PE is focusing more on how talent development can create value at exit. We look at the important questions companies need to address to help build the right human capital for their next phase of growth. Actively developing top talent and the rising stars below the SLT can yield returns.
Starting early is key.
The economic climate, high interest rates, market volatility and value expectation gaps between buyers and sellers helped make 2023 a difficult year for exits. Many PE houses delayed exit timelines and of the exits that did take place 62% went to trade with only 36% to secondary buyouts. The outlook for exits in 2024 is brighter and McKinsey predicts that within this more positive environment, secondaries will grow.
To maximise exit value, PE will need to focus on more than just financial engineering or the operational and strategic levers of value creation, they will also need to focus on human capital. PE firms that actively build and develop talent in their portfolio companies (portcos) will see higher returns on their investments - effective leadership in portcos can enhance financial performance by up to 15% and increase market valuation by 30% impact on financial performance (Summit Leadership Partners).
PE are now paying more attention to human capital, some creating roles aimed at developing talent within their portcos. However, many investors still undervalue talent’s role in generating returns and this is often because of a lack of expertise in both the portcos and PE senior teams, especially in the low mid-market.
Timing is critical: the best PE houses will see talent as integral to value creation and have talent strategies and succession plans for key individuals from the beginning. This gives buyers and investors confidence and helps mitigate any unplanned management changes, which are often costly. Demonstrating to potential buyers that you have a team that is fit for the future (with successors in the wings) increases value and reassures buyers that the business is planning for the next phase of growth. The talent plan should be integral to strategy and a key feature of the exit plan.
For a secondary buy-out, avoid disruption to the leadership of the portco prior to exit and present a strong team with potential to deliver and scale in a more complex business environment. The SLT (and tier two) needs to be future-ready, with both the motivation and skill set to deliver further growth.
"Asked which levers are most important for creating value in their portfolio companies, PE executives cite leadership effectiveness more than anything else— 70% more often than they cite operational effectiveness."
~ AlixPartners PE leadership survey 2022
How to ensure human capital is future ready?
PE and portcos recognise that talent is critical for success, so what can they do as they approach exit to ensure they are ready for the next phase of growth?
Horizon scan: identify key changes, opportunities and threats in your environment to inform robust and future-oriented people strategies
Define the key value-creating roles throughout the organization—not just at the top and create succession plans
Be disciplined in identifying the skills and capabilities required for the future: look forward, don’t rely on what worked in the past
Use insights from your management due diligence to inform executive development; this should have identified capability/experience gaps within the team
Conduct an independent assessment of the leadership capability against the explicit requirements in the value creation plan. Don’t let power, influence and relationships get in the way. Do this for all the value-creating roles you have identified and focus on tier two leadership to identify potential successors
Engage and align the Board; a strategic and forward- looking Chair can help the SLT ensure they are always looking to develop themselves and their team for the future challenges so they are well prepared for exit
Invest in development opportunities for those assessed as high potential – this need not be costly, apply the 10/20/70 model. Focus on giving high potentials new responsibilities, supported and guided by coaching and mentoring. Use external expertise and give people the scope to learn, even if this means failing in the short term
Keep the talent plan alive - review, align and update the talent and succession plan against the strategy all the way to exit
A good plan takes time to develop and implement. Start now.
"A portfolio company CEO after one year of investment and within a year of exit brings the most disruption to the organisation. Yet 58% of CEO replacements are made precisely within that time frame."
10 Key questions
Does your exit strategy rely on having a strong leadership team with clear successors?
Has your CEO and C-suite articulated their personal goals and ambitions for the future?
Do you have a clear and aligned (PE house and portco) view of the skills and capabilities required for your future leaders?
Do you have a structured process for assessing and developing people in critical roles?
Have successors been identified and developed for these roles?
Which roles have key person dependency and how are these being de-risked?
Is there a contingency plan in case any member of the executive team becomes unable to continue working sooner than anticipated?
Do you know who your stars of the future are?
Are your stars at risk of leaving or are they fully engaged and motivated – how do you know? How will exit affect this?
Is the Board aligned and behind the succession plan?
"The strengths and weaknesses of a company’s human capital and
leadership should become part of the pitch to prospective buyers. An asset that has exceptional value-creating leadership will fetch a better price than one where leadership is little more than an afterthought."
~ HBR 2023
References:
- KPMG Mid-market PE report 2023 review
- HBR Nov 2023 Private Equity needs a new talent strategy
- Critical Eye 2023 Exiting through turbulence
- AlixPartners Annual PE Survey 2022 & 2018
About the authors:
Sandra Aldridge and Alton Ainley are Business Psychologists at Highwire, where they work closely with PE to provide robust and commercial views of management teams within the context of mid-market deals.
Find out how Highwire can help you:
T. +44 (0) 7773 396989