Choose carefully: Private equity growth is fueling more interest in portfolio company leadership roles, but not everyone is a good fit. With money pouring into private equity funds, the general partnerships and their portfolio companies have become magnets for everyone from new M.B.A. graduates and ambitious corporate executives, to high-profile business leaders, such as Lou Gerstner, Jack Welch and Jacques Nasser.
In many ways, it is not surprising that private equity roles have become so appealing. One obvious attraction to private equity is the potential for a large financial reward. Entrepreneurial-minded executives often are willing to exchange the relative security and longevity offered by corporations for an equity stake in a portfolio company and the possibility of a large payout following the company’s sale or public offering.
Another attraction is the relative freedom from the kinds of quarterly financial-reporting requirements of a public company and, now, all the expense and preparation required for compliance with Sarbanes-Oxley. With incentives freed from quarterly demands, these CEOs typically can take a longer-term view of the company.
Moreover, a portfolio company’s well-defined end game and smaller size can make it easier to mobilize the organization to accomplish its goals and make decisions quickly. As one experienced portfolio company leader says, “A private equity portfolio company allows for the CEO to be more aggressive and take a more radical restructuring stance in trying to fix a company, which would be almost impossible to do with the same rigor and speed in a public organization.”
This growing interest in private equity leadership opportunities by top executives from the corporate world is a welcome development for private equity firms, which require strong, effective leadership for their investments to be successful. After all, experienced corporate executives typically have exceptional training and education, have broad operational and functional experience and have extensive knowledge about the industry dynamics and challenges.
Unfortunately, a large number of executives who thrive in a large public company environment ultimately fail in their first private equity portfolio leadership role, discovering too late that they are unprepared for the vastly different challenges of private equity, including the consequences of the company’s leveraged position. Also, some also find they are better suited for roles in larger companies with more resources and a more familiar set of expectations.
But how can private equity firms recognize which leaders are likely to thrive in a portfolio company environment? Investors can improve their chances of hiring successfully by understanding the skill-sets required for portfolio company leadership and the professional background more likely to breed success in the private equity environment. When trying to identify candidates for private equity, it is also helpful to understand the unique challenges of portfolio companies.
In the majority of cases, private equity companies have high levels of debt, requiring constant attention to cash flow, spending levels, debt repayment and financial targets in order for companies to achieve their financial milestones and, ultimately, their exit strategies. As a result, “cash is king” at portfolio companies, so quickly increasing revenue and tightly controlling costs are top priorities for their CEOs. They often have to make quick and difficult decisions to cut costs and preserve cash. The attention to cost-cutting also means that portfolio company CEOs often have to do without the perks of the title — that may mean taking a seat in coach rather than a private jet.
Portfolio companies also have fewer human and financial resources. When pursuing new strategies or launching new products or marketing initiatives, these businesses do not have the deep pockets of a large corporation behind them. Furthermore, without the reputation and global brand of a major corporation, portfolio companies can have a harder time attracting top talent under the CEO.
Recognizing the Portfolio Company Leader
The executives who most successfully make the transition to private equity portfolio companies, including management buyouts and corporate spin-offs, typically are change agents – problem solvers who have P&L and balance sheet savvy, coupled with a sense of urgency. They are able to adapt quickly to new environments, different leadership requirements, the unique ownership model and a higher degree of board oversight. With smaller staff and fewer “experts” in any one discipline, they must have a broad grasp of all the functions of a business and be willing to make many decisions that might be more easily delegated in a public company.
Because of the debt load, portfolio company CEOs must possess particular financial knowledge and experience. Successful portfolio company CEOs also must excel at setting priorities and efficiently allocating resources. They must know how to manage high debt and reduce costs, understand pricing strategies and be comfortable reaching out to capital markets. In fact, the private equity firms we work with routinely ask us to identify candidates who have had exposure to a high-debt environment and, ideally, experience in a private investor-backed business. One private equity partner observed that the individuals he has seen fail in portfolio company leadership had difficulty adapting to the relative lack of resources compared with public companies, or were slow to make tough, but important, decisions.
Equally important to their financial and operating experience are executives’ leadership skills. Private equity CEOs must keep the organization focused on executing key priorities, and must be willing to roll up their sleeves to get the job done. At the same time, employees look to the CEO for personal guidance and leadership much more than within the traditional Fortune 1000 company, and they frequently test the CEO’s values, intellect and decisions.
The private equity CEO often is reliant on a small, highly-focused team that may lack the perceived star power seen in bigger companies. Thus, the CEO’s passion and ability to sell his or her vision for the company — both the strategy for building the company and the potential financial reward for success — is crucial. The portfolio company CEO also must demonstrate a passion for the business, have a clear picture of the company’s future that will excite others and be able to spell out the compelling rewards stemming from a potential success.
The supply of experienced portfolio company CEOs being limited, most investors must expand their search for portfolio company leaders beyond those who already have led a successful private company. Often, division heads or corporate “entrepreneurs” bring exceptional industry and management experience and, when they are a good fit culturally and their transition to the private equity world is well managed, they can become successful CEOs.
To improve the odds of finding the right candidate, private equity or venture-backed organizations should look for individuals who have demonstrated an entrepreneurial bent throughout their corporate career. For example, entrepreneurial individuals often are given international assignments, which tend to be much more decentralized and include full P&L responsibility and functional oversight. Frequently accepting new assignments within an organization is another sign that an individual has benefited from incremental leaps of opportunity and has achieved broader leadership success over all functions. Executives who have taken these entrepreneurial roles, which often are riskier and in less-than-ideal geographies, have tested their leadership skills and adapted to different cultures and environments.
While private equity leadership roles can provide dramatic rewards for those who are successful, they are not for everyone. First-time portfolio company CEOs, particularly those who have spent their careers in the corporate world, often struggle with their first private equity assignment. Managing in a high-intensity environment with cash constraints and fewer resources than they are used to requires skills that are not necessarily learned or rewarded in corporations — a desire to seek out and drive change and a willingness to live on the edge. Executives new to private equity need to understand the trade-offs and evaluate whether their experience and preferences represent a good fit for a private equity role.
Private equity partners know that the success of their investments is dependent upon having the right leadership. Corporate leaders who possess strong operating experience and keen financial knowledge can be effective leaders of portfolio companies. Private equity firms can help ensure they have the right leaders by digging deeper into the qualities and competencies — including comfort with risk, entrepreneurial orientation and personal leadership style — that distinguish exceptional portfolio company leaders.
Gil Stenholm is a consultant at Spencer Stuart, who has worked with private equity firms to recruit portfolio company CEOs and senior executives for more than 10 years.