Articles & Papers

PE/VC Trends Report: Technology Edition

Revolutionizing Talent

Optimising human capital to generate value

While digitalisation is increasingly prominent in value creation, the human component remains key. “We are increasingly seeing private equity clients investing in human capital as part of their value creation efforts because they are undertaking bigger and bigger transformations,” says Sarah O’Connell, a value creation partner at PwC.
However, optimising human capital is compromised by a pervasive talent shortage in many sectors, resulting in wider use of retention compensation, offsetting the cost of acquiring and training new talent. It is also now taking longer to fill positions.
With other value creation levers already pulled, human capital has become more of a priority. Value creation has moved from financial engineering, through operating improvements to talent operating partners integrated into operating teams.
This migration is based on the need to address more complex value creation levers over time, given the growing challenge of generating an adequate risk-adjusted return.
37 percent of US company CFOs say access to talent with the right skill sets in critical areas is an obstacle to meeting their PE owners’ investment theses. 47 percent of CFOs report they are understaffed in critical roles.
PE and VC firms are just as vulnerable to unconscious bias as any other industry, and in many cases are behind the curve in addressing natural biases. This affects hiring, culture and performance. A historic tendency to use networks and referrals, particularly from university alumni networks, other investors or previous colleagues from top companies skews the field. Removing the referral component eliminates bias, sharpens the focus on skills and leads to better decision-making.
Referrals are increasingly less common, as PE and VC firms are now more rigorous and data driven in their approach to hiring. The use of scorecards ensures that all investors are aligned with hiring objectives, which underpins the success of an executive search.
In terms of team evaluation, the creation of high performing teams starts pre-deal to map the organisation early on to ensure the right talent is aligned with business objectives to drive through the needs of the business.
Talent teams are being organised to address different aspects of organisational effectiveness. Beyond finding the right CEO, it’s about supporting portcos with culture change, analytics, organisational transformation and with specific functional competencies such as compensation.
There is a consensus that human capital optimisation is about more than hiring. It’s about cultural transformation and leadership team effectiveness; building an ecosystem of leaders to work with repeatedly.
What’s the next frontier in optimising human capital? For KKR, employee ownership programmes are an overlooked and underappreciated value creation tool for creating ownership cultures in portfolio companies. It involves treating employees as owners, giving them a voice, sharing information, boosting financial literacy and more.
Another practical step is to hire and empower and human capital partner. Around half of PE firms (those with more than $2 billion in AUM) have hired a ‘chief human capital officer,’ ‘talent leader’ or ‘performance specialist’. They are starting to appear in middle-market firms too.
The role of human capital partner varies in scope, from managing search firms to participating in due diligence to evaluate the strength of a target company’s top leadership team. Or they assess, or hire external experts to assess, the capabilities of prospective senior hires or coach key portfolio executives (remember Wendy in TV show Billions).
Read more on the topic:
Alix Partners eighth annual PE leadership survey
2023 BDO Private Capital Survey
Private Equity International – Operational Excellence 2023
Antler blog on unconscious bias
HBR: private equity needs a new talent strategy

"Time is of the essence, so decisions around hiring need to be made sooner rather than later to ensure that value creation has more time to take effect. The strategic use of interim managers, rather than relying on existing staff, to target key areas of transformation and manage major programs can be a key differentiator in enhancing overall performance in a rapidly evolving business landscape."

