Private Equity Dry Powder
As we entered 2017, I noticed some important data insights from Pitchbook. Dry powder (capital available for investments by private equity (PE) and venture capitalist (VC) firms) was at record levels. A total of over $754B in 2016 was available for PE/VC investments. In my conversations with PE leaders, the challenge to make acquisitions definitely isn’t about lack of funding. It is a lack of quality companies worth making those investments to acquire. Additionally, PE firms face the major challenge in identifying leaders within acquisitions or to acquire externally to lead their investments. This leadership gap effect on PE is a major obstacle to realizing investment returns.
No Lack of Business Owners Wanting to Sell
The BEI 2016 Business Owner Survey indicated that 75% of business owners would sell their business if the price was right. Yet, only 26% of those surveyed felt no obstacles existed to selling their companies. Middle market PE and dealer broker firms indicate that middle market companies have a significant leadership gap issue. Leadership of family-owned businesses is generational, and not typically based on leadership skills or capabilities. There is also a lack of leaders deeper within these companies. This leadership gap creates challenges for PE and strategic acquirers to make the acquisitions work.
Leadership Gap Effect
According to Deloitte’s 2017 Global Human Capital Trends report, the leadership gap continues to grow in companies worldwide. The leadership gap, defined as importance of leadership versus readiness in developing leaders, has major implications for PE. PE needs to transform businesses it acquires to drive sustainable growth. PE-backed business transformations are involving areas like digital, new business models, and new markets. The leader pool available to make those transformations possible is continuing to shrink. This puts a PE firm’s investment thesis at risk.
What PE Can Do to Mitigate the Leadership Gap Effect
PE has historically placed a premium on understanding the leadership capability needs of their acquisitions. When PE finds gaps, the firms have sought to address this by finding the right leadership talent. There are some additional areas for PE firms to consider to help their acquisitions from a leadership perspective:
- The “Leader as hero” era is dead – As the 2017 Deloitte report states, the era of the “leader as hero” is a dead concept. Global business and organizations have grown far too complex for only a single leader to be successful. Today’s successful organizations are more adept at leveraging teams. For example, in Gen. Stanley McChrystal’s book, Team of Teams, effective organizations are flatter, faster and more adaptable. This concept of teaming requires multiple leaders at multiple levels. This is why looking at leadership talent deeper than the C suite in an acquisition is so important.
- Go deep for leadership talent – PE has historically focused on understanding the leadership talent of the executive management teams in acquisitions. A good or great CEO and/or CFO can have a huge impact on performance of acquired firms, but only if there is leadership talent deeper in the firm. Think of a firm’s leadership capability like an iceberg. PE focuses nearly exclusively on the tip of the iceberg seen above water. Yet, what is also very important is the leadership capability deeper and more broadly across the firm. A good CEO can have a more limiting effect on company success if there is an overall lack of leadership capability in the company. For example, if transformation initiatives are taking longer than anticipated, this can be an indicator of leadership capability risks.
- Dry powder investment in leadership talent pipeline – We know through academic research that 10-15% of company performance can be attributed to leadership. If PE firms are making investments in their acquisitions to drive above average returns, part of that investment should focus on the development of the leadership talent pipeline. These investments should focus on developing leaders deep in the organization and identifying adaptive leaders with potential to lead change. By focusing on these leadership areas, PE positions itself to realize the effect of leadership on performance. Additionally, we know that 20-25% of firm market valuation is driven by perspectives of whether a company’s leadership is effective or not. By taking a more proactive approach to developing portfolio companies’ leadership capabilities, PE can position itself to tell a stronger story and enhance market valuation of portfolio companies.
The leadership gap effect will continue to expand placing a higher premium on finding the right leaders with the right skills. Focusing on new approaches to identifying and utilizing leadership strengths is key.
Delivering actionable leadership intelligence.
Dr. J. Keith Dunbar is founder and chief executive officer of Potentious and recognized expert in M&A leadership