Why Private Equity Firms Need Human Capital Strategies to Accelerate Value Creation
Private Equity is booming. In many sectors, the cost of acquiring companies is at record multiples, and thus the pressure to turn them around quickly and profitably is more intense than ever.
But in response, many PE firms have not deviated much from the standard three-part playbook for managing their acquisitions: financial leverage, operational restructuring, and investments in growth (especially bringing in new talent at the top of the organization).
From our years of advising PE firms in the third area, we have found too many rely almost exclusively on top-grading senior talent with A players and aligning their monetary incentives (a lucrative exit) with that of the general partner. Their belief is that those should be enough to push the strategy forward. Unfortunately, they often do not.
In the worst cases, they result in a new top management team that isn’t fully aligned on the growth strategy, that operates in silos, and thus doesn’t work productively enough to solve cross-functional challenges. These often are the sources of the greatest opportunities to accelerate economic value. The new team of A players work diligently in their silos. However, they don’t work together strongly enough on opportunities to increase demand and create efficient supply that requires truly unified efforts. Therefore, although there is plenty of activity, there is little actual progress toward value creation. This, in turn, can amplify conflicts and dysfunctions that slow down or derail the growth strategy.
We believe the key leadership team challenge for today’s PE-owned companies is no longer just about hiring new talent at the top and giving them strong financial incentives to execute the growth strategy. That will always be crucial. But with today’s demands for more aggressive growth strategies to generate sufficient returns, PE firms need something more. They need to get the leadership of the companies they buy – both new and existing management team – to understand the growth strategy deeply, support it wholeheartedly, work effectively to refine it if necessary, and execute it with passion and excellence.
But creating such a great top team requires not just a growth strategy for the business; it also demands a strategy to align and engage its people. We refer to this as a human capital strategy. To greatly increase the odds of getting the returns they expect, PE firms must devise human capital strategies at the onset of their acquisitions. From helping create a number of such strategies, we explain how to do so.
We also speak with Nick Orum, President of Gryphon Investors, about their approach to human capital strategy and how it accelerates returns across their portfolio of investments.