CEO turnover within private equity portfolio companies is staggering. In a recent survey completed by Alix Partners, 58% of private equity CEOs are replaced within 2 years of an investment. Over the lifetime of the private equity firm’s holding of a company, CEO turnover jumps up to 73%.
When a private equity firm makes an investment, the clock starts ticking towards the eventual sale and hopeful profit that can be passed along to both the General and Limited Partners. What’s most concerning to private equity firms is not only the turnover, but also the lost time spent recruiting and hiring a new CEO and the time required by the CEO (and perhaps a new senior management team) to assimilate into the organization and begin executing their plans.
Why CEO Turnover Is So High
The first statistic, that 58% of CEOs turnover within 2 years, does have an explanation that will be familiar to those in the private equity sector. In particular, when private equity firms purchase a family business, the new owners require the previous owner (who is usually the CEO as well) to stay on for a period of time to provide continuity in the business. Once that stay-period is up, usually within 1-2 years, there is an agreement that the previous CEO will step down and the private equity firm will have the opportunity to choose their own replacement. This scenario constitutes a large percentage of the 58% turnover.
The 73% turnover statistic is much more alarming and a cause for concern. The typical private equity purchase is held for 4-6 years. When you factor in a CEO replacement within that time-period, the ability for the private equity firm to attain desired returns and sell the business becomes more difficult.
How Strategic Hiring Lowers CEO Turnover
The survey from Alix Partners brought up some valid issues, most notably the hiring and assessment process. When faced with making a decision between the two, private equity firms prefer candidates with CEO experience rather than a private equity background. In our experience, this preference makes a lot of sense, though there are some exceptions to keep in mind. The most important consideration is whether prior experience aligns with the position in question. Unfortunately, we often see private equity firms recruit executives from large, academy companies to run their middle market business. While this sometimes works, the vast majority of hires like this end in less-than-stellar results. There is a big difference, in so many ways, between running a division of a Fortune 500 company and managing a middle market private equity portfolio company. Talent is different, processes and systems are not as developed, and resources are oftentimes scarce. That’s why an alignment between prior experience and the current role is essential.
The four top contributors to CEO turnover in private equity are the lack of strategic direction, poor performance, poor communication, and lack of cultural fit. It is also clear that a lack of cultural fit contributes to the other three factors. With that in mind, how can private equity firms improve their chances of success by focusing more of their CEO assessment on cultural fit? Here are a few ideas we’ve found to have worked with our clients:
Step 1: Develop a Thorough Position Profile
Job descriptions are often very generic and lack greater detail. Many companies will simply list the major responsibilities of the job, alongside a list of required skills and experiences, but they are missing an important link. It is essential to recognize that in larger companies, responsibilities and duties are often two separate roles. In a middle market business, however, the CEO is often the one responsible for both managing and executing the work. The levels of management don’t exist in a middle market business; the talent is not there to delegate the work. Thus, a mere list of responsibilities in the job description isn’t enough. It’s important for candidates to know both what they will be responsible for and how involved they will need to be in getting it done. Equally important is for the private equity firm to be comfortable that the candidate understands and, ideally, can display examples of being in a similar situation.
Step 2: Clearly Define and Follow an Assessment Process
Lay out the necessary steps in the interview process, including who needs to be involved and at what stage. Determine the competencies, skills, personal and professional traits required/desired, and discuss who will probe into a specific area. It’s important to delegate responsibilities so that interviews are productive and provide the desired information.
Begin with the end in mind: The ideal scenario is completing the last interview in a format that accomplishes the objective of confirming that both professional and personal qualifications are in line with your needs while providing candidates the opportunity to understand the role and confirm they are interested and motivated to take responsibility for the business.
Step 3: Don’t Hire the Resume
All too often, we’re called by private equity firms that have decided to replace a sitting CEO by picking a candidate because of where he or she had been in their prior role. In most of these cases, the decision was made to hire someone from a large, reputable company within the industry. Whether it was a CEO, or Divisional or Business Unit President, the private equity firm felt that they had hired someone from an academy company who couldn’t fail. As mentioned previously, however, this rarely works out, which is why those firms end up calling us for assistance.
Step 4: Seek Multiple Opinions and Feedback
References are important but must be used for more than just confirming experience and qualifications. Equally important is to solicit feedback on the personal traits, motivation, and best possible fit of the candidate. Speaking to people who know the candidate well can provide insights into the probability for fit within the portfolio company.
Furthermore, trusted advisors to the private equity firm and portfolio company can assess candidates in correlation of their existing knowledge of the PE firm. They have a reference point that allows them to assess fit and performance potential of candidates. Key people within the portfolio company may also be able to provide feedback on a candidate’s potential cultural fit.
Finally, third party assessment tools can provide insight into how candidates get things done, as well as their leadership and management tendencies, all of which can contribute to a stronger assessment of cultural fit.
While there are no guaranteed steps to achieving 100% success in hiring, committing to an iterative process can improve upon past failures in identifying candidates with a high probability for success.
We are definitely in a market where the candidate has leverage. Talented candidates are frequently seeing multiple offers, and companies are moving quickly to secure talent. Companies that don’t take the time to map out their assessment process will find themselves missing out on the talent they desire and need to succeed.