As new funds get raised and GPs that built the firms age, some industry forebears avoid looking the beast in the face while others intently stare it down. Although succession has always been an issue on some level, it’s been thrown to the fore recently by unprecedented levels of fundraising. LPs that want to know who will be in charge of their investment 10 years down the line are confronting with new vigor the Shakespearean question of how easy lies the head that wears the crown?
Moreover, what grows must be institutionalized. The private equity industry of today is no longer led by a handful of charismatic, pioneering entrepreneurs. Rather, the new era of private equity more closely resembles most other sprawling asset management, banking and advisory institutions.
Just last year, one such entrepreneur, Ted Forstmann, called an end to Forstmann Little & Co. Though he still manages a few portfolio companies, the firm will not be out fundraising again and the partners have already left. Some speculate Forstmann had no interest in seeing the firm live on after him, especially when the private equity marketplace had become much more crowded since his heyday in the 1980s and 1990s.
On the topic of succession, “Everyone talks about Teddy,” says one former associate. Another pro who worked with Forstmann, however, lays blame on external factors that led to the firm’s demise, rather than an aversion to succession planning. Namely, the source cites the sudden death of firm co-founder and Ted’s brother Nicholas Forstmann in 2001, as well as Ted Forstmann’s increasing involvement with the Children’s Scholarship Fund and the highly publicized lawsuit brought against the firm by the state of Connecticut. Whatever the reason, Forstmann Little will not live on.
For founding fathers elsewhere, things have taken various routes. It appears that only wild horses could drag Henry Kravis and George Roberts from Kohlberg Kravis Roberts & Co. It was no surprise then in September that two very senior executives, Ned Gilhuly and Scott Stuart, who were leading candidates to take over the firm, abruptly quit.
Thomas H. Lee Partners, meanwhile, has survived, following an amicable and long-planned end to Tom Lee’s connection with the firm he founded in 1974. Lee has had a reduced role for years and turned the firm over to Scott Sperling, Anthony DiNovi and Scott Schoen. Lee has since started over with a new firm, Thomas H. Lee Capital.
What’s Good For The Goose
A doctor’s children, the old saying goes, are the least well cared for. Carl Tippit, a managing director at fund-of-funds Peppertree Partners, said there is great irony in the difficulties of the succession process. Though deal pros are adept at giving advice to and planning the future for their portfolio companies, they often can’t turn the critical eye inward.
Further, there’s so much ego in the business, Tippit said, it’s hard to advise private equity leadership on how they should do anything—apropos of succession or any other issue. Always ready to unload a portfolio company’s management team wholesale if need be, leaders of private equity firms often send the message that they will only be carried out of their firm on a stretcher.
Of course, it’s not always so difficult. With that said, any transition of leadership is bound to be long on time and heavy on negotiation. Take it from a few partners involved in it now. Linsalata Capital Partners Senior Managing Directors Eric Bacon and Stephen Perry are knee-deep in the process of taking over the firm from Founder and Chairman Frank Linsalata. Over the last few years Bacon and Perry have been hammering out the details of how the transition would take place, a process that may take 10 years start to finish, given the long-tailed, illiquid nature of this business, said Bacon.
In the past 18 months, Bacon, 48, and Perry, 51, have had their roles at the firm boosted so they now sit equal to Linsalata, 63. Part of the negotiation included deciding which issues would take a unanimous three man vote and which only needed two thirds. Hiring someone, for example, needs all three. The process began five years ago, said Bacon, as Frank Linsalata kicked off the discussions, after some thinking over his legacy and how the firm would survive.
So what does succession come down to? “Ego, greed and trust,” said Bacon. “You gotta check your ego. It’s like a marriage. It’s a partnership that has boundaries in how you support each other.”
One partner at another firm, who is in his early 30s, is taking part in talks with LPs about succession plans as the firm is in the midst of raising a fund. The partner didn’t want to be quoted because of the sensitivity of the issue at the firm. The source described how the younger team has become the driving force for deal making and because of that has considered splintering off. The younger team wants a bigger economic stake as well as recognition.
But it’s not always that easy. They face the problem of being a “nobody” raising a first time fund. Also, the group recognizes that the brand of their current platform has value, and often the firm will get calls out of the blue, simply based on brand recognition.
“What you weigh is the value of that platform versus the cost of that platform, which is what you give up to the founders who are taking less and less of a role,” the source said. “Typically a transition happens over the course of a fund or two, where they ratchet down their economics and others ratchet it up, and that’s the purchase price of the platform.”
To LPs, “this is the issue,” he said. “They’re saying, ‘Fine, you generated the returns, but the question is who did it and are they doing the same thing in the next fund. That’s the most important thing to them: who’s in and who’s out.”
