Replacing an underperforming CEO promptly following a transaction can be crucial for growth, morale, and returns for private equity portfolio companies. Yet many investors and independent directors say doing so often takes two or more years, according to the 2017 AlixPartners-Vardis Private Equity Survey.
Given the expected five- to seven-year holding period for portfolio companies, boards may be able to avoid having to make a switch in two years by being more proactive in assessing the CEO early in the ownership period. This may require directors to be more mindful of the most effective qualities of a private equity portfolio company CEO, as well as what the board’s relationship should be with the CEO.
A Harvard Business Review article, “How Private Equity Firms Hire CEOs,” looked at five qualities that researchers say private equity firms look for in CEOs for portfolio companies:
Egon Zehnder chair Damien O’Brien, however, offers a few caveats. “Private equity investors typically back the CEO and his/her management team when they make their investment,” he wrote in a recent article. “The investment is predicated on top management’s ongoing involvement because of their knowledge of the business and/or relationships with customers and other key employees. This can create a level of dependency, however, which impedes the ability of a private equity board to be independent of management and, for example, deal with a problematic CEO in a timely manner.”
So how does the board expedites its assessment of the CEO? By tackling areas of iscommunication between the board and the CEO that can be more readily assessed than underperformance, which may take several quarters to observe.
In an effort to learn what behaviors contributed to the retention or dismissal of a founder/CEO, Larry Stybel and Maryanne Peabody interviewed private equity investors for the Journal of Leadership and Management. One observed behavior dubbed “Smoke Gets in Your Eyes” refers to when the CEO agrees with an investor or director suggestion without any level of follow through or investigation. A second behavior, labeled “The ‘Problem Solved’ Problem,” demonstrates the portfolio company CEO’s perception of the board (and the investors) with regard to the business. Here, a problem is first reported to the board only after it has been resolved, and is a sign that the CEO misunderstands his or her relationship with the board.
The directors who participated in Stybel and Peabody’s research suggested that alleviating these types of contentious relationships (or at least surfacing them sooner) often requires a type of shuttle diplomacy on the board’s part. This could take the form of an independent director playing “good cop” to the controlling investor board member’s “bad cop”—which may be too obvious and appear forced—or simply result from the presence of several independent board members who serve as a safe harbor for executives.
This article, which originally appeared in the September/October 2017 issue of NACD Directorship, was adapted from Building a Foundation for Growth: Governance in Investor-Owned Private Companies, which was sponsored by the KPMG Board Leadership Center and is available at NACDonline.org.