July 28, 2021 – There have rarely been two industries more compatible than private equity and executive search. According to Mike Myatt of N2Growth, PE firms are adept at identifying and monetizing synergies that fall within their investment guidelines, but they are curiously less skilled at taking advantage of enhanced value creation opportunities amplified through professional services relationships. “I can remember back to the wild-west days of private equity when PE firms were few and investment opportunities were plentiful,” he said. “These were the days when the buy-side called, and the sell-side answered the phone. PE firms were less structured in approach, valuation models were squishier, the valuations generally higher and competition was scarce. Those were the days.”
A lot has changed in recent years with regard to the complexity of maximizing returns on investor-backed companies, according to Mr. Myatt. There’s obviously more money chasing fewer deals, but more specifically, smarter money is chasing shrinking deal flow. These days diligence is more diligent, both structure and pricing of valuations are tighter, and as with all good asset classes, the yields get squeezed as markets mature.
Winning the Talent Game
“I’ve worked in and around the PE and VC communities for years,” Mr. Myatt said. “I’ve been a principal in buy-side and sell-side transactions and have also represented both sides as a professional advisor. I’ve witnessed average talent crater sound investments, and tier-one talent maximize sub-par investments. When I look across portfolio investments with PE clients, it’s quite easy to determine what separates the overperforming investments from the underperforming ones – the people. Even if a certain industry, segment, or vertical is struggling, great talent will overcome those hurdles and outperform the competitor set.”
Smart PE firms have learned to bet on talent as the primary driver of the investment thesis. In fact, according to Mr. Myatt, talent has become the investment thesis for many PE firms. “The best performing PE firms spend just as much time underwriting and optimizing talent as they do in financial engineering,” he said. “They have learned that organizational design, culture shaping and leadership development matter just as much quant gymnastics. Even the strongest investment thesis and business case can quickly become eroded, if not altogether unwound, by underperforming humans.”
Mr. Myatt says the problem is that while executive search and private equity should be great dance partners, the simple truth of the matter is that most PE firms fail to show up to the dance. There are PE firms in the market that have large numbers of portfolio companies that try to solve the talent needs across the portfolio just by working their network. “If it wasn’t so sad,” he said, “it would be funny.”
Not a single sophisticated commercial client across any of the Global 3000 would take such an approach. “They would view it as an exercise in frivolity at best, and as an irresponsible breach of fiduciary obligation at worst,” Mr. Myatt said. “Corporate clients understand that the creation of competitive advantage is found in winning the talent game, and that this occurs most often when you increase the number of resources used to create a rigorous, exhaustive, comprehensive go-to-market strategy for talent. The goal is to expand your options for talent, not limit them.”
“I recently spoke to the head of talent acquisition of a smaller-ish PE firm with 30 portfolio investments,” Mr. Myatt said. “When I asked how big his team was, he answered, ‘I am the team.’ Even more interesting is that on the PE firm’s website they list one of their key differentiators as helping portfolio companies attract talent. The disconnectedness here is mind-numbing, but not unusual in private equity.”
The good news is that some PE firms really do get it. In a recent conversation with Matt Breitfelder, CHRO at Apollo Global Management, Mr. Myatt said they spent the majority of the time talking about talent as a driver of investment performance. “Matt is one of the most insightful CHROs in the private equity space, and he understands that Apollo’s ability to attract, coach and develop executive leadership talent has a disproportionately positive impact on Apollo’s investment success,” Mr. Myatt said. “While more and more private equity firms are adopting a mind-set like that, most are still not there yet. The problem with many PE firms is that while they are exceptional in financial diagnostics, they are less than exceptional in human diagnostics.”
Their financial risk management strategies are well designed, he said, but their human risk management capabilities are less refined. “It’s naïve, costly, and it’s also a competitive disadvantage for PE firms to overlook the many benefits the right executive search partner can offer them,” said Mr. Myatt. “Beyond straight retained search, let’s take a look at a few specific solutions available to PE firms that could make a difference for private equity firms looking to upgrade their talent game.”
Proactive vs Reactive Talent Strategies
“I can’t even begin to count the number of calls I’ve had from PE firms that have a new deal in play and they’re running around with hair on fire at the eleventh-hour scrambling for talent,” Mr. Myatt said. “Sound familiar? The smarter solution for PE firms would be to stop the frenzied, last-minute scramble for talent and partner with search firms to create a curated talent pipeline that is ready on demand.”
