We have learned from our close involvement with private-equity (PE) firms and portfolio companies that their relationship and mutual cooperation are instrumental in determining whether a company performs well or falls short of expectations. While the cooperation between the honey-guide and the ratel is probably apocryphal, our research has shown that the PE-CEO relationship can be highly symbiotic, producing significant benefits for both sides.
To more fully understand the nuances of the relationship between CEOs and their PE firms, BCG has conducted interviews and surveys with both PE professionals and current and former CEOs of PE portfolio companies. This report covers the most revealing and salient results of these studies.
A Successful Partnership :
Most PE professionals would describe their relationships with their CEOs as partnerships, but even the most successful partnerships have points of friction. For example, CEOs accustomed to running their own show often bristle when PE firms intervene in management issues.
By the same token, PE firms have the right (and indeed, the obligation, considering the fiduciary duty they owe their investors) to remove under-performing CEOs—and they are quick to assert that right when necessary. In fact, our research into 198 companies currently under PE ownership found that 57 percent have alreadychanged CEOs since being acquired. Some of those changes were planned prior to acquisition, but many occurred because the PE owners came to the conclusion that the incumbent CEOs were not suited to the task at hand.
Despite the inevitable challenges and complexities of the relationship, we found that the overwhelming majority of CEOs at portfolio companies—more than 90 percent—agree that the PE owner has had a positive effect on their company’s performance. Perhaps more surprisingly, an almost equal percentage of CEOs say that the PE firm has enabled them to succeed in their role and has made them better at their jobs.
In this report, we will consider a few crucial questions, guided by the thoughtful and candid responses of the CEOs and PE professionals who participated in our research. Those questions include :
- What do PE firms look for in a CEO ?
- What role do both sides expect the PE firm to play ?
- What are the most common reasons for a breakdown in the relationship between a PE firm and the CEO of a portfolio company ?
- What key principles and best practices should PE firms and CEOs follow to promote and support a successful partnership ?
What PE Firms Look for in a CEO :
By its very nature, the PE-CEO relationship differs from other owner-manager relationships. The professionals at PE firms are highly skilled and expert shareholders and, crucially, they have been given powerful incentives to succeed. They therefore think and behave differently than less engaged shareholders do. Their mindsets and practices are sometimes misunderstood, and as a result, even the CEOs at portfolio companies sometimes fail to grasp what PE firms prioritize when they select and evaluate a chief executive.
Our survey revealed significant differences in the ways that PE professionals and CEOs view the capabilities and mindset required to succeed as the CEO of a PE-owned company. (See Exhibit 2.) PE firms, for example, generally want their CEOs to focus primarily on operational matters, while CEOs view themselves as strategists first and operators second.
PE firms also expect CEOs to balance their focus between the big picture and operational details. They demand that CEOs execute on stated plans and goals, and consequently they seek CEOs capable of intense attention to detail, with a hands-on operating style. CEOs, by contrast, believe that it is their role to focus more intently on the big picture.
It is also a common misconception that PE firms are biased toward short-term goals and thinking. In fact, PE professionals told us that they want CEOs to focus more on the long term. This is because PE firms take a long-term view of value creation. They embrace a holistic and pragmatic approach that sees no conflict between generating cash in the short term and building value in the business over the long term—both are equally valid and viable paths to their goal.
Finally, and perhaps most tellingly, PE professionals said that they want CEOs to be biased toward risk-taking. By contrast, CEOs believe they need to balance risk-taking with risk mitigation. These divergent views go a long way toward explaining why the relationship between the PE firm and the CEO can sometimes go awry.
What Role Both Sides Expect PE Firms to Play :
We also asked PE professionals and the CEOs of PE portfolio companies to rank by importance several different roles for PE firms.The points of agreement between the two sides are as telling as their differences. CEOs tend to believe that the proper role of the PE firm is to provide capital, monitor certain areas of performance, and serve in a limited way as a sounding board for managerial decisions. And they see less of a place for the PE firm as an advisor on operational matters or in day-to-day oversight of the business.
PE professionals, however, take a more expansive view of the firm’s role. They place somewhat less emphasis on capital provision and believe that the PE firm ought to have a greater voice in key decisions. And they see themselves as having significant expertise to offer on specific areas of the business. CEOs, by contrast, believe there should be little engagement from the PE firm on revenue-related and operational issues. As one CEO of a portfolio company told us, “PE firms should avoid getting involved in anything close to managing the business. That’s my job. They don’t have the resources or the expertise to offer the proper support.”
Our discussions with PE professionals and CEOs made clear that their differing perspectives on the appropriate level of engagement by the PE firm did not necessarily reflect any operational shortcomings of the PE firms themselves (of which there are some). Rather, their divergent views reflect a greater divide on the ways PE firms can and should contribute to value creation. (See Exhibit 4.)
