2010 Private Equity Leadership Outlook

The debate persists: Where are we in the global recession cycle? As 2010 unfolds, it’s hard to recall a period of time when economic and market conditions have been more capricious. Nonetheless, no one is ready to stand up and declare stability. The first half of last year sent reverberations through the boardroom as business levels deteriorated at a shocking pace. Traditional access to short-term capital was all but eliminated, and long-term sources felt paralyzed as well. The latter half of the year seemed to be about responding to what we had just experienced—in the form of cost cutting, new strategies and resetting of expectations. As clouds of ambiguity still hover above, what will this next phase of the “Great Recession” bring? How do private equity-backed businesses work with their shareholders and boards to go forward constructively? What can PE firms do to help their portfolio companies and keep their eye on the prize?

It’s clear from our conversations with the private equity community that a new level of Q&A has developed at the boardroom, a level that is more challenging but also more forward looking than in the past. Perhaps one of the most critical questions being asked is this: Does our organization have the right leadership competencies in place to act on future challenges and opportunities?

Furthermore, we’ve seen that boards are looking in the mirror and asking the same types of questions of themselves. Does the board have the right skills to analyze these critical issues? Is the requisite experience in place? What competencies are needed to guide a given company through uncertain times? Boards that address these questions and take action on them are giving their companies a distinct advantage in the marketplace.

Inside View: What Fellow PE Investors Are Saying About Their Companies

We continuously ask people in the private equity world (venture capitalists, later-stage growth firms, middle-market investors, buyout firms and turnaround groups) what they look for in their portfolio companies and their own firms’ market response. We have valuable feedback to report, particularly with regard to how portfolio companies have responded to these business challenges, made structural changes and positioned themselves to be more nimble going forward. Some specific observations include:

• The overall business environment remains frail.

If nothing else, there is a new-found fragility in most organizations around market visibility, financing access and regulatory influence, among other matters. External resources and constituents that were easy to count on in the past no longer are as reliable.

• No region is economically immune.

Because this has been a worldwide recession, companies started paying attention to the effects of a global economy. The bad news is that there is no place to hide, and the good news is that we’re all in this together. As a result, awareness is higher, and everyone is paying more attention to emerging markets, currency values, natural resources and outsourcing strategies.

• Penny-wise and dollar-wiser.

All organizations raised the bar on cost consciousness in 2009, and boards played a large role here. How long this approach lasts will be interesting to watch.

• Collaboration is on the rise.

Leadership teams trying to cope and find their way forward are talking with each other more than ever before. While no one is opening the kimono on competitive information, there seems to be safety in numbers in openly discussing common challenges and showing empathy. Hard lessons learned by one organization need not be repeated by another.

• Operators in high demand.

We have seen an increased emphasis on bringing operating experience to the portfolio management process throughout this recession. This is intuitive given that delivering successful operating results is intrinsic to the value-creation process. Still it’s worth highlighting that in many firms the need for experienced operators is trumping almost all other needs.

The Art of Competency Analysis: Picking the Right Leader

With all these factors contributing to the dialog, we see PE firms experiencing the prism effect: Depending upon the angle, things can look pretty different, pretty quickly. As a result, nimbleness, strong business discipline and battle-tested experience have become highly valued leadership traits. Knowing which competencies to prioritize is one of the most crucial and valuable decisions an investor/board member will make in the life of the investment. There is more art to this than science, and it is incumbent upon those responsible for the ultimate outcomes to make this assessment of both opportunities and challenges. To make the process more manageable, we propose the following approach to this critical task:

To be clear, opportunities to improve both the top and bottom lines almost always arise from both external and internal actions. Further, some will be strategic in nature and others more tactical, yet both can be immensely valuable. Some executives perform better when looking at new opportunities and others when addressing existing challenges, some excel when inward focused and others outward, and some are particularly strong in strategic areas while others contribute significantly in tactical implementations. Investors are increasingly reminding themselves of this business logic: Genuinely understanding the range of needs of the organization and the true competencies of the executives is of paramount importance.

While this model is no different from what we have been advocating for many years, we do see an opportunity to conduct this analysis more proactively in this current climate. Further, we believe that taking a “competency audit” approach, as laid out in the example below, is particularly applicable to PE-backed companies because of the closely held and hands-on nature of the ownership structure.

The primary role of most PE firms is to add value to the portfolio through their board and, sometimes, consultative roles. Thus, if proactive discussions are not being initiated by a company’s leadership, it is to be expected that their PE firms would. Regardless of who raises the issue, it is entirely appropriate that the board work with the leadership of a company to assure that the opportunities and challenges are well-understood and that the organizational competencies are in place to meet or exceed the expectations.

