Three years ago, I did a bit of work for a private equity firm related to one of their new acquisitions. The company’s founder had made a bad investment, plus there had been a structural shift in their industry to which he hadn’t adapted quickly enough. His “sick baby” was now on the verge of bankruptcy. That was good news for the PE firm because they could “buy cheap.”
The firm had a team of us go in to take a good hard look at the management and the board. Strong advocates of traditional talent management expected that wherever a seat was empty or occupied with “inadequate” talent, we simply would fill it, and our job would be done. We knew the CEO, as part of the deal, would be moving on. It was tough, but within 90 days, we found someone to replace him. Not too bad for a first step, considering the new Executive Officer had to be not only proficient at leading a major turnaround but also unfazed by the brand’s reputation in the marketplace. Next, we decided to keep a lot of the management team, including the CFO and the Chief Commercial Officer (CCO). However, several other incumbents were clearly not a good match and fit. In the next two months, we hired a new CHRO, two new General Managers, and a new Head of Procurement. We finished our job by bringing in several strong board members.
Unfortunately, this “seat empty, seat filled, job done” approach to the organization’s talent was necessary but not sufficient for the profitable growth of the business.
It didn’t help us understand what roles were critical for value creation. It didn’t allow us to dive deeply enough into the organization to actually discover the bad news: value was leaking all over the place for a variety of reasons. Months later, those reasons became apparent.
In the commercial organization, the CCO had boxed everyone into commodity hell with new “big box” retail customers. The organization hadn’t priced aggressively enough to stay ahead of inflation. Shortages of raw materials led to allocation cuts to their new B2C customers. And then came the coup de grâce. Entering the second year of the pandemic, the new Head of Procurement, backed by the operating partner, decided to offshore the company’s entire supply chain to new vendors (whose “foreign” supply chains were subject to international regulations and, therefore, much more complex). To top it all off, the new CEO we had brought in ended up being a bit too “nice:" he didn’t address any of the bad decisions in sales, pricing, and procurement. He simply let the talent in the CCO and Head of Procurement roles linger, unquestioned, in place.
Just last week, I heard the CEO is being replaced. The company still hasn’t gotten above $100M in EBITDA. The PE firm is three years in and nowhere near close to exit.
Value leakage is the symptom of a problem, one that can often be traced back to poor strategic choices and bad business decisions. The quality of those choices and decisions, as well as the time it takes to make them, is material to value.
That experience made me realize PE firms can do several things related to talent to positively impact MOIC (Multiple on Invested Capital) and IRR (Internal Rate of Return).
1. Understand where and why value is leaking. Conduct a thorough review of the entire operations as part of due diligence before acquisition. Investigate supply chain inefficiencies, high overhead costs, and wasted resources, as well as current shifts in the industry. Identify who made the strategic choices and poor business decisions that brought or are bringing the enterprise’s value down.
2. Get your C-suite hires right. Sometimes this is hard to do, especially if you are hiring people into an enterprise that is seen as “failing.” This involves more than just making sure they have the skills and experience to run the business effectively. Use what you discover in due diligence, along with your firm’s investment thesis, to determine exactly what each C-suite hire must contribute to the company’s value agenda. Connect them to the value. Identify the challenges each role will face before you review incumbent talent for their ability to make wise decisions and deliver the value in time.
3. Understand all the roles critical to value. C-suite roles are obvious. Not so obvious are the N-2 through N-4 roles in an organization (that is, roles two to four levels below the CEO), where value gets created, protected, destroyed, or leaked. If we had, for instance, understood what was really going on in the commercial organization, we would have changed out the CCO.
4. Don’t throw good time after bad. Value leaks when you let poor decisions stand and insufficient talent stay. The CEO and the operating partner should have been all over the new Head of Procurement’s move to offshore the supply chain. That was bad judgment, never mind bad timing. In trying to save a nickel on price, the company lost a dollar in availability.
Your PE firms invest in private companies for two reasons: 1) to help them grow the enterprise value to its full potential and 2) to provide your investors with a solid return. Value leakage can negatively impact your ability to do both. For that reason, it is your responsibility to stop stealing from your portfolio companies and to start identifying and shoring up the leaks.
