MANAGE THE PE-CEO-CFO RELATIONSHIP: NO EASY FEAT
The relationships between a PE spnsor, a portco's CEO and the portco's CFO count among the most critical a PE firm will ever have to manage.
Trouble in any of the three legs of the relationship triangle—such as jealousy, mistrust, and poor communication—can torpedo the success of an entire investment by preventing key members of the management team from executing the investment thesis, thereby ultimately sabotaging returns. To safeguard an investment’s
success, PE owners have to proactively manage each dimension of the triangle, including identifying and swiftly mitigating risks.
“Almost 50% of investors agree that assessing the CEO/CFO relationship is vital—but few actually do it.”
We think PE firms should pay closer attention to that imperative. Consider that only about 50% of the investors in this year’s survey said they view the assessment of CEO–CFO relationship dynamics—including collaboration between them—as "extremely important" or "very important." However, just 43% of those who hold that view said they actually conduct an independent assessment of a target portco’s management team in the predeal phase.
PE investor, CEO, and CFO respondents each shared perspectives on how to determine whether the CEO–CFO relationship is problematic. The need for collaboration, communication, and alignment on strategy and execution underscore the complementary nature of the roles. These views suggest the need for careful assessment of the relationship—not only in the due diligence phase but also at key junctures throughout the investment hold period—to make sure the relationship dynamics remain healthy and alignment remains intact.
The common theme of lack of collaboration across the three groups in our study indicates that both CEOs and CFOs view their relationship with each other as one based on teamwork—with each person depending on the other for successful execution of accountabilities.
MUTUAL UNDERSTANDING: A KEY TO BUILDING TRUST AND FOSTERING CANDID COMMUNICATION
Keys to the relationship: Trust and communication
Proactively building trust and engaging in open communication between PE sponsors and portco top executives about such matters as accountability and expectations are key to managing the relationship triangle. PE respondents identified factors they deemed critical to maintaining a constructive relationship with their portco CEOs:
- 96% "trust"
- 94% "open communication"
- 93% "an understanding of the CEO’s drivers and motivations"
- The lowest-ranked response was "realistic strategic execution," at 85%
In their own words: PE Sponsors
We asked the PE respondents, "This year, what has been the one things that portfolio company CEOs need to understand better about their PE investors?"
The key theme: Urgency.
- "Our insistence that we act quickly on value-creation priorities"
- "The need for speed."
- "[That] the pressure to delivery performance and returns has only increased."
- "The importance of investment timeline."
- "[The important of] positioning for exit."
In their own words: Portco CEOs
We asked, "This year, what has been the one thing that PE firms need to understand better about their portco CEOs?"
The key themes: Alignment and execution.
- "Trust the executive team with execution, and give them space to deliver."
- "Let the CEO run the company; micromanagement isn't helpful."
Another key theme: Uncertainty.
- "[It's] never been a tougher time to be a CEO, so many obstacles outside our control."
In their own words: Portco CFOs
We asked, "This year, what has been the one thing that PE firms need to understand better about their portco CFOs?"
The key themes: Alignment and execution.
- "We have to balance the company's best interests and the PE firms' objectives."
- "Understand our company's inner workings to put information in perspective."
Another key theme: Competency.
- "We are operations CFOs, not financing gurus."
- "CFOs are actually running the business, too."
- "Great CFOs are critical to the value-creation process."
We believe that investors and portco executives can set the stage for success by conducting an independently facilitated alignment workshop soon after the close of a deal between a PE sponsor and a portco management team. The gathering should be devoted specifically to reaching agreement on and committing to shared expectations. In our view, such a workshop—a standard practice during that crucial, first-100-days period—is a form of insurance for getting off to a productive start in the post-deal phase.
Defining an investment thesis: Misalignment on the importance of human capital
When deciding where to channel their investment dollars and crafting an investment thesis for new assets, PE firms must consider multiple factors.
Near term priorities for portcos: Human capital comes in second only to growth.
When we asked our PE and portco respondents what they considered the most-pressing near-term issues their portfolio companies face, we saw a stark contrast in their
responses. Although "growth"—especially in revenues and margins—topped the lists of both of the groups, 63% of the PE-firm respondents cited “human capital” as their number two concern versus just 42% of portco respondents (see figure 1 below).
