While many private equity (PE) investors are quite optimistic about the year 2024, the current challenging geopolitical situation, coupled with slow economic activity and tight credit markets, undeniably exerts pressure on the entire industry.
This situation intensifies the pressure on PE firms to refine their current investments and maximize their value. According to a research project by Harvard Business Review, the leadership of portfolio companies (portcos) has a 10 to 15% impact on financial performance and a 25 to 30% impact on market valuation. In essence, talent emerges as one of the most crucial assets for private equity firms in creating value for their acquired companies. This trend is gradually overshadowing proprietary deal flow and financial engineering.
Given these circumstances, the role of Human Resources (HR) in private equity becomes pivotal. Despite this, we still observe many portcos where the HR function remains transactional and, unfortunately, does not adopt the strategic scope we anticipate. At the very least, we would expect the following strategic competencies:
- Getting the best talent on board
- Retaining and motivating the talent
- Integrating different cultures
1. Getting the best talent on board
Time is of the essence in private equity, but…
For a PE firm, it is crucial to assemble the right team before completing the acquisition process. When executive search is involved, HR professionals often face a common challenge. Both portco and PE executives may, at times, emphasize the urgency of time, pushing HR to take shortcuts, such as hiring based on personal connections or past success stories. This can prove to be a costly approach. Each acquisition unfolds under unique market conditions, and each portfolio company confronts distinct challenges—no story can be replicated. The only correct approach is to conduct a thorough executive search supported by an extensive list of target companies, including already recommended candidates.
Even after the top management of a portco is hired and settled, the active role of HR persists. According to data from AlixPartners, 73% of CEOs are likely to be replaced during the entire investment life cycle, and even 30% of replacements will be replaced. These alarming numbers apply similarly to other executive positions. This places special stress on HR professionals to continually observe the market and benchmark internal candidates against the best external ones. The most efficient way to do so is through talent mapping, often provided externally by most executive search firms.
2. Retaining and motivating top talent
Without a doubt, one of the primary tools for retaining, motivating, and attracting key individuals in portcos is the executive package. Quality packages typically include two or three percent equity, and this percentage may increase based on the seniority of selected executives. The HR professional must ensure that packages, even those with little or no equity, are supplemented with other meaningful incentives to maintain the loyalty and motivation of key talent.
In addition to enticing executive packages, HR should also play a pivotal role in creating and managing other tools to retain and motivate key talents. These may include, for instance, clear communication of the company’s vision, employer branding, or hybrid working models, just to name a few.
Learn more about the latest trends in the labor market. Check out the following publications:
- Gen Z employees becoming managers: What can we expect?
- Create a resilient culture in times of uncertainty
- AI for businesses: How to combine technology and human skills
3. Integrating different cultures
Culture is key to success (and failure) in private equity deals…
When a PE firm acquires a company, it usually has a significant impact on the portco culture. The encounter of two different cultures can be fatal for the entire deal. While PE professionals excel in numbers and deal structuring, they often lack excellence in people skills. Their financially focused, change management, or time-pressing attitudes can create significant stress for portco management, easily destabilizing the whole team and hampering its productivity. The situation may worsen if the portco CEO or CFO also comes from the PE industry.
This is where the crucial role of HR executives comes into play. With strong support from other top executives, they need to integrate both cultures and smooth out sharp edges as quickly as possible. Cultural fluency, involving consideration of the other person’s perspective, is key. This can be achieved by deploying various tools such as continuous communication of the company mission and objectives, introducing a new organizational structure, conducting workshops and team-building events, fostering employee engagement, etc. However, the most important tool for each stakeholder involved is mutual respect and humility.
Value creation in private equity occurs through various mechanisms, but ultimately, it is driven by people. Every PE firm, especially in middle-sized and larger portcos, should appoint a strategic HR executive with a broad mandate (but at least at the minimum scope mentioned above) and a sufficient budget, as this can significantly increase the company’s value more than anything else.
About the author
Lumir Meloun is an executive search professional with over three decades of experience and a proven track record in top management positions across diverse industries. His expertise is concentrated in the private equity and financial services sectors in continental Europe and the UK, with a particular emphasis on the CEE region.