The case for replacing portfolio CEOsTough times call for tough decisions. Every week seems to bring news of job cuts, closures and CVAs in private equity-backed businesses. But nor is the future all doom and gloom.
The prospects for many portfolio companies do remain strong. But, given the challenges of Covid-19, PE houses can’t afford to retain underperforming leaders in their portfolios. PE houses that have already made changes at the top have seen rapid results, especially in smaller to mid-sized companies.
At the extreme end of the scale, sticking with the wrong CEO can sink a whole investment. The more likely scenario is a failure to keep pace with the milestones of the investment strategy – even if that has been re-set in response to the pandemic. Delivering transformation and scaling a business is challenging enough in a favourable economic climate. Every day that an underperformer is left in place is another day holding back value creation.
The evidence is out there
The case for bringing in a new CEO/MD is strengthened by recent Covid-themed research from Boston Consulting Group (BCG) and McKinsey & Co. BCG’s report features some statistics that really stand out.
New CEOs often cause a significant, sustained change in performance. The companies of the top 20% of CEOs outperformed their sector by 9 percentage points per year over the course of their tenure, controlling for other factors.
In contrast, the companies of the bottom 20% of CEOs underperformed by 11 points.
Now that’s a massive difference in itself. According to BCG Overall, this is 20 percentage points per year—which, over the median CEO tenure of six years, accumulates to a gap larger than the value of the company at the start of the CEO’s tenure.
But the performance gap is increased further in ‘smaller’ firms ie. the kind of scalable businesses, high potential business favoured by many UK PE houses. BCG’s research shows smaller companies with top CEOs outperformed their sector by over 17 points, driven by higher upside for top-quintile CEOs in smaller companies.
Moreover, BCG have showed that CEOs have the largest impact when they take on companies in high-growth, technology-intensive contexts: those with healthy high-growth and asset-light services value patterns.
A different world calls for a leader
The BCG research focused on the importance of high calibre leaders in the present circumstances. Their insight is based on years of data. McKinsey & Co, meanwhile, have analysed the actions and behaviours of successful leaders during the pandemic period. It makes for very interesting reading.
One insight is that CEOs making bold moves is vital to achieving outstanding performance, which itself is elusive—only one in 12 companies goes from being an average performer to a top-quintile performer over a ten-year period. Making one or two bold moves more than doubles the likelihood of making such a shift; making three or more makes it six times more likely.
If your current portfolio company CEO is ill-equipped to make ‘bold moves’, then that’s further justification to replace them. It’s impossible to predict what 2021 and beyond will hold. But it will definitely take bravery and vision to create value, scale up or deliver transformation.
McKinsey add that their research has also shown that CEOs who are hired externally tend to move with more boldness and speed than those hired within an organisation. So, if you are going to replace, think carefully before promoting from within.
Getting the replacement right
The research findings show the difference that high-performing CEOs make – the top 20% in particular. PE houses need to take enough time to run a robust search, assessment and selection exercise. It’s especially valuable to include a sophisticated data-led assessment process to pinpoint future high performers – it’s risky to make hiring decisions on previous track record and interview performance.
Speed, however, is of the essence here. Imagine the value that could be lost from waiting three to six months for a new CEO to take the reins. With this in mind some PE houses have turned to a creative solution to this problem, a hybrid Interim-Perm recruitment exercise.
In effect, the PE house engages a specialist provider for a dual assignment – put a high-quality Interim CEO in place, while launching the permanent search and assessment process. This enables the underperforming CEO to be dropped quickly, while the interim holds the fort and starts laying the foundation for faster value creation.
The best situation is where the interim expresses a potential interest in the full-time position. The PE house has the opportunity to ‘try before they buy’. At the same time, the search team can use performance and assessment data from the interim to benchmark the external candidates.
Even if the interim is not interested in the permanent role, they will still be providing this crucial benchmarking data. Providing the assessment process is well-run, the PE house is in a great position to select a future high-performer.
This type of dual solution has the further advantage of being simpler and more cost-effective than running separate interim and perm search exercises. Fewer briefings, meetings and updates are required. The total fees are lower.
Ultimately of course, it is not so much the ‘cost’ that matters. It is the return on investment. switching an under-performer for a high-performer can translate into millions of pounds difference on the balance sheet.
For a discussion on how we can help you find, assess, deploy and transform the senior leadership team in your PE backed business, please get in touch.