Customizing the Competency Analysis Dividend

Once a competency assessment is made, the board and leadership team will have a rich data to apply to organizational requirements. This audit can help identify those people who should be accountable for the specific opportunities and challenges. It also will shed light on the impact that new mandates might have on an executive’s current responsibilities. If it is determined that the most fitting leadership talent exists elsewhere in the organization, the analysis will identify the opportunity to redirect talent. Finally, this model allows an organization to recognize any voids and to acknowledge when the leadership talent does not exist within the organization and, therefore, must be obtained externally.

While this needs-assessment process isn’t structurally different for public, closely held or PE-backed companies, the process of how PE firms facilitate these discussions and the resultant actions is different. PE firms tend to interact with leadership teams primarily in the boardroom. Thus, the board’s perspective on how an executive presents himself or herself, sets high-level goals and creates a tone of accountability is particularly important. Further, the cultural overlay of individual PE firms will almost certainly be reflected in the talent-assessment process. Investors will emphasize various attributes of a business that they perceive as valuable such as predictability of revenue, margins, growth prospects and return on internal investment, as well as style differences in how they communicate and manage. There is rarely a one-size-fits-all solution when finding talent that matches particularly well for any given PE firm or business situation; rather, we advocate a case-by-case assessment that addresses both the competency and cultural needs of the portfolio company and its PE firm.

The Many Roles for Operators

It’s not just portfolio companies that are in need of experienced operators. Many firms now are asking us to help find experienced operators to sit on their portfolio companies’ boards. This comes as no surprise given the previous discussion. To reiterate, one of the primary roles of the board is to help the leadership in identifying the opportunities and challenges of the business on a strategic level. Importantly, another role is to assess that leadership and hold it accountable. We are actively supporting PE firms in this quest to have experienced operators at the table for these discussions. It stands to reason that the more a PE firm brings operating experience into the boardroom, the more responsive board members can be to dynamic situations, and the more influential they can be on the direction of the company.

There are a number of PE firms, notably some very large buyout firms, that have built impressive forces of operating partners over the last five or more years. Earlier-stage venture investors have been building cadres of EIRs (entrepreneurs-in-residence) for at least as long. These experienced executives typically
are brought along to help with due diligence and/or to troubleshoot when problems arise. Some even take direct operating roles. Nonetheless, it still is relatively uncommon to see an experienced CEO take one of the firm’s board seats, much less step into the role of investing partner.

We are just starting to see some activity, which we hope becomes a trend, that could take the overlay of operating experience in PE investing to the next level. There is a growing school of thought that integrating investing and operating experience more closely makes good sense. As one highly experienced PE investor pointed out to us, “This allows a firm to demonstrate to its limited partners that it truly is creating fundamental value. Governance, management enhancement and operating improvement all are part of the value-creation role.” In fairness, we recognize the risk of the pendulum swinging too far if a paucity of investing experience is created. The disciplines and rigor that come with PE investing also are a critical part of the value-creation model, and foregoing those skills creates a different set of challenges, even if they are overshadowed in the current environment. As with all balancing acts, the situation always will be dynamic.

Closing Thoughts

We would be remiss not to mention what may be the biggest concern held by financial sponsors right now: the sheer lack of market visibility that everyone is facing. While the global outlook for economic conditions feels better to some, many CEOs are predicting a long road back to the early 2008 pace of business. It is a commonly held view that, notwithstanding some recent upbeat economic announcements, the majority of CEOs are not willing to commit that their company is out of the woods just yet. An end-of-year Gallup economic confidence poll was sobering: Fifty-seven percent of respondents said the economy was getting worse—although that’s better than the 80 percent who said so a year ago. Indeed, conversations about the shape of the curve for this economic recovery remain perplexing (Is it a V? Is it a W? With any luck, could it be a Nike Swoosh?).

While the lack of visibility is the biggest immediate challenge, the one constant is the need for exceptional talent. With so much at stake, the extra work to identify the opportunities and challenges, clarify the nature of the leadership needs and specify the competencies required is time very well spent. Objectivity and thoughtful analysis will help bring the clarity and focus needed in many businesses working their way back to success.

About Russell Reynolds Associates

Leadership. In today’s ever-changing global business environment, success is driven by the talent, vision and leadership capabilities of senior executives.

Russell Reynolds Associates is a leading global executive search and assessment firm with more than 300 consultants based in 39 offices worldwide. Our consultants work closely with public and private organizations to identify, assess and recruit senior executives and board members to drive long-term growth and success. We value teamwork, serving our clients with a collaborative approach that spans our international network of sector and functional experts.

Our in-depth knowledge of major industries and our clients’ specific business challenges, combined with our understanding of who and what make an effective leader, ensure that our clients secure the best leadership teams for the ongoing success of their businesses. For more information, please visit us at www.russellreynolds.com.