Areas Of Your Team That Really Need PE Experience?

A significant majority of our respondents believed that PE experience is essential within certain sections of the management team, particularly for mid-cap businesses. “How do we professionalise and elevate from single-digit EBITDA to figures in the 20s or 30s? We need individuals who have that expertise,” said one respondent.

The CFO role consistently stood out as crucial for PE experience. As one Partner stated, “There will almost certainly be leverage in the deal, and some CFOs lack the experience in managing debt, handling covenants, overseeing cash, discerning where to best invest capital, and understanding if the Capex will achieve its intended results.” Interestingly, one investor leaned towards hiring CFOs who’ve navigated multiple deal cycles. Another respondent expressed a likelihood to promote a Financial Controller with PE experience over a CFO without one.

A head of talent at a small/growth cap fund said her fund, “prefers Chairs and CFOs who have experienced at least one transaction – that’s pivotal for us.” Another investor commented that CFOs without PE experience tended to have a less impressive track record. However, roles in HR, marketing, or technology could be more flexible in this regard. This sentiment was echoed by a deal partner at a mid-cap firm: “If you come from the corporate sector, having experience with M&A or joint ventures is essential for success.”

Another contributor noted, “Having a CEO with PE knowledge is beneficial, given the swift pace of the industry, decisions and changes need to be made in 60-90 days, they can’t wait a year.”

What Style Of Fund Are You Working With?

The interaction with the PE fund is another pivotal dimension. While some funds take a hands-on approach, others lean towards a more detached style. Often, leaders who navigate these varied dynamics have PE backgrounds, but that’s not a given.

Certain funds are backed by an extensive operating team with diverse functional expertise, while others rely on a well-defined value creation blueprint that they expect businesses to adhere to.

There are also funds that step in predominantly when significant issues arise or if the business deviates meaningfully from its expected trajectory. Recognizing the ethos and modus operandi of the fund is crucial when determining what kind of managerial skills a business should seek.

The timing of the fund’s engagement holds significance as well. As one respondent from a small cap/growth firm remarked, their nature as “patient capital” allows them to overlook the immediate need for private equity experience. For instance, foundational tasks like “maintaining single-digit EBITDA” or “producing management accounts” might not necessarily demand PE expertise.

“A lot depends on the person,” the respondent said. “Motivation is key, as is whether there is someone adequately educating the CEO on what they are signing up for.”

What Character Attributes Do You Need?

Several respondents said that character, adaptability, and a passion for learning in many cases supersede private equity experience. In several instances, corporate executives with a strong character and a proclivity to push boundaries have flourished in the private equity environment.

We also know that businesses seek out leaders that can contribute positively to company culture, whether by reinforcing values already in place, or moving them forward.

One respondent from a small/growth gap fund put it best:

“Whether you need PE experience is the age-old question. So much depends on the deal and the fund involved, but investors know what they like, and it’s helpful when candidates have worked with investors. But so much of this is about character.

“A corporate animal, reserved and introvert? They would probably need PE experience. But someone with 20 years’ experience pushing corporate boundaries? They will do well. There are so many variables, but adaptability and a passion for learning new things are vital, as is wanting to do it and get it right. Doing the work for the right reasons.”

Factors such as the fund’s approach, deal size, organisational culture, challenges at hand, and the existing team composition inevitably influence the kind of leadership style that will resonate.

What Are The Benefits To Hiring Someone With PE Experience?

Being proficient with both the Balance Sheet and P&L often underscores the importance of PE experience. “In my experience, numerous public market executives lean heavily towards P&L and might be uneasy with the ambiguity and rapid decision-making pace demanded by PE,” one respondent told me.

Regarding the necessity for PE experience in interim roles within PE-backed portfolio companies, one individual shared, “I think it’s crucial. The dynamics of the role require executives to make decisions, sometimes with incomplete data and information.”

“In the corporate realm, EBITDA isn’t a typical focal point. However, seasoned PE operators recognize its significance, especially when positioning a company appealingly for potential buyers”.

The choice to embed private equity experience in a leadership team is multifaceted, influenced by various elements: the business’s trajectory, the nature of the fund, and the innate qualities and flexibility of potential leaders, to name a few. The approach should be rooted in a thorough situational analysis and an understanding of the available talent pool, rather than restricting the search exclusively to the narrower realm of PE professionals.

If you are looking to strengthen your management team or bring in additional capability please contact Nick Hart using nickhart@mcleanpartnership.com or 07961 918 416.

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