Mike Myatt is founder and chairman of N2Growth. He is a leadership advisor to Fortune 500 CEOs and their boards of directors. He has worked directly with hundreds of public company CEOs and board members globally, and his representative corporate clients include Accenture, AT&T, Bank of America, Deloitte, EMC, Humana, IBM, Lincoln Financial Group, McGraw-Hill, Merrill Lynch, PepsiCo, and other leading international brands.
At N2Growth, the firm offers a Talent as a Solution (TaaS) service specifically designed to create talent on demand for PE firms. “We take the PE firm’s investment guidelines (industry focus, geography, company size and stage, event horizon, etc.), current portfolio holdings and targeted number of near to mid-term investments, and map them against the market to create real-time, curated talent pipelines for key roles.”
The result is that when a PE firm needs executive talent (board member, CEO, CTO, CFO, CPO, CRO, CMO, etc.) N2Growth can immediately deliver candidates who have been pre-vetted against their specific needs/criteria/requirements, and who have already provided an expression of interest in the PE firm. “There is no need to kick-off a cold search from scratch as all the work has already been done,” Mr. Myatt said. “There are few things a PE firm can do that will generate more return on invested capital than maximizing talent opportunities.”
When PE firms begin to understand that unleashing human capital to unlock hidden value in their investments is the ultimate force-multiplier on financial capital, good things start to happen.
“I recently keynoted at a PE firm’s annual CEO summit where they brought together all their portfolio CEOs for two days of collaboration about what is, and is not, working across their portfolio,” said Mr. Myatt. “I had initially assumed this was a regular event, only to later find out that this was the inaugural event. I probed further to ask if they considered holding similar events for the balance of their C-suite teams and other executives in charge of key functions/roles across their portfolio companies. The answer was interesting: ‘Wow, we hadn’t thought about that.’”
When we look at private equity portfolios, we universally see the same thing. Every PE firm has investments that perform at expectation, outperform expectations, and underperform expectations, said Mr. Myatt. “The bad news for PE firms is that underperforming investments are the largest part of every PE portfolio,” he said. “Clearly, not all investments will pan out, but quickly identifying and triaging the underperforming portfolio assets can have a huge impact on not only stabilizing, but actually boosting overall fund performance. This is very low-lying fruit that isn’t harvested nearly as often as it should be by private equity.”
Mr. Myatt said the irony of the cognitive dissonance of PE is that when you ask any managing director of a PE firm about their best performing investments, they quickly tell you about the rock star CEO who outperformed expectations. “If you ask that same MD about their worst performing investments, they also quickly point the finger at the CEOs who failed to execute,” he said. “The best exits are less about market timing, but rather navigating to the right place in the market, which require insightful, driven, committed talent. Without the best talent you’ll inevitably always find yourself on the wrong side of market timing. But for the people there are no products, services, sales, technology, platforms, brands, customers, etc. It’s always about the people.”
Spotting Warning Signals
Mr. Myatt points to one last example of the impact of talent on investment performance: “We had a PE firm looking at what they considered to be an attractive investment play,” he said. “They liked everything about the deal. I asked them about how the diligence was conducted for the leadership team and other key roles, and after hearing their answer, I suggested our process might be a bit more enlightened. The PE firm agreed and engaged us to help them assess leadership, culture, team dynamics, and organizational design. We quickly spotted inconsistencies that led to uncovering financial improprieties the PE firm missed in their financial diligence. We also spotted other warning signals that didn’t get picked up the first time around.”
“Rather than go pencils down, the PE firm lowered their offer by nearly $25 million which was eventually accepted,” Mr. Myatt said. “We then were engaged by the PE firm to replace the CEO and CFO. We also placed a chief strategy officer, and two new board members. Additionally, we provided CEO coaching and board advisory work. The PE firm exited the investment in 23 months, nearly two-years ahead of proforma event horizon at a nearly three times the expected return on investment.”
PE firms can either put people in boxes, or free them from boxes, said Mr. Myatt. By not leveraging people, but creating leverage for people, PE investments become scalable with greater impact and velocity. “Capable executive search firms serve as thought partners for their PE clients and can simply make the PE journey faster, smoother, and more financially and emotionally rewarding,” he said.
Mr. Myatt’s conclusion is this: The private equity firms that believe talent to be their investment thesis will outperform legacy-based investment theses largely based on financial engineering. “Talent is the ultimate value creation engine – this is incontrovertible. I’m encouraged by the numbers of PE firms that are beginning to understand the value creation amplification that executive search firms can offer,” he said. “I look forward to meeting more PE firms on the dance floor in 2021.”
Contributed by Scott A. Scanlon, Editor-in-Chief; Dale M. Zupsansky, Managing Editor; and Stephen Sawicki, Managing Editor – Hunt Scanlon Media