LPs Force The Issue
Loren Boston, head of origination in the private placement group of Merrill Lynch, agreed. “It’s a huge issue. It can kill a fundraise.” Boston said he likes to see senior members of a firm transition out over the period of a few funds. Step one is the founder taking an “elder statesman” role. “People try to make the change six months before they start fundraising. It’s just too late.”
Tippit agrees, saying that after a firm passes the IRR litmus test, next in importance is succession. Who is generating the critical investments? What is their desire to stay in the business? When are they going to retire to Montana? “We make a calculated risk on how much time they have left,” said Tippit. “At a smaller firm, it’s a big deal, whereas at a Bain, if one of the partners left, it wouldn’t move the needle.”
Bart Shirley, head of fund-of-funds operations at Key Principal Partners, said in the last three or four years particularly, succession has become a critical issue, though it remains more poignant at venture capital firms, which are more entrepreneurial, smaller and less institutionalized. At any private equity firm, though, the senior team “believes they had a huge hand in value creation, building up the firm when the capital under management was smaller. So now is their payday.”
One other succession pointer mentioned by several people was this: don’t exclude the junior team on the fundraise. Said one placement agent, “The moment the senior team is no longer on the road, LPs will say, ‘This isn’t the same firm.’”
It’s All In The Handoff
The issue can be handled with care though. One example might include the job done by Clayton Dubilier & Rice’s Joe Rice. Rice transferred power to current CEO Donald Gogel about eight years ago and remains an active chairman today.
It seems likely the example he set will be repeated in the next generation. Tom Franco, a partner at CD&R, said beneath Gogel are several tiers of partners in their 30s and 40s, and a natural progression of leadership is evident.“You have to have a founder committed to the principle of perpetuity. There are some leaders that want to create a lasting institution while for others that is not a priority,” said Franco. “Having the institutional vision is the key. Everything flows out of that. That means you’re trying to build something that endures, and that goes to the values in people.”
There are other examples. Fox Paine & Co.’s Co-founder Saul Fox earlier this year reduced his role at the firm, turning over more control to Co-founder Dexter Paine and three other partners. He will take a role as senior advisor. LPs were reportedly told about the change in the fourth quarter of 2005 when it began marketing its third fund. Merril Halpern, who founded Charterhouse Group in 1973, has passed the reigns over the last three years to Thomas Dircks, the managing partner. Though Halpern remains chairman, he said, “It’s clear that Tom Dircks is running the firm.”
Many larger firms have left behind the monarch-style of leadership and embarked with the committee model, which simulates a partnership. Firms that fall into this category include Advent International, Bain Capital and TA Associates. “I don’t think there’s any right way to do it. People have been successful with a lot of different models,” says David Mussafer, part of the management committee at Advent which was established in 1998. He added that LPs originally questioned whether the firm would be nimble enough without one sole designated decision maker, but they now consider it a success. Younger partners “appreciate having the input. We’ve been able to develop a broader group of talented people who want a larger voice in management.”
The Carlyle Group is another that has made strides using the executive committee. Co-founder David Rubenstein, 57, told Buyouts in 2005 that he believed the mid-50s to be “the prime of life” and a spokesman for the firm confirmed the founders aren’t leaving anytime soon. The spokesman added that Co-founder Daniel D’Aniello recently confessed that he is so in love with his job, he “doesn’t get out of bed, he levitates.”
That said, under former IBM chief Lou Gerstner the firm has made changes in the last few years. Carlyle created a committee of a dozen individuals that represent the heads of Carlyle’s various divisions. Of those, Rubenstein said two or three will likely emerge as the leaders of the firm. “Over the next ten years, all of the founders of the best-known private equity firms will probably be transitioning away from the leadership of those firms and that’s probably a very good thing for the industry. It shows that the private equity firms are not just an extension of their founders, that serious institutions have been built over the years,” said Rubenstein.
But maybe the industry isn’t quite ready to be institutionalized. John Wood, a senior director with executive search firm Spencer Stuart, said the private equity industry was founded by entrepreneurs and remains an entrepreneurial industry for the moment. In any business, it’s very rare to find someone who built a firm up that is then willing to just step away, said Wood. “Especially as the [private equity] sector has grown into a worldwide business, there are new challenges, new issues, all related to growth. Those are fun.”
As partners and critics alike debate what exactly makes for a smooth transition, one pro, who founded a private equity firm in the 1980s and now oversees $4 billion of assets under management, believes its as simple as being “nice.” The source, who didn’t want to be identified, says, “In a nutshell, the final line of your story should be: succession only goes as nicely as the people involved in it.”