As private-equity firms hold on to their investments for longer periods, the importance of improving portfolio company operations has intensified, prompting more firms to question whether they have the right leaders in place for the job.
"Now that they're stuck with assets that they can't get out of, they're saying, 'We can't do financial engineering or grow our way out of [our entry valuation], we need a CEO that's an operator,'" said Dan Hawkins, founder and chief executive of leadership advisory firm Summit Leadership Partners. "Private-equity firms are really starting to change what their [portfolio company] needs are, so there's a lot more focus on the CEO."
In some cases, he added, sponsors are saying, "We're going to kick [our hold period] out by two or three years, and we don't have the right person."
Shifting macroeconomic conditions, including rising interest rates, have contributed to the difficulties private-equity firms have had in exiting assets in recent years, leaving more companies sitting in portfolios for longer periods. Of the 33,853 private-equity backed companies globally at the end of September, 8,074, or nearly 24%, have been held for at least seven years, according to data provider PitchBook. Historically, many private-equity firms have typically sought to hold their investments for three to five years.
Elongated hold periods also contribute to some of the biggest challenges facing leaders of private-equity sponsored companies, according to a new report from Summit Leadership, which surveyed 176 private-equity executives. About 52% of the respondents said that the shifting requirements of the CEO role beyond the skill set or fit of the current person holding it is one of the biggest challenges associated with longer hold periods, while 46% of respondents cited CEO burnout. Among those surveyed, 72% said they had brought in a new CEO in more than a quarter of their portfolio companies.
Hawkins and private-equity executives also said that buyout firms are increasingly opting to swap out CEOs in the middle or even toward the end of their investment holding periods, a move that was much less common only a few years ago.
"Now, if the hold [period] is twice as long, there might be a second moment where you say there's such a phenomenal transformation that you need to reconsider whether that person is still right for the role," said Maggie van de Griend, managing director of portfolio talent at New York-based Warburg Pincus, which has overseen more than one such mid-hold leadership transition in recent years.
The rapid development of applied artificial intelligence technology has also altered the skill sets required to lead and grow businesses, private-equity executives say. Among the executives Summit surveyed, 67% said that they use some sort of formal criteria or structured assessment to analyze a CEO's capacity to use AI to drive value.
"The skills we are over-indexing in this brave new world we find ourselves in are agility, the ability to pivot and the ability to learn, test and try," said Lane McDonald, managing director at Omers Private Equity, which has invested more than $25 billion in private equity as of the end of last year.
"Five or 10 years ago we were hiring leaders for experience, not for agility. I wanted to work with someone who's done what I needed done three times. I wasn't necessarily testing whether or not they're a learner," McDonald said.
Private-equity investors say that when fund managers do need to swap out a CEO, how they communicate that change to the incumbent leader and the rest of the organization remains critical to the company's future success.
"Anytime you do make a change at the CEO level, it is highly disruptive to the organization," said Jim Scarfone, chief human resources officer at midmarket firm MidOcean Partners. "When we do decide to make a change, we do it with all the grace and transparency that we can."
That means that, ideally, a leadership change wouldn't come as a surprise to the current CEO, according to Warburg Pincus's van de Griend.
"In our conversations, we would consider it a personal failure if it was a complete surprise," she said.