Private equity firms are increasingly recognizing the importance of talent management in driving value creation. The article outlines seven key behaviors that advanced firms are adopting, including integrating human capital into deal planning, improving talent assessments, and fostering leadership development. These practices mark a shift from traditional approaches, emphasizing the strategic role of talent at all organizational levels.
The private equity industry has long known that it needs new approaches to value creation.
PE firms are holding onto companies in their portfolios for longer time periods and doing more complex transactions (such as industry "roll-ups"). There is more money chasing fewer potential acquisitions, and higher interest rates are creating higher bars for performance. These factors explain why operational performance now accounts for twice as much value creation as deal-making and financing. Executives have also known—or claimed to know—that leadership, human capital, and people skills are the sparks that ignite value creation: 69% of PE and portfolio company leaders cite talent, more than name operating efficiency (49%) or organic growth (30%), as the most important factor.
But doing something about it? For an industry famous for a high-pressure, get-it-done-yesterday mindset, that's a leap. In my 30-plus years of offering advice about human capital to PE firms and portfolio companies, I can't tell you how many eyerolls I've seen or how often someone has said, "That's interesting," but not meant it.
The last few years, however, have seen real movement from lip service to action. It's by no means universal, but we are seeing enough change that it is possible to identify the elements of what I've begun calling "PE Talent 2.0." Here's what it looks like, in the form of four behaviors and three capabilities.
Let's start with the behaviors — things that advanced PE firms do differently.
They connect talent to value creation explicitly from the start.
The most forward-thinking firms incorporate human capital in their buying strategy and deal planning. The change shows up in three ways: developing the deal thesis itself, incorporating assessments of executive talent early on, and explicitly discussing the culture of a company and its relationship to productivity and business results.
Though PE firms informally gauge leadership in selecting targets, it is still rare to see deals that are premised on the quality of management and talent. But it is happening more often, particularly as private equity expands into industries where talent is an indisputably important asset. Here's an example: When Investcorp purchased Wrench, a regional HVAC service company with $150 million in sales, in 2016, it was with an eye to growing the investment by buying and folding in similar companies. Wrench's deal thesis rested on two cultural pillars: becoming the "acquirer of choice" in a consolidating industry, so that it could select target companies that shared Wrench's ethos of customer service, and capturing the value by ensuring that the growing collection became one enterprise. And it did just that. At Wrench, the corporate center is called "branch support," not "headquarters," reflecting the belief shared by Investcorp's CEO, Ken Haines, who was promoted from a divisional leadership role, that value creation depended on a servant-leader model of executive. Three years later, Investcorp sold the company for three times what it paid — and since then under Haines's leadership the company has continued to grow, to the point where its revenue is 10 times what it was in 2016.
Choosing the right leader begins with assessment, and across the private equity industry, I see significant improvement in the way firms have historically evaluated talent as part of due diligence and during the first months of ownership. Evidence suggests that assessments have often been done poorly in the past: According to AlixPartners research, CEO turnover is rampant during the first years of a takeover, is usually unplanned, and has negative impact on results. The reason, I believe: Traditional assessments looked for traits deal partners prize (like tough-mindedness and a bias toward execution) but paid scant attention to transformational leadership skills like emotional intelligence, cognitive (strategic) flexibility, and an appetite for learning.
At the same time, we're seeing improvements in due diligence designed to surface leadership problems and strengths at the operational level as well as in the executive team. Leading firms are getting out of the data room and onto the shop floor, sending deal teams with operating experience to walk the halls and the plant floor and provide behavioral insight – borne of their own operating experience – about company culture and the quality of operating management.
They don't just assess talent; they build it.
Next-level PE firms are deploying programs to help leaders grow and become more valuable. Traditionally, PE firms did little of this, because of their short-term orientation. Factors such as extended holding periods, flatter organizations, the disruptive impact of new technologies like AI, and the changing demands of a multigenerational workforce make firms more interested in upgrading executive talent immediately.
A growing number PE firms bring senior portfolio company leaders — CEOs, CFOs, sometimes others — together once a year for workshops and shared learning, some of which I described in a 2023 HBR article. The most advanced do more — moving from once-a-year events to more frequent interactions. "These can be particularly valuable for executives who are new to private-equity ownership," according to Joelle Marquis, president of Arsenal Capital Partners, which has held such forums for 16 years. Marquis finds that more frequent touchpoints are especially valuable for executives at middle-market companies because many have not had sophisticated human capital or talent management functions or have had little opportunity to network with peers. Such initiatives emulate the kinds of leadership development programs that large corporates have long but which were nonexistent in PE.
These learning initiatives benefit from the multi-industry nature of private equity. Because PE portfolios include businesses from many industries, the chance for cross-pollination can be even greater than it is for corporates. One firm that specializes in investing in industrial businesses has seen more than half a dozen instances where a high-potential executive was promoted to a position at a different company in its portfolio; pleased with the results, the firm plans to launch a formal program to across-the-portfolio talent development program for direct reports to C-level executives.
They take succession planning seriously — and deep into the organization.
