Asset management industry outlook

People power: How private equity talent strategies drive sustainable value

A perfect storm of variables has shifted the conversation about value creation

Mar 14, 2024

Key takeaways

The inventory of PE-owned assets is the largest it has ever been.

PE fund managers are looking beyond traditional financial engineering to keep investors satiated.

Leadership development for portfolio company management teams and PE fund teams is key.

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Financial services Economics Asset management

The perfect storm of variables hitting the asset management ecosystem has shifted the conversation about how and where value is created. High interest rates, recession predictions and geopolitical tensions have all slowed sales of investments to new lows since the Great Recession. This, in turn, has resulted in longer holding periods for existing portfolio companies, as well as a shift in deal types.

Due to the high cost of capital triggered by high interest rates, more and more private equity (PE) fund managers are having to look beyond traditional financial engineering commonly used in the sector to maximize value and keep investors satiated. Some firms are turning to their talent strategies and reassessing how talent factors into the value equation.

Investment holding periods are getting longer

In the third quarter of 2023, PE exit values hit their lowest quarterly level since the 2007−09 financial crisis (aside from one quarter during the height of the pandemic), according to PitchBook data.

If market conditions are causing misalignment in value expectations between the buyer and the PE fund sponsor, the sponsor generally prefers to hold the investment rather than being forced into a sale. This puts increased pressure and focus on current operations within existing portfolios.

The median holding period of U.S. PE investments exited in 2023 was 6.4 years, a new record, per PitchBook. As of Dec. 31, 2023, the median holding period for investments still held in the United States by PE funds was 4.2 years, the highest level since 2012. With deal activity outpacing exits, the inventory of PE-owned assets is the largest it has ever been.

With interest rates expected to stay higher for the foreseeable future, holding periods are expected to keep increasing. However, this can change if investor demands for liquidity need to be met sooner than expected. These demands could trigger forced sales or sales on the secondary markets, both of which would accelerate holding periods.

Operational excellence

According to PitchBook, the investment-to-exit ratio dropped to 0.36x by the end of 2023, meaning that for every 100 investments made, only 36 exit opportunities were available. In an overcrowded playing field, how does a PE firm differentiate itself? An operating team that can drive long-term growth throughout extended holding periods can separate the winners from the losers.

The operating partner or operating team role within the private equity space is inherently challenging to fill because individuals in these roles must understand and execute on the needs of both the PE fund team and the portfolio company’s management team—needs that are sometimes conflicting. These roles become even more challenging when holding periods are extended.

It is not uncommon for a PE fund manager to replace the leadership team at the portfolio company once it has been taken over. This is generally a strategic decision made in advance of an acquisition; however, unplanned C-suite turnover happens, on average, in 54% of takeovers, according to a recent article in the Harvard Business Review. The article notes, “Unplanned exits cause enormous disruption: Forty-six percent of PE firms say that unplanned CEO turnover erodes the rate of return on their investments.”

Furthermore, add-on deals have seen significant growth in the buyout playing field because they allow for continued capital deployment through smaller deals. Add-on deals are generally easier to finance due to their size and existing lines of credit from their larger platform acquirers. Even so, the successful integration of these add-ons to existing companies can be challenging due to differences in company culture. Cultural synergies are just as important as operational synergies in measuring the long-term success of an add-on transaction.

CONSULTING INSIGHT

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Having a trusted operating team that facilitates cohesion and drives innovation both throughout the integration process and post-integration is a critical value driver in creating a quality business. Some ways firms can achieve this include:

  • Establishing open channels of communication to address questions and provide updates that help minimize concerns for all parties involved
  • Analyzing workflows to identify fractured processes and suggest optimization solutions
  • Continuously gathering feedback and staying in tune with overall team sentiment post-integration
  • Prioritizing team-building activities to accelerate the cohesion of company cultures

With higher price tags comes lower tolerance for Band-Aid fixes that can just as easily be ripped off later. A clear operational strategy will be the competitive differentiator needed to get exits out of the gutter.

Having a trusted operating team that facilitates cohesion and drives innovation both throughout the integration process and post-integration is a critical value driver in creating a quality business.
Daniela Cohen, RSM US financial services senior analyst

Evaluating talent strategies

Although there isn’t a singular answer to the question of how PE firms can best create value, there are ways to identify key value drivers that can help their portfolio companies enhance their operational performance and achieve long-term sustained growth.

TAX TREND: Talent strategies

Total rewards programs provide compensation, benefits, recognition, and developmental rewards to executives and employees for their achievement against specific business goals. This holistic approach is especially important in retaining top talent.

Understanding the tax implications of these total rewards programs can help organizations maximize their returns on their workforce investments while achieving their enterprise goals.

From a talent strategy perspective, enhancements that can go a long way in the value creation cycle include:

  • Investing in executive programs that prioritize leadership development for both the portfolio company management teams and the PE fund team
  • Developing a succession plan for key leadership positions within portfolio companies to mitigate the consequences of unexpected turnover
  • Reevaluating the skill sets prioritized for certain key roles during hiring, and placing a premium on emotional intelligence, change management and leadership
  • Assessing and aligning the organizational culture of portfolio companies with the overall strategy and values of the PE fund
  • Providing vigorous human capital support to portfolio companies
  • Developing a playbook for sharing best practices, tools and resources for effective talent management

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