What explains the 21% delta between PE and portco responses? Perhaps PE firms are looking more to talent as a mechanism for accelerating growth in their portcos—
and portco executives may be complacent about their current talent benches.
We see additional signs that PE firms are increasingly recognizing that investment success isn’t just about the numbers; it’s also about the people. Among PE respondents who indicated that they install or upgrade portco management teams, 40% said they wait more than one year to replace the CEO. As much as 72% of those who retain portcos’ existing management teams still end up replacing the CEO after one year. However, last year’s participating investors cited assessing portco management teams and establishing senior team alignment as top priorities during the first 100 days post-investment.
40% of PE respondents say they wait more than one year to replace the CEO. But their behavior suggests otherwise.
Nevertheless, when deciding where to invest, PE firms in this year’s study emphasized targets’ financial performance and operational efficiency over the quality of the targets’ current leadership teams and organizational cultures. We found that surprising given that investors had named human capital as a major concern regarding their portcos. Despite longer hold times and stiffer competition for talent, a weighted average of roughly 50% of the investors in our respondent pool said they’re not doing
much to change their talent-management strategies—including in the area of CEO and CFO succession planning. In fact, the response “No change” to the question about whether hold times had caused owners to rethink their approaches to CEO succession was up from 38% in last year’s survey results. "Human capital is a top concern, but surprisingly not cited as a key factor when deciding to invest."
What explains this misalignment? Investors see the importance of onboarding and retaining top talent to achieve successful sales—but still have work to do in this area.
Sponsors emphasize operational efficiency more than portcos do. We also saw misalignment on what most drives value creation in portcos. PE and portco respondents see organic and inorganic growth as key drivers—but 52% of investors also named operational efficiency, versus just 30% of portco executives. The delta may indicate that sponsors focus more on operational efficiency because it delivers cost savings that go straight to the bottom line. Moreover, cost savings can translate into head count reductions, and CEOs may be feeling protective of their in-house talent.
ASSESSING PORTCO EXECUTIVES AND CULTURE: MUCH TALK, LITTLE ACTION
When it comes to assessing portco executives' leadership skills and companies' organizational cultures during the predeal phase, we saw additional misalignment - on multiple fronts.
“We're good at executive assessment - but we seldom do it."
Perhaps most telling, 59% of representatives of PE firms in this year’s study gave themselves high grades ("very strong" or "above average") for their ability to take
stock of their portcos’ leadership teams. And they agree that such assessment is vital, yet only half of them said they "always" or "often" formally assess CEOs’ and
CFOs’ leadership competencies. Moreover, as much as 67% said independent assessments of targets’ incumbent CEOs would be useful to them during the predeal due diligence phase of the investment cycle.
"We assess CEOs and CFOs differently."
In assessments of incumbent CEOs, PE investors cited "ability to drive value creation" as the top factor they consider, followed by "ability to build, motivate, and work on a strong team. That’s clearly a nod to the importance of managing talent effectively. But other key interpersonal competencies—such as "self-awareness" and "communication skills"—fell closer to the bottom of the list. With regard to assessments of CEO candidates, both investors and portco executives identified "drive and work ethic" along with "people leadership skills" as vital. Portco CEOs also noted "personal compatibility with the board/investors" as an important ingredient for high performance. When we widened the lens to include assessments of CFO candidates for portcos, another form of misalignment came to light: more than 89% of PE-firm
respondents cited "technical and financial skills," "prior CFO experience," and "drive and work ethic" as "very critical" or "extremely critical."
Does it matter more to portcos than to investors? As much as 86% of the portco executives said they see culture assessment as important when a PE firm adds a new asset to its portfolio. But just 28% of them said their PE investors "always" or "often" conduct such assessments.
11% of represented PE firms said they do not perform diagnoses of portco culture.
For PE firms this year that do carry out such assessments, conducting individual interviews is their method of choice—far ahead of other methods such as:
- Reviewing a company’s reputation in its industry
- Conducting employee surveys
- Evaluating a company’s identity on social media
- Performing psychometric assessments
We view PE firms’ heavy reliance on speaking directly to individuals in a portco as risky. The reason? In itself, that approach may not be structured enough to paint a comprehensive and accurate picture of a portco’s organizational culture.
Clearly, there’s room for improvement there—given that 34% of the PE firms rated their ability to assess a portco’s culture as "average," and 11% gave themselves a grade of "below average" on that ability.