Jonathan Nosal, Partner, San Francisco and Newport Beach, USA
Lee Brantingham, Managing Partner, Hong Kong, China
How PE Firms Can Attract the Best Portfolio Leadership
The global private equity sector is more than three times bigger than it was just ten years ago. How can PE firms ensure that they are attracting the best talent to lead their portfolio companies?
Despite a COVID-induced 22% downturn in private equity fundraising and deal volume when the pandemic first hit, the broader multi-year trend is that the sector is extremely healthy, growing fast, diversifying and becoming much more competitive. Global capital raising has ballooned in the last decade, growing from $155 billion in 2010 to $503 billion last year. The sector now employs 8.8 million people in the US alone.
Within this context, we spoke with 10 private equity company founders and executives about their key suggestions for how to source and retain the most talented PE leaders. Speaking anonymously, their raw insights and perspectives paint a complex and evolving picture.
Resurgence of Competitive Activity
2021 saw a resurgence in deals and activity, particularly in the last three quarters of the year. Investors appear to have a higher risk appetite than they did when the global financial crisis hit in 2008, advantaged this time by the low cost to debt and the fact that certain industries are primed for hyper-growth.
The amount of liquidity and activity in the sector is no less than astonishing in 2022. Up and down the scale of funds, whether it’s private going public or public buying private, specialized versus generalist, everyone is competing for deals.
On top of this, sovereign wealth funds have tweaked their investment philosophy which has made the environment even more competitive. Historically, state-owned firms invested in things like infrastructure, real estate and ports - low risk, large dollar value investments that are relatively safe, and provide low but consistent returns. In the last decade the dynamics have changed, and the majority of them are now looking at much more concentrated bets that are higher risk with the consequent higher reward. This means they are competing for deals with more traditional private equity firms and investment banks.
This climate means that the war for the best private equity talent is getting ever-more intense. According to a partner at a US-based PE firm, the success of a particular venture is integral to the talent that you have driving it.
“The common perception is that PE funds are just predators that want to come in and dismantle and pick apart an organization, but this is false. You make money by growing businesses, ideally organically, which gets you the best return. Some industries that aren’t growing organically mean they are doing so inorganically (usually through mergers and acquisition). Both scenarios are completely dependent on talent for success – and the talent knows it.”
Greater Fluidity/Dynamism of Talent
Many of those we spoke to highlighted that there is also a greater degree of fluidity in terms of hiring and movement within the sector at the moment. Five years ago, it was far more common for executives to want to keep working for firms with similar profiles. Very rarely would someone from a Fortune 100 go into a sub-$20 million business. That is not necessarily the case anymore. They are seeing much more openness to PE leadership making quite profound career jumps, particularly with how compelling some deals are.
Added to this is the multi-generational impact on the PE workforce. Much younger executives, aged in their late 20s to early 30s, are having an impact – they are mobile, agile, and not afraid to take risks, which is a positive within the PE space (to a degree). If they fail, they tend to fail quick and pivot. Learning from a point of failure is easier for this more youthful demographic to grasp, as the world is changing just as fast around them.
Executive Packages Are Key
The group felt that putting the most appealing compensation structure together is absolutely crucial when attracting the right talent. Good packages usually comes with 2-3% equity, although some offers for key CxOs can be as high as 5% vesting over five years.
Some offers are performance based and some are time based. Most of those we spoke with said performance-based packages have bigger pay-offs. By taking a performance-based offer, an executive has to believe in the vision, culture and market opportunity of the company to earn compensation based on success or failure. Along with the standard assessment metrics such as EBITDA, cash flow, and gross margin, team building is another system of measurement, although this is harder to quantify.
Several executives we spoke to emphasized that the profile and/or location of some portfolio companies made it harder to recruit top talent into them. Small manufacturing and value-added businesses, particularly those in secondary cities, lack prestige in the minds of some candidates and are therefore harder to fill. Compensation and reward structure is one way to at least partly mitigate these factors.
Team Assessment Strategies
According to a senior investment leader of a top 15 global sovereign wealth fund we spoke with, the degree to which the incumbent team influences an investment in that company is usually dependent on the maturity of that business. He explained:
“In early stage (more VC) investing, the CEO and his/her relative knowledge and capability in a given space is hugely critical. One third to half of our investment decision is based around what we think of the CEO and his/her direct management team.
If we’re investing in a fund, then we look at the executive group and want to understand the stability, how long they have worked together, and what they have achieved. We would like to understand if they’ve established incentives and been able to drive the right behavior.
In much bigger deals with a business that is already at scale, the management team is important, but if you have to change out the CFO or bring in a new head of operations, that can be done with much less disruption. The CEO is still very important, particularly if he or she is a founding CEO, but for these later stage companies, the management team is more like 20% of that decision.”
Working With Talent Acquisition Partners
All of the firms we talked to use executive search partners for key talent placements across their portfolio companies. Some of the common denominators for success include:
• Firstly, selecting a firm that has extensive experience in the relevant sub-sector is crucial (eg. ‘fintech’ or ‘healthtech’). The more granular the experience the better.
• Ensuring deep communication takes place between the company and the provider, particularly at the beginning of the process, with many finding weekly updates to be best practice.
• Some felt that the larger firms offer only formulaic search that bubble up the same candidates and have too many off-limits constraints.
• Bandwidth of the recruiters doing the work was also noted as a key factor in ensuring success. It’s important to find out how many projects the team you are contemplating engaging is working on before you grant the search.
• Consistency of engagement was also mentioned as crucial several times – the firm should regularly provide feedback, insights and drive the cadence of the search.
• Lastly, reference checking cannot be underestimated. A detailed assessment of a candidate’s accomplishments and why he or she may have left previous roles is worth the investment of time.
The PE space is currently hyper-competitive on many levels: remarkable levels of liquidity exist, the investor appetite for risk is high and a huge number of different investment vehicles are competing for the same deals. As a consequence, there is an unprecedented demand for leading talent. Establishing a good cultural fit, creating a performance-based compensation structure and ensuring you pick the right executive search partner are crucial elements for success.
Case Study: Chief Executive Officer | Chinese Food Service Business Private Equity-Backed