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.

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


 Contact Us
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complete CFO Recruitment white paper
which includes:

  • The 7 characteristics to evaluate during your CFO search and selection process
  • The intangible traits that best predict portfolio company CFO success
  • 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.

Top 7 Risks for First-Time Private Equity-Backed CEOs

OVERVIEW

Serving as the CEO of a private equity-backed company can be a rewarding challenge with significant wealth creation potential.  However, many executives underestimate the degree of difficulty of these uniquely demanding roles. As a result, first-time private equity-backed CEOs can be particularly vulnerable to derailment.

Private equity Boards:

  • Have minimal patience for learning curves;
  • Offer little in the way of onboarding and;
  • Demand results quickly.

Although there ample challenges to address, there are seven common risk factors faced by CEOs leading their first private equity-backed company.

SPEED

Private equity simply moves faster than other asset classes.  Period.  In spite of believing they move fast, many first-time private equity CEOs are at risk of being caught flat-footed by the break-neck urgency of private equity.  Speed of execution is paramount and arguably the most important thing any CEO can contribute to value creation.  Maintaining a private equity pace for many years is easier said than done.

TEAM

Private equity CEOs must quickly assess their inherited management team’s horsepower and act decisively to replace, upgrade, coach or create key positions.  In the corporate world, leaders are used to relatively more methodical management of human capital and often benefit from the support of a sophisticated human resources group.  CEOs would be wise to make a call on each key management team position within their first 90 days.  If a key role requires action, now is the time.

HANDS ON

Many corporate leaders view themselves as hands-on only to find out the hard way that their private equity sponsors have a more intense interpretation of this concept. Private equity-CEOs must be quasi-micromanagers who work alongside their teams with sleeves rolled up and with proverbial dirt under the fingernails.  CEOs must also have a clear command of the business details…a necessity that will be tested during each monthly operating review and quarterly Board meeting.

RIGOROUS GOVERNANCE

Private equity drives rigor and process into everything it touches, including portfolio company governance.  Leaders can anticipate lively calls with the Board chairman each week; intensive, on-site monthly operating reviews; and rigorous, quarterly Board meetings.  Along the way, CEOs will encounter a variety of other demands from their sponsors that add to the pressure to perform.

MANTLE OF CEO RESPONSIBILITY

Private equity-backed CEOs play a huge role in value creation.  They do so without the benefit of a traditional boss or team of peers.  Portfolio company CEOs are on an island of accountability and pressure.  Even the most rigorous corporate cultures don’t fully prepare a Division President for the transition into the realm of private equity.

FINANCIAL SOPHISTICATION

True P&L experience is a viable training ground for a private equity CEO.  However, these P&L roles benefit from treasury as a shared service.  As a result, these leaders often understand how to drive a P&L but can struggle when it comes to the competing dynamics of the balance sheet.  First time CEOs also lack experience partnering with a full credit CFO and managing through the many and varied cash flow issues seen in an LBO.

“PETER PRINCIPAL”

As many know, the Peter Principal states that all leaders will be eventually promoted to the point of incompetency.  Many strong corporate leaders simply can’t successfully make the transition into a private equity-backed CEO setting.  The degree of difficulty of these assignments is among the most challenging in business. One imperative for any candidate considering the transition in to private equity:  be intellectually honest with yourself about the challenge ahead.  Many candidates can get caught up in competing for a private equity CEO role and can miss the important step of diligencing their own capabilities against the gravity of the portfolio company challenge

SUMMARY

In my experience, first-time private equity CEOs can be just as effective as their more experienced counterparts.  However, they face unique challenges that should be openly explored during the search process.

 

CEOs vs. Private Equity Boards (Part II – Risk Taking vs. Risk Mitigation)

Overview

In a recent post, we dug into the differing priorities of Boards and CEOs cited in the Boston Consulting Group’s “Private Equity and the CEO, Partners in the Quest for Value”.  Following is a more focused analysis of that report’s findings on risk.  When BCG asked investors and CEOs about risk, more private equity investors responded that CEOs should primarily focus on risk-taking while more CEOs responded that risk mitigation was the priority.

