The #1 Factor that Makes Private Equity CEO Roles so Difficult

HIGHLIGHTS

CEO roles of private equity-backed companies are arguably the most challenging jobs in business.


There are many factors contributing to the degree of difficulty including the compounding effects of leverage, urgency, M&A, rigorous Boards, etc.


However, one element is more responsible than any other for the degree of difficulty:  intense, relentless pressure.


OVERVIEW

CEO roles in private equity-backed, middle market portfolio companies involve greater rigor, urgency and expectations compared to general management and CEO roles across other asset classes.  Private equity firms and their portfolio company leaders face greater demands from investors, and multiples remain historically high.  These realities place unprecedented value on a CEOs ability to execute at the highest level.  Millions of investment dollars are at stake and incremental multiples of invested capital (MOIC) will be gained or lost on a deal based upon the quality of the management team, and most importantly, the CEO.

The degree of difficulty for PE-backed CEOs is compounded by: leveraged balance sheets, M&A integration; extreme urgency; limited resources; demands for breakneck execution; finite hold periods.  The net effect is that there are two realities that fundamentally make private equity CEO roles uniquely challenging – pressure and solitude.

PRESSURE

The pressure felt by private equity-backed CEOs is unique because of its daunting combination of intensity and relentlessness. Hard-core accountability is a must.  Tens, and even hundreds of millions of investor dollars rest on a portfolio company CEO’s performance. As a result the CEO also feels the weight, focus and pressure and expectations of the private equity GPs and LPs.  Private equity investors are among the most ambitious leaders in business and their lofty expectations include exceptional portfolio company CEO performance.

The pressure in private equity is not only intense, it is relentless.  The private equity CEO manages through an endless, rigorous gauntlet of weekly Board calls, monthly operating reviews, quarterly Board meetings, annual budgeting processes, cash flow challenges, covenant issues, etc. In short, portfolio company CEO assignments are 4-5 years of the most pressure packed time of a leader’s careers…no breaks, no down time.  Relentless and intense.  This environment can test the most ambitious leaders.

PE PRESSURE IS DIFFERENT

It is important to recognize that most business leaders are accustomed to some degree of pressure.  However, pressure is a relative term and it can be argued that private equity CEOs are under more pressure than their peers in other asset classes.


Most CEOs believe they are comfortable with pressure only to be caught flat-footed by the intensity and relentlessness of the private equity crucible.



CEO PERFORMANCE IMPLICATIONS

Intense pressure brings out the best in some leaders.  However, private equity pressure will cause a lesser CEO to second-guess themselves, lose confidence and therefore increase their risk of derailment. Intense pressure impedes action, limits execution and amplifies unhealthy levels of fear of failure.

SOLITUDE

Effects of private equity pressure are felt with even more intensity because of the relatively lonely existence of a portfolio company CEO.

SUMMARY

Private equity CEO roles can be professionally and financially rewarding beyond the realm of other asset classes.  However, the rewards are usually reserved for those who can manage, and thrive within, the relentless and intense pressure of PE.

THE IDEAL PROFILE FOR DEALING WITH PRIVATE EQUITY PRESSURE

The best private equity CEOs have personal and professional standards that are equal to, or even above, the extremely high levels of their Board’s expectations.  These leaders place as much, or more, pressure on themselves when compared to the intense pressure of private equity.  CEOs should very carefully (and intellectually honestly) evaluate their tolerance for a high-stakes, high pressure environment before accepting a portfolio company leadership role.

ABOUT ROB HUXTABLE

Rob is a recognized expert on the topic of private equity CEO performance.  He is Founder & Principal of PrivateEquityCEO.com.  He is also Managing Partner of Integis which is the nation’s leading search firm focused exclusively on the private equity-backed, middle market.

 

 

 

 

 

 

 

 

 

7 Criteria for CEOs to Diligence a PE-Backed Opportunity

OVERVIEW

A portfolio company CEO’s fit with a deal is obviously critical.  However, CEO candidates can fail to fully assess their fit with a particular opportunity. Thoughtful, intellectually-honest analysis can benefit both the CEO the sponsor by helping to avoid a derailment down the road.  Stay tuned for more detailed, follow-up posts exploring each for the following criteria more deeply.