Old-style PE operating management didn't pay much attention to succession planning: the PE firm's job was to rebuild a company's structure and finances; management's job was to get on with it. Even today, only a minority of portfolio company executives (about a third) say they have successors in mind for key positions. Their reasons are somewhat shocking. A majority — 55% of portfolio companies, 54% of PE firms — say succession planning is not a priority or they have no process in place. That's a failure of governance. Almost all the rest — 47% of portfolio companies, 43% of PE firms — say they cannot find internal candidates. That's a failure of talent management and leadership development.
These are emergent practices, not common ones. Only one in three portfolio companis and one in nine PE firms have conducted a formal analysis to identify can't-lose people in the organization. Even fewer (18% of portfolio companies, 12% of PE firms) say they have a formal process to identify or develop successors for key mid-level roles. But that minority is pioneering a new path. As part of these next-level practices, some firms are using assessments not just to evaluate people but to help them become more valuable. Arsenal's human capital team works with portfolio company leaders to create a raft of individual development plans — for portfolio company board members, C-suite executives, high potentials, and employees who occupy key positions — which are reviewed twice a year. Ongoing learning programs, like succession planning, are part of the trend toward creating leaders, not just exploiting them.
They see talent in the whole organization.
If there's one "tell" that distinguishes the level 2.0 PE firms from others, it's their recognition that talent creates value at all levels. The old model, where CEOs, CFOs, and a handful of others got all the attention — and an equity stake in the portfolio company — reflected a financial-engineering-based model of value creation. But when you realize that value creation depends on people, you need to address the organization as a whole.
A dramatic example of new practice is Ownership Works, a nonprofit dedicated to encouraging widespread employee ownership of companies. An impressive contingent of large PE firms (among them Advent, Apollo, CrossPlane Capital, KKR, Silverlake, TPG, Harvest Partners, Riverside, and Opengate Capital) are sponsors of Ownership Works and have made specific promises to implement models of shared ownership in their portfolio companies. (AlixPartners, my employer, is also a partner of Ownership Works.)
They endow human capital leaders with hierarchical power in both the PE firm and its portfolio companies.
They have hired and empowered human capital partners to improve talent management in the portfolio companies, and to develop capabilities for operating partners who oversee those portfolio companies; they work assiduously to ensure that operating partners (who are the day-to-day liaison between portfolio companies and the firm) understand talent strategy and make it a key part of their oversight; and they insist that portfolio company HR leadership is strategic, not just transactional. At the Apollo group, the CHRO is a member of the firm's executive committee, giving him a voice in the firm's investments and decisions. At Blackstone, the firm utilizes senior operating partners who have previous CEO experience to provide feedback and support to portfolio company CEOs. I could go on.
They talk talent in board and operating meetings as a matter of course.
Power and process should go hand-in-hand. For old-school PE firms, talent management is an afterthought left to portfolio companies. That could explain why portfolio company HR leaders are viewed as strategic business partners by 43% of their portfolio company peers, but just 14% of their PE owner-investors, who mostly see HR leaders' jobs as filling the talent pipeline — and 9% can't even say what HR does. Talent 2.0 firms see the CHRO as a full-fledged value creator, not just someone who manages search firms. In a PE-owned company, leadership has two jobs: running the business and transforming it. "For the most part, the business knows better how to run its business," says Jimmy Holloran, the operating partner in charge of talent at American Industrial Partners. "What we need to teach is our approach to transformation"—while convening regular conversations between investors, management, and the talent team to make sure operating and transforming stay in sync.
They use data to prove their point to investors.
Leading private equity firms are increasingly using data to secure investor support for talent investments. Employee engagement, attrition rates, morale and sentiment analysis, diversity and inclusion data—all of these provide insights into the strength of portfolio companies' workforces and cultures, reveal risks or opportunities for improvement, and identify best practices to share across a portfolio. But they do more: Data change the conversation with financially-focused deal partners — at the time of acquisition, during the holding period, and as firms prepare an asset for sale. As Courtney della Cava, human capital partner at Blackstone says, "At Blackstone we measure impact in quantitative terms. Everyone understands that human capital is valuable in theory, but our investors bring an analytical lens to business questions, including all things talent and human capital. So we, too, endeavor to quantify everything we do across the investment lifecycle — from predicting the success and failure of formal leadership assessments to evaluating portfolio company engagement scores as leading indicators of business health."
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As I said, these are leading practices, and I have not (yet) seen any PE firm that does them all consistently across funds and portfolio companies. But the pattern is clear and points in one direction; the art and science of management has become more important in the private equity industry.
At the same time, great management in PE is not exactly the same as it is in public companies. For one thing, the clock speed increases when PE comes to town. For another, as Jimmy Holloran put it to me, a PE executive needs to be equally skilled at the arts of transformation and operation—and needs to be supported by a board and investors who understand that both sets of skills matter. Superior performance in both transformation and operation depends on sustained and systematic investment in people and capabilities; better management from CEO to front-line supervisor; and better talent processes, at all levels, from executive recruitment and assessment to learning and development to planning for succession.
Originally published by Harvard Business Publishing, 5 December 2024
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