Transforming Portfolio Companies and Driving Value Creation via Human Capital

February 7, 2023 – At the beginning of last year, Gartner predicted a 20 percent rise in turnover rate across industries. Heightened inflation, rising interest rates, post-pandemic priority shifts, and hybrid work preferences have created a fierce scrimmage for companies worldwide trying to hire the people necessary to drive long-term profits.

These challenges are compounded for private equity firms with numerous portfolio companies, according to a report from JM Search’s Trista McCarthy. “Aside from achieving sustainable growth, your team is tasked with ensuring that each company in your portfolio can hire and retain talent for everything from line-level openings to vacancies in the boardroom and C-suite,” said the study. “Because at the end of the day, a healthy EBITDA and proper valuation are only possible with the right people in critical positions.”

This very topic was a key discussion point at the recent Private Equity Chicago Forum, where PE industry experts meet to discuss topical opportunities, trends, and challenges of investing in private markets. “During the event, I had the pleasure of facilitating a panel discussion on how leading funds are creating value and transforming portfolio companies via human capital,” Ms. McCarthy said.

Ms. McCarthy offers advice on what you should know about how private equity firms are approaching talent management to improve performance across fund life cycles, as well as enhance portfolio company valuation: 

1. Incorporating Talent Management into Due Diligence

The due diligence process is reasonably comprehensive. “The funds, time, and resources allocated for PE associates to identify and articulate the target company’s industry positioning, debt/equity ratios, competitive dynamics, technology, and other qualities mitigate the investment risk for a portfolio company,” Ms. McCarthy said. “However, talent isn’t always assessed or quantified during the valuation process.”

Trista McCarthy is a partner at JM Search and co-leads the firm’s go-to-market team. She has over 25 years of experience in executive search, human resources, and brand marketing. She focuses on recruiting C-suite executives and senior leaders across the industrial and services sectors, with a functional specialization in marketing. Ms. McCarthy supports large public clients and mid-market private equity and Family office-backed businesses.

So, why aren’t we treating talent like any other due diligence KPI? Ms. McCarthy notes that employee satisfaction, quality of hire, and retention rates determine operational continuity and post-acquisition success. “Assessing talent early in the process is critical and making informed talent changes within the first year is imperative,” she said. “Metrics like cost-to-hire or time-to-hire show the health of talent acquisition or the market challenges you’ll need to overcome. These and other talent measures highlight two key lessons: monitor existing talent at the start of an investment and have a plan for making talent upgrades or new hires to rectify any shortcomings of the organization.”

Often, a CHRO can help achieve this level of due diligence but not all mid-market PE-backed businesses have a CHRO, according to Ms. McCarthy. “The pandemic revealed the strategic evolution of the HR function in private equity,” she said. “Additionally, it showed how the C-Suite needs leaders who will prioritize human capital and use data provided by target portfolio companies to maximize the outcomes and performance of talent acquisition.”

2. Creating a 100-Day Plan to Resolve Key Questions

The early days after an acquisition are critical to the scalability and the future valuation of your asset. Ms. McCarthy notes that growing companies need the perspectives and momentum from the outset to accelerate the speed of improvement, dictate KPIs, and align talent with any directional changes necessary to scale. “If these are not present within the first 100 days, there’s a risk of stunting the acquisition’s growth, which can cascade outward and lower valuation,” she said.

Related: Retaining Your Employees During the Great Resignation

The focus of your post-acquisition plan depends on three key questions: what are you solving for, what are the biggest gaps, and how can you resolve the two to increase the internal rate of return (IRR)? “Those are not meager questions, and even if founders can articulate their goals and gaps, they might not have the observations and knowledge set to lead the transition,” said Ms. McCarthy.

For example, the CEO of a medical tech company might have ideas to optimize their product lines but not how to take the next steps. Or the president of a promising subscription service might grasp market challenges but may not know how to outmaneuver the competition.

“Your firm’s talent pipeline can and needs to draw in executive-level leaders who can create the right 100-day plan,” Ms. McCarthy said. “This flexible blueprint, one that provides structure but reliably evolves, requires the presence of C-suite members with experience ushering portfolio companies into the next stage of maturity. Essentially, these leaders need to set the tone and, if necessary, collaborate with preexisting executives and PE leadership to reengineer any processes that prevent the scaling necessary to meet your metrics.”

3. Determining the Potential Impact of a C-Suite Candidate

Adding an executive or board member for a portfolio company is a transformative action, according to Ms. McCarthy. “Members of the C-suite reshape businesses in ways that have serious repercussions for their sustainable performance and profitability as well as their growth rates and valuation,” she said. “Whether those changes are positive or negative depends on careful consideration by private equity firms about how potential candidates complement or uplift the preexisting company culture.”

Ms. McCarthy compares the process to a chemical reaction. Is the person you hire going to bring out the best elements to create something new? “There is no universal answer,” she said. “Some organizations will benefit from leaders who possess prior experience in the C-suite role and industry; others will thrive under the guidance of dark horse candidates who quickly adapt, act with urgency, and keep the team dynamic in mind.”

Technology, Quality, and Quantity in Private Equity Recruiting
In a new report, BrainWorks looks at the recruiting industry’s embrace of technology to help meet the continuing demand for talent. “Finding and engaging talent continues to be the top challenge for staffing agencies,” said the study. “With the labor shortage, it’s no surprise that high-growth firms report using technology tools to attract and retain the best talent.”

Ms. McCarthy notes that another important question to ask is “Are we hiring a leader who can help to develop more sustainable operations that can deliver reliable dividends for the firm, LPs, and shareholders?” “Portfolio companies are better equipped to scale and grow when there’s alignment and collaboration between the PE firm and existing management as well as any new executives who are brought to the table,” she said.

4. Identifying Key Gaps

Scaling any business beyond initial growth requires businesses to close the gaps in their own strategies and capabilities. The founder may have an exceptional wealth of ideas, have an exceptional go-to-market strategy, and comprehend how to create a product or service that the general market or their niche audience wants. “What they often lack is the perspective to elevate the company beyond middle market stature and a wide spectrum of C-suite roles can help to remove those barriers,” said Ms. McCarthy. “Hiring the right balance of skills and experience to round out the C-suite is critical.”

Moreover, conducting 360-degree feedback assessments or identifying operational silos can provide a checklist of organizational deficiencies for executives and board members. “Whatever is preventing your ability to scale operations and profits to your target level is where you need to have top-down expertise that can surmount the hurdles to your funded businesses,” said Ms. McCarthy.

5. Hiring Board and Advisor Members Who Can Yield Growth

With the intent of maximizing profits over a fixed three-to-five-year period, you need a board that is capable of not only prioritizing fiduciary obligations but also guiding big picture decisions that augment executives and directors’ experience.

“Again, the selection process should evaluate the right qualities,” Ms. McCarthy said. “Does a potential board member grasp the intricacies of the portfolio company’s industry? Do they know how to augment the strength of leadership? Will they speak with candor and assert their expertise in tricky situations while also acting like a team player? Finding an A-team of board advisors can prove challenging for organizations but assembling them early allows your portfolio companies to surmount hurdles and evolve their playbook with developing circumstances.”

Related: Hiring Top Talent in Unprecedented Times

Contributed by Scott A. Scanlon, Editor-in-Chief; Dale M. Zupsansky, Managing Editor; and Stephen Sawicki, Managing Editor – Hunt Scanlon Media