The Private Equity Risk Perspective

CEOs must understand that financial sponsors are risk-takers by definition.  Consider that many Investment Partners are entrepreneurs who started their own firms.  Moreover, most private equity funds employ less than 50 personnel so, in spite of their portfolio size, they are risk-tolerant, small companies in their own right.

Further, private equity firms are in the business of taking risk on behalf of their LPs. Private equity is a top performing asset class, in part, because its risk appetite.  Additionally, private equity firms only own their portfolio companies for a finite period putting a premium on moving the ball down the field quickly…moving fast means incurring risk.

Finally, private equity firms realize that they must drive meaningful change in their portfolio companies if those businesses are to grow even faster and/or turn around even more quickly.  Driving change is hard, and, represents risk.

The CEO Perspective

Unless they have been true entrepreneurs, most private equity CEOs have advanced in their careers, in part, by properly managing risks for themselves and their businesses.  If not properly balanced, this otherwise responsible perspective may be at odds with the private equity’s ambition.

When running a private equity-backed company, many CEOs are conflicted by what they perceive to be competing forces — driving a winning equity outcome and protecting their positions/careers.  Ironically, a conservative leadership approach usually leads to a derailment.

The Psychology of Risk for Many CEOs

As human beings, many CEOs fear failure and therefore can sometimes postpone important initiatives.  They also operate under the scrutiny of high-horsepower Boards and do not wish to fall out of favor with their private equity sponsors. Some CEOs can lack the confidence and self-assuredness required to accept failures as part of a winning formula.

The Winning Approach for CEOs

In my experience, one trait required of all great private equity CEOs is an intense bias for action.   The best CEOs are always moving forward and taking high-velocity, focused action at all times.  With these ideal leaders, risk is mitigated one of two ways: a.) they fail fast on incremental steps and recover quickly; and/or b.) they rely upon the wisdom of their Boards to help make strategically decisions that can benefit from the wisdom of the team.  Private equity Boards appreciate this action-oriented, risk-tolerant approach from CEOs and will be more forgiving when setbacks do occur.

CEOs vs. Private Equity Boards – Where to Focus (Part I)

Overview

In the piece “Private Equity and the CEO, Partners in the Quest for Value”, a Boston Consulting Group survey revealed instructive disconnects between PE investors and CEOs in terms of CEO success factors.

Areas of CEO and Board Alignment

The survey revealed general alignment between CEOs and PE investors on the following:

  • CEOs should balance their focus on the long and short-term.
  • CEOs should balance consensus building with direction setting.
  • CEOs should be driven by a balance of process and ideas.

Areas of CEO and Board Disconnect

However, the survey revealed three significant disconnects that can threaten deal performance.  My own experience in working with private equity Boards and CEOs supports BCG’s research here:

1. STRATEGIC PERSPECTIVE vs. OPERATIONAL PERSPECTIVE

  • The most common response from CEOs is that they should be primarily strategic in their perspective
  • In contrast, the most common response from PE investors was that CEOs should primarily take an operational perspective

2. BIG PICTURE vs. DETAIL ORIENTATION

  • The most common response from CEOs was to focus primarily on the big picture while placing a lower priority on the details.
  • In contrast, the most frequent response from PE investors was that CEOs should take a balanced approach that emphasizes details as much as the big picture.

3. RISK TAKING vs. RISK MITIGATION

  • The most common CEO response was to prioritize a balanced approach between risk taking and risk mitigation
  • In contrast, the most common PE investor response was the prioritize risk taking

In my experience, Boards and CEOs often fail to be intellectually honest about their differing perspectives during the interview and CEO selection process.  The philosophical fit between a Board and CEO will either contribute to alignment or to friction.  The latter can be dangerous for LPs, GPs and CEOs.


In upcoming posts we will address the psychology and behavioral traits that can contribute to CEO derailment in the aforementioned three buckets.

Takeaways for Boards and CEOs

For Sponsors

  • Come to terms with your own governance model and how/where past CEOs have suffered from disconnects that have led to poor performance.
  • Realize that many CEO candidates have an uninformed view of private equity’s needs.
  • Recognize that meaning is often lost in translation during the interview process….for example, most CEOs think they are hands-on but may not come close to PE’s definition of getting in to the details.
  • Take a careful approach during CEO recruitment to conduct behavioral interviews that reveal a CEO candidate’s preferred orientation.
  • Search for CEOs that are a philosophical extension of your fund.
  • Avoid the cognitive bias in interviews that will lead you to see what you want vs. what is true.

