February 12, 2021 – The past year has brought a degree of challenge to private equity that surpasses industry events that have confronted the very best fund and portfolio operators over the last several decades. The spreads between winning and losing decisions have increased dramatically and the variance across verticals and industries are both volatile and more difficult to predict than before. “The battle for capital against a backdrop of unprecedented levels of new liquidity, fiscal policy, geopolitical headwinds and global health risks has created a paradox of the need for greater returns on capital in a context where the certainty of those returns is increasingly difficult to predict,” said Eric Frickel, managing director for executive recruitment firm BrainWorks. “Inexpensive debt exacerbates the edges of this polarity, increasing the temptation to consider leverage to push multiples and yields towards and perhaps even beyond historically typical risk tolerances.”
The confluence of all of these phenomena, indeed, calls for courageous decision making and portfolio discipline to sustain the higher returns of recent years. “Portfolio level and component acquisitions within the portfolio will benefit at this time from discounts on impaired acquisition targets, increased capacity to leverage and increased overall liquidity in the markets,” said Mr. Frickel. “That said, the low cost of debt paired with the uncertainty and unpredictability of returns increases an already challenging polarity for PE firms.”
These days, private equity and venture debt leadership require greater nuance and precision than before the pandemic. “The capacity to discern the myriad ways that COVID and its concomitant disruptions are critical,” Mr. Frickel said. “In the case of analysts and associates, in several industries and sectors, this may be the first time in their careers that tried and true models need to be revised, recalibrated and oriented to the current landscape at the current scale and depth. For portfolio-level leadership, the stakes for making the right call have never been higher. New characteristics will be required including substantive patience, the capacity to impute the impact of paradox and polarity, enhanced risk assessment capacities and a steady hand to keep those assessments in perspective together with a greater capacity to forecast and interpret market signals and activity together with traditional private equity skills.”
A Rare Opportunity
During disruption, said Mr. Frickel, the top one or two percent of private equity talent differentiate themselves even further. Polarity and disruption in the economy further accentuate and differentiate expertise in the industry from the high performing nature that industry lore is made of. “It is in these times that the delta on results between first and second tier talent can be measured in deciles rather than a handful of percentage points,” he said. “Identifying and securing this talent will similarly separate the field. During disruption, some of this top talent will seek alpha by looking for those industry players that are prepared to make the investments necessary to capitalize on the moment. Savvy investors will recognize the rare opportunity to secure top talent that otherwise might be unavailable in the market.”
The challenges of the past year have placed an even greater emphasis on the role of the portfolio chief financial officer. The pandemic requires businesses to have exceptional leaders at the CFO level to navigate the challenges the pandemic has created. “It tested whether there have been strong processes in place to allow companies to accurately forecast and have systems and tools that provide critical insights into operations and key value levers,” said Mr. Frickel. “It has been critical that companies can pivot quickly when the data is suggesting that there are potential pitfalls and opportunities.”
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Top CFO performers scorecard high on competencies such as decisiveness, resourcefulness and perseverance, said Mr. Frickel. They also show a more fluid capacity to assess risk, to calculate impacts of events without recent precedent, to refocus and retrain staff, and to communicate financial objectives and strategies with new clarity and understanding. Additionally, those executives with a well-rounded tool-kit have been paramount in being able to quickly drive transformation initiatives across the business creating sustainable improvement.
“The CFO is no longer the role of being highly competent in reporting and/or FP&A,” said Mr. Frickel. “Great CFOs are highly adept in operations, IT and have a strong grasp of the commercial side of the business. Some have also had to take over HR. They require the ability to partner closely with other business leaders so that finance is embedded into every aspect of the business. Additionally, many businesses have had to refinance over the past two quarters and CFOs that are highly adept with treasury, managing lender relationships and have detailed forecasting processes to make lenders comfortable have been critical,” he said. “Finally, there has been significant movement towards excellence in the integration area. There has been a strong need for CFOs to be able to execute M&A transactions leveraging their developed playbook on integration.”
Caught in Limbo
For the first half of 2020 executive search volume could be described by searches geared towards quickly changing out leaders that were not driving value or persevering through the pandemic, said Mr. Frickel. “On the candidate side, many executives were caught in limbo and pondering whether they should stay and wait it out as exits were put on indefinite hold or pursue another opportunity where a potential liquidity event was nearer or had more economic upside long term. Several companies may take years to recover from this event or require pivoting their business models such as those in brick and mortar retail.”
“However, some sponsors have seen their portfolio do a complete 180 as they were heavy in food and packaging, have strong e-commerce models, and or within verticals associated with cleaning products or hygiene,” said Mr. Frickel. “Industrial services saw a tremendous amount of volume given the fragmentation and the ability to easily scale via M&A. Overall, we have seen good volume in E-commerce, SAAS, industrial services and packaging.”
Last year, deal flow eventually came back very strong for a number of sponsors as many deals had been put on hold when the pandemic started. Bankers and intermediaries were sitting on CIMs ready to go to market. “If not for the pandemic, it would have been a record year in terms of successful exits,” said Mr. Frickel. “New deals are starting to emerge as well.”
A Recruitment Slowdown
Private equity investment team recruiting, meanwhile, saw a significant slowdown. COVID-19 delayed the summer 2022 associate recruiting cycle. Prior to COVID, it had been steadily moving up, reaching a height in 2019 starting in the fall. “Many firms decided not to recruit in 2020, and several processes that were in progress had been put on hold over the summer,” said Mr. Frickel. As with 2020, 2021 is expected to see a lot of off-cycle hiring as firms will go back to market when deal flow returns. “We are already seeing that happen with timing shifts mirroring the return of deal flow and demand for unfulfilled capacity returns,” he said.
Last year also saw the continued emergence of private equity portfolio operations and transformation groups. “Sponsors are continuing on this trend and we are seeing operations teams starting to scale with levels similar to that of investment teams with emphasis on roles at the principal, vice president and associate levels,” said Mr. Frickel. “Each group tends to have its own niche and preference as to the types of people they prefer typically based on the investment strategy, size and sector focuses. We have been active in recruiting strategy consultants, corporate leadership development groups, and restructuring/turnaround professionals. We see this trend continuing as firms need a distinctive value creation strategy to win deals, drive top returns and separate themselves from peers.”
The times are both trying and exciting, said Mr. Frickel. “In over two decades of working both within the industry and in service of its success, I can remember few examples where the value add of differentiated recruiting is so clear,” he said. “The opportunity to revisit, reanalyze and refine candidate scorecarding and success characteristics is exhilarating and seeing my partners at every level of the industry adjust and return again to fantastic success makes each day more compelling.”
Contributed by Scott A. Scanlon, Editor-in-Chief; Dale M. Zupsansky, Managing Editor; and Stephen Sawicki, Managing Editor – Hunt Scanlon Media