It’s clear from the survey responses that PE firms are not as meddlesome as many CEOs might think or fear. CEOs told us that PE firms rarely initiate an intervention in Operational issues and “focus instead on Strategic, Financial, and—to a lesser extent—Operational topics.”
Rather than barging into a CEO’s office issuing orders, most PE professionals take pains to persuade a CEO that an intervention is in the best interests of the organization. Following such discussions, BCG research has found, it is most often the CEO who initiates an intervention or who jointly agrees with the PE firm to step up its involvement.
When analyzing the responses to our survey by PE professionals and CEOs, clear points of contention emerge. At the same time, however, both CEOs and PE firms have a deep appreciation for what the other side can contribute to value creation. Several topics, highlighted below, elicited the most passionate and thoughtful responses.
The Importance of Engagement by PE Firms on Strategy and Governance – CEOs see PE firms as natural partners in finance-related matters such as M&A, exit strategy, and balance-sheet management. In fact, many CEOs expect PE firms to take the lead when such questions arise. One CEO told us, “Our PE firm has been able to provide financing and legal expertise that we do not have in-house. We face more complicated issues than we did before the acquisition, and their expertise is welcome.”
PE Involvement in Cost Issues and Revenue-Related Operational Questions – Both sides agree that this type of involvement is not a priority. But PE professionals said they would like to be more engaged as a sounding board on these subjects. By contrast, CEOs in general want less involvement from PE firms on operational matters but recognize that PE firms can be helpful on questions of costs. They also accept that PE firms rightfully place a priority on issues of cash flow, such as capital expenditures and working capital. In general, CEOs said they believe that PE professionals’ experience qualifies them as experts on costs yet still leaves them without an intimate understanding of the business needed to address revenue issues. As one CEO said, “On detailed growth and cost projects, either you stay and help execute—which is not practical—or you stay away and let the CEO get on with running the business.”
Which PE Interventions Are Viewed as Helpful and Desirable – PE professionals told us that they see the value creation plan, with clearly associated key performance indicators (KPIs), as the core of the PE governance model; they also said they want to play a large part in its creation. Typically, the PE firm and the CEO reach alignment on the plan’s thesis and underlying principles before closing the deal, and the plan’s principles are translated into a coherent set of activities during the first 100 days of the new entity’s operation. CEOs generally said they prefer to take charge of drawing up the action steps, and many expect a limited amount of input from the PE firm. Because the plan is central to the PE business model, however, firms generally want to be closely involved in putting the plan into operation.
Successful CEOs recognize the critical importance of aligning with their PE owners on the plan—which will set the CEO’s agenda for the next several years—and managing a division of labor that plays to the strengths of both sides. They take responsibility for the specific operational details but look to their PE owners for guidance on constructing a robust framework for tracking progress on the plan, knowing that PE firms place heavy emphasis on a considered use of KPIs and an effective program management office. Without the PE firm’s expertise in designing tracking frameworks, CEOs often resort to deploying measurement systems already in place to track other programs. Such programs, however, are usually smaller and less far-reaching than the value creation plan—and are thus unequal to the task.
Most CEOs, especially those with prior PE experience, also invite their PE owners to participate in discussions of geographic expansion. And they want more engagement from PE firms on matters regarding market and industry intelligence. The CEOs recognize that PE firms have valuable, well-developed external networks.
The Most Common Reasons the PE-CEO Relationship Breaks Down :
From our research and extensive experience in the private-equity arena, we have identified FOUR root-causes that result in the relationship between a CEO and the PE firm failing to reach its full potential :
- A lack of understanding of the other side’s perspective
- A failure to adapt to the unique demands of the relationship
- The lack of a fully trusting and transparent relationship between the CEO & PE firm
- An incomplete appreciation of the value a PE firm brings to the table
Four Imperatives for Successful Collaboration :
The most successful relationships require mutual and ongoing effort. Both CEOs and PE firms have “FOUR Imperatives” to fulfill :
- Understand where your partner is coming from – In particular, understand their mindset. For CEOs, this often means refreshing or gaining new technical skills, and for the PE firms, this often means taking time to identify and dispel any preconceived notions about PE that CEOs might hold. PE firms also need to recognize that they probably made implicit agreements with the CEO before the acquisition—agreements they need to honor to foster trust and transparency.
- Define the relationship up front – Set clear and achievable objectives together, defining roles in detail and avoiding a one-size-fits-all approach.
- Make the relationship work throughout the cycle – Transparency is the most important factor in maintaining a relationship that adds value to the company and the PE firm. Maintain transparency when the news is bad as well as when it is good.
- Get the full benefit from your partner – Work together to make your partner your greatest ally.
Without doubt, a successful relationship between a PE firm and the CEO at a portfolio company can deliver huge benefits to the PE firm, the portfolio company, and the CEO. Conversely, a bad relationship can ruin the CEO’s career, tarnish the PE firm’s reputation, and cripple the company. In a world where private equity is focused on driving real value creation, making the relationship work should be a priority for PE firms and CEOs alike.