In the final analysis, business is about money and people. By definition, successful private equity firms understand finance, but on average they tend to be less sophisticated about people issues. This makes sense: deal partners and analysts are trained in finance and are good at spotting undervalued assets. But savvy private equity players also understand that reviving an underperforming business depends to a large degree on people issues—in particular, it depends on the leadership of the portfolio company and its working relationship with new ownership.
Considerable evidence suggests that PE firms could do a better job evaluating the ability of the leadership team in their acquired companies. A recent survey by Alix Partners found that nearly three-quarters of portfolio company CEOs are removed during the investment life cycle. Over half are replaced in the first two years; but only 15% are replaced at the outset. These data suggest that, for 4 out of the 5 replaced CEOs, the decision takes too long, thereby delaying strategic milestones and prolonging the hold time.
PE firms can more quickly realize returns on their investments if they analyze the leadership of the companies they acquire with the same rigor that they analyze the business fundamentals during the diligence phase. The good news is that there is a science to analyzing people and the same discipline that is used to identify untapped business value can be used to evaluate the leadership potential of CEO candidates.
Barking up the Wrong Tree
In our experience working with PE firms, the conventional wisdom regarding what to look for in portfolio company CEOs can be misleading. People assume that brains and experience are crucial. But it turns out that IQ and prior industry and CEO experience do not predict the ability to lead through a profitable exit. For instance, a recent survey of managing partners at 32 PE firms (including Blackstone, KKR, and Carlyle) revealed that experience as a CEO in a publicly traded firm does not prepare people for success in the intense PE environment. The data also showed prior industry experience predicts the tendency to run the same playbook rather than driving radical change typically required.
The experience factors associated with successful leadership of a portfolio company include having worked in a PE environment and having previously performed a similar transformation. This doesn’t necessarily mean having been a portfolio company CEO before; having held a big job in a PE environment is enough to appreciate the pace, the sense of urgency, and the need to be in close communication with ownership about everything from strategic direction to performance details. And a track record of having performed the same task successfully—whether that be cutting costs, growing revenues, managing debt, raising capital, going digital, expanding channels, or what have you—bodes well for doing it again and quickly.
Soft Skills Make the Difference
Beyond PE experience and task experience, the factors that best predict the ability of CEOs to lead to a successful exit are found more on the soft side than the hard side. And this is where it can be challenging for financial experts: understanding people is different from understanding balance sheets. However, people differ in certain regular and quantifiable ways and research has shown which differences make a difference when leading a portfolio company. They fall into two general categories.
The first category contains the personal factors common to most successful PE CEOs. They include:
- The ability to build and lead a high-performing team with complementary strengths
- A tough-minded temperament with a sense of urgency
- Resilience—the ability to recover from the inevitable setbacks
- The willingness to admit problems and face difficult realities without spinning or sugarcoating them
PE environments usually have limited resources, which points to the need for versatile chiefs with a broad range of expertise and skills. But versatility is a rare commodity. Less than 10% of senior leaders are able to consult with their staff in decision making while still being able to act acting decisively, or pay attention to the big picture while also attending to the day-to-day details. Successful portfolio CEOs need to be able to recognize their limitations and staff accordingly; they also need humility in order to turn their staff loose. It’s a complex set of capabilities, which accounts for the staggering number of CEOs who are replaced.
The second category of differences concern the chemistry between the CEO and PE ownership. The big issue concerns compatibility: can the CEO and primary deal partner agree on performance expectations, communication cadence and content, and other, often unspoken, rules of engagement? This is about far more than “liking” each other; it more about mutual respect and trust. Establishing a short-hand vocabulary, sharing values, and minimizing surprises is very important in a fast-paced, pressure-cooker environment.
The Science of Personality
Many people tend to think that personality tests are on-line questionnaires or magazine quizzes designed to tell them about their “type,” “color,” or the house at the Hogwarts School of Witchcraft and Wizardry into which they would best fit. However, there is a science of personality assessment based on research going back over 100 years. It isn’t rocket science, it’s behavioral science—and it leads to solid, dependable results. The evidence is clear that personality assessment powerfully predicts real life behavior; hundreds of studies with hundreds of thousands of working adults show that competently constructed personality measures predict performance with surprising accuracy. Properly validated personality measures predict job performance, career success, and leadership better than any known alternative, including IQ. Personality is stronger than Viagra: the correlation between personality and leadership is stronger than the correlation between Viagra use and improved sexual functioning.
Moreover, well-designed personality assessments can forecast an individual’s ability to build a team, make tough calls, handle pressure, and be candid, flexible, and humble. Being able to penetrate the veil of self-presentation is important because sitting CEOs are likely to be on their best behavior during the courtship phase of an acquisition. There is a big difference between people at their best—what we call “the bright side” of personality —and people under sustained pressure when you see their “dark side”—the behavioral tendencies that derail teams and careers. For example, over time confidence can turn into arrogance, collaboration morphs into appeasement, and passion and a sense of urgency turn into erratic tantrums. Personality testing is especially useful when evaluating possible replacement candidates, because you will often have little direct exposure to the person yourself and smart people can conceal their dark sides for short periods of time.
Personality testing is also effective at determining the compatibility between people. It’s the basic theory and measurement system behind successful online dating platforms, and it can also be applied effectively to working relationships. In addition to predicting how well two peoples’ interpersonal, thinking, and communication styles will mesh, personality assessment can also predict how people are likely to rub each other the wrong way and push each other’s hot buttons. Perhaps most importantly, a comprehensive personality assessment that includes core values can identify whether people are aligned in what they really want—versus likely to be working at cross purposes. In a PE context, for example, it is vital that the CEO and the primary deal partner agree about core values—i.e., about the relative importance of money, status, fame, relationships, and pleasure.
Managing Risk on the People Side
Assessing the personalities of CEOs and their leadership teams should be a routine part of doing diligence on a potential acquisition company. On the one hand, evaluations of the leaders’ work histories can indicate whether they understand the pressures of PE environments and if they know how to execute the sorts of changes needed to realize value. This tells you whether people can do the job on paper. Similarly, personality assessment will provide a sense of what it would be like to work with them—how they will do the job once in office, what it will be like to have them in your life. It is interesting to note that most failures of leadership are less about a deficiency in what they know and more about how they prioritize time, focus attention, and interact with key people. And the most important interaction of all is between the CEO and the primary deal partner; with so much at stake, it’s best to understand how this relationship will work at the start, including how it could go wrong and how to manage it when things get tense.
*This post was co-authored by Robert Hogan and Rob Kaiser, and was originally published by Hunt Scanlon Media.