Succession planning for private equity is critical to any firm’s long term financial success
Succession planning is important for any type of business that would like to see the legacy continue after the founding members are gone. Often, private equity firms put a lot of thought and effort into the succession planning of their operating companies, yet fail to practice what they preach when it comes to their own firm.
Succession planning refers to the process of ensuring organizational operations and performance continue to work smoothly in the event of a leadership departure. The departure can be either planned or unplanned, but both can cause upheaval in the organization—as well as with investors and portfolio companies.
Private equity firms suffer from the same pitfalls of poor succession planning as other types of companies. It can lead to a loss of customers, talent turnover, and reduced company performance. But the unique nature of private equity introduces additional threats to the company when succession doesn’t go well. International Leadership Development Strategist, Jenn DeWall shares, “For private equity, this can mean loss of investor trust, leading to fewer investments, instability in relationship management, gaps in asset management and gaps in asset management.”
Why is Succession Planning Important for Private Equity firms?
It’s important for private equity leaders to understand that experienced LPs recognize that poor succession planning can be bad for their returns. Many will want to know about the firm’s succession plan during due diligence. Those private equity firms that can’t provide clear and effective answers are considered more risky investments.
This is because private equity leadership is unique. Your firm needs leaders who understand the intricacies of navigating relationships with a variety of stakeholders, including partners, investors, leadership teams of portfolio companies, as well as their own firm’s internal team. They also need to be able to understand how to continue to develop a strategic focus on value creation in current investments, while continuing to develop new opportunities. There are not very many people out there who understand and can effectively navigate these factors, particularly through a period of transition.
When a leadership exit happens in a private equity firm, there is a significant risk that the transition period will cause turmoil. It can often result in key partners and/or employees leaving the organization. It can also create changes in the strategic focus of the firm. Any of these outcomes have the potential to impact investors’ returns, even as they are stuck in a long-term contract. If the ship isn’t quickly righted, investors begin to feel the burn and will react in kind. Not only will the firm find it difficult to retain investors, but it will also have a tough time bringing in new ones.
5 Private Equity Succession Planning Best Practices:
- Start early
It is never too early to begin succession planning. A great example of this is the story of Blue Point Capital. This mid-sized firm had a succession plan almost from the very beginning, and was able to exercise that plan by their third round of funding.
The earlier you begin your firm’s succession plan, the easier it is to put the rest of these best practices into place. It also gives you ample time to groom your next generation of leaders, helps react to an unplanned exit easily, and improves transparency and communication among investors and the internal team. When you plan for succession early on, it becomes an organic transition rather than a knee-jerk reaction.
- Firm Culture Rules
Firm culture rules in effective succession planning for several reasons. First, if you’ve developed a sense of ownership and fairness in economic outcomes amongst your team, they’re much less likely to react negatively to a leadership transition.
Developing a culture of open communication and transparency also helps with the transition. It means that you’ve been communicating with staff, partners, and investors openly about your succession plan so that there are no major surprises when it happens.
Further, when your firm has a culture that is focused on the professional development of your employees, it becomes much easier to promote from within. This way, you’ll know that the next generation of leaders intimately understands the business, the culture, and has a standard of shared values. Developing your next generation of leaders should include a mix of leadership development training, mentorship programs.
When the time is right, and for the right people—promoting co-leaders to provide hands-on experience and training. As the founding leadership team of many top private equity firms are entering their twilight years, this approach to transitioning to the next generation of leaders is proving quite valuable. Bain Capital and KKR & Co. are two examples of top firms incorporating new co-leadership positions into their succession plans.
- Keep a “portfolio” of leadership contenders
Many private equity firms keep a “portfolio” of potential CEO contenders for their investment firms. But this is also a good practice for your firm’s own succession planning. Some firms simply don’t have the resources or the talent pool to be able to promote from within. In this case, you will need to do an outside search for leadership talent.
Maintaining a list of potential next-gen firm leaders helps your leadership team keep an eye on their professional development and achievements over time to help determine their fit in the future. It also helps make the transition less time consuming and costly if there is an unplanned leadership exit.
- Fair Incentive Programs
Fair incentive programs for your firm’s next generation of leaders is a must in your succession plan. All too often, new leaders become frustrated and disenfranchised when they take on greater work and responsibilities in the firm, while the original founder sits back and continues to take the lion’s share of economic benefit. This often leads to the successors leaving the firm prematurely to start their own firms.
Make sure your next generation of leaders are well compensated and cared for if you want your firm to be treated as a going concern. They need to feel a real sense of ownership in the organization, even if they weren’t the original founding members.
- Letting Go
Perhaps the most difficult thing for a founder to do is to simply let go. It’s risky to hand the reins over to the young and less-experienced. Founders worry that they’ll watch everything that they’ve worked so hard to build crumble. It’s a legitimate concern, but one that must be pushed aside if you want your succession plan to be a success.
New leaders will likely do some things in a different way and make different decisions than what you would make. But these things aren’t all necessarily bad. Founding leadership teams need to not let their egos stop their firms from continuing on without them.
Succession planning in any organization is inherently difficult. For private equity firms, it’s even more difficult to do right. The transition that takes place around a key leader exiting the firm can cause a significant amount of financial pain—for the private equity firm as well as investors. But putting a transparent and fair plan into action that focuses on the development of your internal team early on can smooth the transition and make sure things get back on track as quickly as possible.
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