For CEOs

  • Understand that each private equity firm has a unique view of where CEOs should focus.
  • Accept that you may be a great fit with one fund and a derailment statistic with another fund.
  • Moreover, understand that often each deal partner represents a sub-culture within a private equity firm.
  • Take time to explore a particular fund’s (and deal partner’s) needs and preferred areas of CEO focus.
  • Exercise intellectual honesty to critically self-assess your fit with a particular sponsor backed role…far, far better to walk away than suffer derailment 1 or 2 years in to the role.
  • Consider that, in my opinion, the single biggest predictor of your success will be the alignment (or lack thereof) you enjoy with your private equity Board.

About Rob Huxtable

Rob serves as the Managing Partner of Integis, a retained executive search firm with offices in New York, Cleveland and San Francisco that is exclusively focused on the private equity-backed, middle market.  The firm’s mission is to drive multiples of invested capital (MOIC) for private equity firms by recruiting high-impact portfolio company C-Suite leaders.  The firm has played a key part in helping many of its private equity clients achieve top-quartile and top-decile results.  Under Rob’s leadership, Integis has been recognized as one of America’s fastest growing privately held companies by the Inc. 5000 for 2015 and 2016.

Arrogance: the most lethal trait for CEOs

Overview

The difference between confidence and arrogance is often difficult to detect in CEOs during an interview process.  This unfortunate reality plagues Boards since arrogance is, in my view, the single most dangerous trait for a private equity-backed CEO.  Let’s consider all of the implications of an arrogant leader.

They usually:

  • Don’t welcome counsel and may not readily accept guidance from the Board
  • Have difficulty evolving and improving making them less adaptable
  • Exhibit artificially low levels of respect for the competition making them susceptible to market share losses
  • Underestimate the difficulty of challenges
  • Struggle with self-assessments and therefore self-improvement
  • Become susceptible to corner cutting believing their own ability can make the difference
  • Find it challenging to recruit A-players
  • Don’t respond well to setbacks
  • Hesitate to push accolades out to their teams
  • Struggle mightily with leadership

Confidence (plus Wisdom) is a Must

In my expeirence, the winning recipe involves CEOs who possess exceptionally high levels of confidence, gorunded in wisdom and humility.

Confidence drives:

  • Setting and achieving stretch goals
  • A winning and competitive culture
  • The ability to respond to setbacks

For the full power of confidence to be released it must be grounded in humility and empathy…and powered by wisdom.

Assessing the Difference

If you know the tells, arrogance can be identified during an interview process. Look for arrogant signals such as:

  • A lack of true self esteem
  • Discomfort when answering questions about mistakes and lessons learned
  • Lower levels of empathy
  • A personal career agenda rather than one focused on the greater good of the business and investors
  • An inability to articulate a personal development plan for continuous learning
  • A lack of unwavering ownership of all outcomes

Pay close attention whe referencing a CEO.  Comments from the team that reported to your CEO candidate will provide valuable insight.

Wisdom

Pay close attention to your perception of each CEO candidate’s general levels of wisdom.  Wisdom and arrogance are essentially mutually exclusive so ample wisdom is a very good thing…in more ways than one.  A private eqiuty Board’s ability to assess wisdom is often instinctual so search commitee memebers must listen to their inner voice – it will usually steer Boards in the right direction, at least in terms of evaluating wisdom.

Conclusion

Boards should veiw arrogance as a fast-lane to a hiring mistake.  Instead, Boards should prize supremely confident candidates while also assessing for humility, empathy and – most of all – wisdom.

 

 

Expectations of Private Equity Boards

Joann S. Lublin’s Wall Street Journal article  “When the CEO Reports to Private-Equity Bosses” suggests private equity-backed CEOs must be able to handle (among other issues), three key realities:

  1. “strict personal accountability”;
  2. “intense scrutiny”; and
  3. “speedy decisions”.

I’ve made a couple of recent posts on PE speed so I’ll focus my comments on accountability and scrutiny.