Recommended items include:

1. Fit with the private equity firm’s governance approach.  Many sponsors seem similar on the surface.  Further analysis reveals that all private equity firms are very different – particularly in how they engage with, and govern, the CEO.   CEOs must understand if the sponsor in question is more-or-less operational and hands-on, or, more-or-less a strategic investment partner.  A majority of firms sit in the former camp which means many CEOs will have company in running the business.  This involvement can be in the form of welcome support or burdensome control.  Be certain your style is a fit with the sponsor’s approach.

2. Stage of the investment in the hold period.  Although hold periods can last as long as 10 years, private equity firms would prefer to transact in 4-5 years, or less.  This relatively shorter timeline fuels a stronger IRR metric at exit.  Portfolio company CEO roles are always high pressure, but the pressure increases as the hold period matures.

3. Most pressing strategic challenges AND how they line with your capabilities.  CEOs should keep their ambition in check and insure their core competencies fit well with the objectives of the business.  A CEO’s ability to execute quickly will determine her/his success or failure.  Many candidates are over-confident and/or underestimate the gravity of the challenge.  Intellectual honesty is critical when evaluating a CEO role.

4. Purchase multiple.  If a CEO is joining a healthy, growing company then the sponsor most likely paid a full price for the asset.  They may have even knowingly overpaid given the competitive deal dynamics and pressure to deploy capital.  As a result, CEOs are expected to accelerate that company’s growth rate in order to yield a discounted purchase multiple (on a backward looking basis).  Going forward, there is risk of some level of multiple contraction as interest rates are expected to rise.

5. Viability of the investment thesis at current state.  CEO candidates would be wise to create their own value-creation models and share them with the sponsor.  Alignment of “what success looks like” is critical before a CEO and sponsor sign on the dotted line

6. Reason for the CEO search.  A CEO search for a private equity-backed company usually means one of two things: a.) succession planning for a founder replacement; or b.) unplanned replacement of an ineffective CEO (founder or otherwise).  Each scenario has unique challenges and candidates should think carefully about the genesis of the CEO search to understand the undercurrents at play in a given private equity portfolio company.

7. Estimated cash proceeds at exit.  Many CEO candidates focus on the option grant percentage.  While this number has meaning, it is secondary to the estimated cash proceeds at exit.  Candidates should focus on the amount and viability of wealth creation and not the percentage of ownership.  It’s better to get 2.5% of a winning deal than 4% of a dog.  For later -stage hold periods, synthetic equity packages (such as a sale bonus) may be employed by the sponsor.

ABOUT ROB HUXTABLE

Rob is a recognized expert on the topic of private equity CEO performance.  He is Founder & Principal of PrivateEquityCEO.com.  He is also Managing Partner of Integis which is the nation’s leading search firm focused exclusively on the private equity-backed, middle market.

Reach Rob here.

CEO Co-Invest? An Analysis for Private Equity Leaders

HIGHLIGHTS

Some private equity funds offer co-investment opportunities to new portfolio company CEOs, other funds require it.

Aligned ownership, figuratively and literally, is key for private equity Boards and CEOs.

CEOs should use co-investment analysis as a proxy for whether or not they should join the company at all.

PRIVATE EQUITY ALIGNMENT

Private equity firms strive for alignment throughout their endeavors.

It’s a long held belief that portfolio company alignment can be achieved through management compensation packages that include an option/equity grant.  This strategy does create a certain level of alignment but at a relatively intellectual level.  Experience tells us that alignment is most powerful when it exists at both an intellectual, and at a deeply-rooted emotional level.

UNDERSTANDING THE PRIVATE EQUITY PERSPECTIVE

Private equity firms put their heart, soul and skin in the game by putting their own capital and the capital of their investors at risk on every deal.  The stakes don’t get much higher. The depth and intensity of a firm’s commitment is unflappable and all consuming.

