3 Qualities Private Equity Companies Seek When Picking Portfolio CEOs

June 19, 2020 – Private equity firms conduct rigorous due diligence in assessing acquisition targets. Those with the best track records place high trust in their ability to size up a prospect’s financials, operations and market position. But many mid-sized PE firms are less successful in choosing the CEOs who run their portfolio companies. One study of PE firms, in fact, found a little less than half had to change the CEOs who ran their portfolio companies.

Thinking, Building & Developing

How does this happen? According to a report by FMG Leading, a business and human capital advisory firm, “Investors can overlook three leadership skills that are crucial to rapid, profitable growth: thinking strategically and systemically; building alignment and commitment to the firm’s strategy; and developing essential team members.” PE firms with solid track records of turning around or accelerating already-growing businesses in a short period of time have a well-developed knack for choosing businesses with great growth or turnaround potential. “In short, they buy right,” said the report.

‘Buying right’ has become more important in recent years for PE firms, yet also more difficult, said the study’s authors, Matt Brubaker, FMG Leading’s CEO, and principal MaryCay Durrant. In addition to facing increasing competition on deals, many PE firms struggle to determine whether they have the right CEO for the job.

“Whether or not a company is owned by a PE firm, its CEO has a massive impact on performance,” said Dr. Brubaker. And a delay in replacing an underperforming or ill-equipped CEO can be costly. Larger PE firms are more likely to be prepared to evaluate CEOs and CEO candidates. “They have developed the infrastructure to employ seasoned HR experts, resources and processes to incisively size up their portfolio firm CEOs,” said Ms. Durrant. “However, midsized PE firms typically lack the resources and don’t have the time to develop proprietary tools in the human capital arena.”

Both experts said they were not surprised that many midmarket PE firms struggle to assess the CEOs of their portfolio companies. “Good investors trust their instincts, and often those instincts are sound,” said Dr. Brubaker. “But relying only on those instincts alone can be faulty, as the statistics on CEO turnover at PE-backed companies demonstrate.”

The unique demands that PE firms place on their portfolio companies, they said, require CEOs who excel on three fronts:

1. Combining Strategic and Systems Thinking

PE firms need CEOs who can help them plot a new, faster-growth course for the companies they buy. “Strategic skills are a given,” said Dr. Brubaker. “But CEOs must also be able to get beneath the bold strokes of a new growth strategy. They must be able to identify and orchestrate the process and people changes needed to pull it off – i.e., the larger system dynamics.”

The top component of a strategic and systemic thinker is the ability to balance strategy and tactics – the big and small picture. This is often missing in founder CEO who have successfully built and sold their firms to PE companies. The skills to scale that firm for rapid growth – a firm that will become far more complex to manage – are very different. “Those skills are about understanding how to make the key working parts of the organization function together like a well-oiled machine,” said Ms. Durrant.

2. Building Strategic Alignment and Commitment

Every company, PE-backed or not, needs the top team and the managers below them to be aligned on the firm’s strategy and be clear on how to execute it. CEOs of PE-backed companies face even more urgency to ensure their management ranks are aligned on the strategy. The systems, processes and cultures of PE-owned companies must be clarified and scaled much faster for rapid growth in a five to seven-year timeframe.

“To accomplish that, the CEO must be able to communicate clearly, make sound decisions collaboratively, and be a solid business planner,” said Dr. Brubaker. “When a CEO is strong in these areas, he enables others to climb the mountain with him – to do the work and be committed to excellence.”

“The best CEOs know they have far more impact when they equip and empower others to execute successfully,” said Dr. Brubaker. “Their thinking differs from the CEOs who believe they contribute most by focusing on the excellence and capacity of their own execution skills. This type of CEO often feels the need to continually demonstrate their competence. With an insatiable desire for personal recognition, they unconsciously discourage others from participation.”

3. Developing Others on the Team

PE-owned companies too often overlook talent development. Because of the short timeframe in which they hold their portfolio companies, investors may view time dedicated to executive development as a luxury. In addition, the investment required to truly develop talent can be hard to validate using short-term ROI metrics. PE firms frequently view hiring as the answer to talent shortages. Why take months or years to make an executive more effective when you can simply hire new talent?

“The best-run PE-owned firms we’ve worked with emphasize both talent development and recruitment,” said Dr. Brubaker. “When they develop talent, they do it wholeheartedly and strategically. They focus on skills they believe are crucial to their competitive advantage and not widely available in the marketplace. In other words, they are huge proponents of talent development – but are usually quite selective of which individuals and which skills they develop.”

Share This Article


Notify of
Inline Feedbacks
View all comments