- James Hunt
Partner, U.K., Interim Management

Outperformance through CEO alpha

Operational improvements are well recognised as a crucial lever for realising exponential returns. But another important enabler of PE value creation is CEO alpha – the value created from a CEO’s outperformance.
Top-quintile CEOs have historically delivered total shareholder returns 9 percent above industry peers in each year of their tenure, according to McKinsey. In financial services and automotive they achieved excess total annual returns of 16 percent on average.
In a 2022 survey of GPs, 94 percent believe PE portco leadership contributed an average of 53 percent toward investment returns.
Outside of private equity, high performing CEOs deliver x3 more total return to shareholders within an industry. However, Fortune 500 CEOs have a 1 in 24 chance of taking a company from average to top quintile performance and value creation.
To achieve CEO alpha, PE portco CEOs need distinct capabilities, going beyond the typical leadership traits of top performing public company CEOs. They need to account for PE-specific time horizons for investment, and exit, and speed to impact.
PE portco CEOs face unique challenges in a complex role: the level of autonomy in decision-making; the degree of focus on EBITDA; and the way boards govern are all different in PE portfolio companies.
PE portco CEOs tend to come from varied backgrounds, typically growing a small business, then leading a midsize company with different needs. Most leadership development programmes are not tailored to the unique needs of these CEOs.
Top performing, non-portco CEOs work to different time horizons regarding investment, impact and stakeholder interest. They seek greater alignment and adaptability in decision-making; focus more on team psychology; work on helping the board to help the business; and play to their unique strengths, doing what only they can do.
The three essentials of portco CEO alpha are: (i) talent management: building a fit for purpose team; (ii) cascaded performance: using financial and operational dashboards to run the business; and (iii) strategic planning: achieving far more in far less time.
Research and anecdotal evidence suggest PE firms are prioritising CEO development and leadership effectiveness to generate outperformance. They are starting to put as much emphasis on recruiting, onboarding, peer learning, succession planning and performance management as they do on other key levers of value creation.
Read more on the topic:
McKinsey: CEO Alpha
FastCompany report on McKinsey book ‘CEO Excellence'

"Hiring the most effective leader for a portfolio company is crucial for PE funds. They invest significant time and energy in multilayered processes to screen for individuals who can not only perform the job but also motivate and inspire the team, collaborate effectively with the owners, and deliver results. Experience is valued over potential, as this is not the space for taking risks."

- Siwan Jones
Managing Partner, U.K.

Diversity – threading or moving the needle?

Diversity, equity and inclusion (DEI) have become an important part of the fundraising, hiring and investing landscape for participants in private markets. LPs report a willingness to allocate x2 capital to a gender-diverse team and nearly x3 more capital to an ethnically or racially diverse deal team, all else being equal.
Institutional investors are asking PE firms to reveal more detailed DEI data on their investment teams and portfolio companies during the fund-raising process: requests have risen steadily, exceeding 50 percent for the first time between 2019 and 2022.
This interest has spread beyond the investment team to portcos and their boards, pushing PE firms to track and report metrics, driving greater diversity and inclusion in the industry.
However, progress is patchy. Firms leading the field have 32 percent women at MD level and 32 percent of MDs from ethnic and racial minorities. Firms behind the curve have no women and just 2 percent ethic and racial representation at MD level.
Globally, women hold 23 percent of investing roles at PE firms; at MD level that shrinks to 12 percent. At almost every level, women in investing roles are promoted at much lower rates than men. Male colleagues in investing roles are 50 percent more likely to be promoted across all levels.
Regional differences show that PE offices in the Americas have the highest share of women in the C-suite; APAC has the greatest share of women in mid-level investment roles; and Europe has the greatest share of women in entry-level investing roles.
For all investing roles, 26 percent are held by women in APAC; 23 percent in the Americas and 21 percent in Europe. However, this drops to 10 percent at the senior levels in Europe and APAC, and 20 percent at MD level in America.
Black and Hispanic executives are particularly underrepresented. While accounting for 14 and 19 percent respectively in the US population, they account for 8 and 9 percent of MD roles at the most progressive firms.
There are three principal levers to address lack of diversity: external hiring, debiasing the internal promotion process and managing attrition. All three, combined with coaching and sponsorship of women are needed to shorten the timeframe in meeting DEI objectives.
The landscape around DEI is changing as LPs push to share data during fundraising. However, GP’s methods of calculating and reporting DEI vary, as do the expectations and definitions of DEI held by LPs. Tracking and metric consistency will help firms to improve progress in measurement and planning.
Read more on the topic:
McKinsey: private markets turn down the volume
McKinsey: the state of diversity in global private markets
McKinsey: the state of diversity in US private equity
Pensions & Investments: private equity and venture capital

"The importance of DEI objectives has increasingly become a core topic for investors, board members, and all stakeholders who understand that diversity contributes to business success. While progress may be uneven geographically and among interest groups, the trend to ensure diverse leadership teams is here to stay. The conversation goes beyond metrics and diverse hiring to the importance of work cultures that promote inclusive environments. The latter is what’s really moving the needle."

- Diane Turek Pire
Global Practice Leader, Human Resources Practice

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