THE CEO DISCONNECT – FOR THOSE WHO HESITATE TO CO-INVEST

CEOs accept a new position based upon a belief that an opportunity is worth changing the course of their career and often relocating (or spend significant time away from) their families.  So how can a CEO make such a significant professional and personal commitment and yet still hesitate to make the same financial commitment? 

A CEO who does not insist on co-investing may be suffering from a lack of true belief in the opportunity or in their own capabilities. Therefore, those not interested in co-investing may be unwise to accept the role under any circumstances.  Portfolio company CEO roles are difficult as it stands, that difficulty only increases if there is a question mark in about a CEO’s level of commitment and/or belief. CEOs anxious for alignment should insist on having the opportunity to co-invest to help forge a more meaningful partnership with their private equity Boards.  Investing also creates more wealth, taxed at capital gains, for the CEO.

CO-INVESTMENT AMOUNTS & TIMING

Co-investments should be a “personally meaningful” amount.  In general terms, a minimum of $100,000 is customary.  Target amounts between $250,000 and $500,000 are traditional.  Consider that a CEO is expected to deliver a 3X cash on cash return so co-investment can be an excellent wealth creation tool.  PE funds require that the CEO’s investment be made within 90 days of starting employment.

WHAT ABOUT PERSONAL LIQUIDITY CHALLENGES?

Many successful candidates are facing cash flow pressures such as college tuition and other expenses that impact liquidity.  In these and other cases, CEOs should investigate a self-directed IRA.  This tool will enable co-investment check to be written from a roll-over IRA without penalty.

ABOUT ROB HUXTABLE

Rob is a recognized expert on the topic of private equity CEO performance.  He is Founder & Principal of PrivateEquityCEO.com.  He is also Managing Partner of Integis which is the nation’s leading search firm focused exclusively on the private equity-backed, middle market.

Reach Rob here.

Recruiting a Portfolio Company CFO: A Field Guide for Private Equity CEOs

OVERVIEW

The best CEOs build the best teams.  And selecting the right CFO is arguably the most important decision a CEO can make when building her/his team.

CFO roles in private equity-backed, middle market portfolio companies involve greater rigor, urgency and expectations compared to finance leadership roles across other asset classes. Private equity firms and their portfolio company leaders face greater demands from investors, and multiples remain historically high. These realities place unprecedented value on a management team’s ability to execute at the highest possible level.


Millions of investment dollars are at stake and incremental multiple of invested capital (MOIC) will be gained or lost on a deal based upon the quality of the management team, including the CFO.



The Degree of Difficulty for PE-Backed CFOs is Compounded By:

  • Leveraged Balance Sheets
  • Private Equity Demands
  • M&A Integrations
  • Extreme Urgency
  • Finite Resources
  • Financially-Savvy Boards
  • ERP Implementations/Upgrades
  • Demands for Forecasting & Analysis

Historically, many CEOs have settled for CFOs who, in retrospect, were more-or-less strategic controllers or tactical CFOs. Today, leading private equity funds are actively raising their standards on CFO hiring. However, and in spite of the increased focus on CFO recruitment and assessment, CFO hiring mistakes consistently outpace mistakes made on other management team hires.

The bottom line is that talented private equity-backed, portfolio company CFOs are in rare supply and can be difficult to assess. The price paid for an average or poor CFO hire can be steep.

Poor CFOs Can Mean:

  • Frustrated CEOs and Funds
  • Poor Visibility into Company Performance
  • Earnings Restatements
  • Audit Adjustments
  • Poor Forecasting/Visibility
  • Covenant Violations
  • Ineffective Integrations
  • Underutilized ERP Systems

WHITE PAPER: THE 7 DEFINING CHARACTERISTICS OF AN ELITE, PE-BACKED CFO


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  • The 7 characteristics to evaluate during your CFO search and selection process
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  • Most frequent derailers of private equity CFOs
  • Compensation analysis including salary, bonus & options/equity
  • Vetting guidelines


ABOUT ROB HUXTABLE

Rob is the Founder & Principal of PrivateEquityCEO.com.  He is also Managing Partner of Integis which is the nation’s leading search firm focused exclusively on the private equity-backed, middle market.  He leads the firm’s CEO search practice.