When a private equity fund sells a successful company, the company’s leadership team would seem to be a valuable asset for the new owner. After all, the team built shareholder wealth and it has intimate knowledge of the business. But in many cases, the executive leadership team does not survive the change in ownership, even if its performance was stellar. According to longtime CEO Jozef ”Jos” Opdeweegh, ”Unless the ownership transition is undertaken with great care, it can undermine the continued success of the company and its value.”
Opdeweegh, a veteran of four private-equity company transitions, notes that when a private equity fund initially invests in a company, it is common for the purchase to be based on an investment thesis. ”Such a thesis may be based on premises like turn-around, M&A, organic growth, SG&A reduction, balance sheet optimization or a combination of these elements. The company leadership team executes to that thesis to build shareholder wealth. When the end of the investment horizon approaches, a private equity fund will sell the business to the highest bidder.”
So, what are the issues that can prevent a new owner from meshing with the incumbent leadership team? Below, Opdeweegh explains why, when, and where things tend to go awry.
1. The inability of the leadership team to participate in choosing the new owner
In an auction, which is the typical process used to sell a company to the highest bidder, the executive team is not typically invited to weigh in on the selection of the new owners. According to Opdeweegh, ”This can lead to a dissonant outcome. Oftentimes, a clash of strategic views and corporate cultures occurs.”
2. The new owner’s failure to recognize the importance of the management team
”Some private equity owners view a management team as an end to a means, rather than as a valuable and continuing asset,” cautions Opdeweegh. ”In determining their future strategy, they quite often they will trust the judgment of a less qualified consultant over that of a seasoned management team with a proven track record.” Additionally, notes Opdeweegh, ”Private equity fund leadership often fails to appreciate how challenging it will be to achieve the post-purchase target return, and consequently, they fail to recognize the importance of the management team.”
3. An unbalanced payout to the owner compared to the management team.
Opdeweegh says, ”There is an institutionalized lack of balance in the economics of private equity deals. It is not uncommon to have deals in which an individual private equity partner earns a larger payout than the entire management group.” He goes on to explain that the inequity in compensation illustrates an apparent lack of appreciation for the complex and demanding work of management teams.
4. A clash of corporate cultures
”It is not atypical,” says Opdeweegh, ”for a clash of cultures to arise between a new shareholder group and an existing executive team.” The acquired executive team typically has worked together for an extensive period and has developed a shared set of core values. This set of values, which constitutes the corporate culture, may be very different from the behaviors the new owners wish to instill into their company vision. Says Opdeweegh, ”If values such as fairness, openness, inclusiveness, the speed of decision-making and respect are not aligned, cultural and business issues will surface.”
5. Preconceived notions and impulsive decision-making by new owners
Opdeweegh says that new owners often jump to conclusions when assessing the talent in their acquired business. For instance, during management presentations, they might conclude the CFO is lackluster or the COO is nontraditional. ”A rush to judgment is not only unfair to management,” he warns, ”it can lead to a crisis for the new owners because a forced executive replacement usually triggers an executive team exodus. Such a migration will significantly impact the business with the loss of much institutional knowledge.” Opdeweegh adds that hasty management churn can easily result in a three to four-year setback in revenue, EBITDA trajectory, and performance.
6. Disagreement over the new strategic plan
Speaking from his experience in the business, Opdeweegh explains how a new owner will develop a strategic plan to form the foundation of their investment decision. ”This strategic plan is based on assumptions relating to organic growth rate, diversification across geographies, customer and industry verticals, M&A activity, balance sheet structure, cost of the back-office functions, and other relevant aspects of value creation. The incumbent executive team may view some important aspects of the plan as unattainable or undesirable for shareholders’ wealth creation.” Disagreement about the strategic direction of the company and the key underlying initiatives is another classic reason for a failed relationship between the acquirer and the acquired executive team.
7. Second guessing of management team decisions by the new owner
Even if the new owner and the incumbent management team agree on the strategic plan, the new owner can undermine success by continually second-guessing management decisions. Says Opdeweegh, ”Private equity funds recruit from a pool of the best and brightest professionals, but these individuals have spent their careers building experience in the grueling PE environment and therefore tend to lack concrete corporate leadership experience. Undoubtedly with the best of intentions, these hardened professionals will have an opinion about many facets of the day-to-day, tactical and strategic management of their portfolio companies.” Adds Opdeweegh, ”Consequently, the management team spends an inordinate amount of time communicating or justifying the rationale of certain decisions to the shareholders. The resulting drag on time and morale can cripple efforts to reach target returns.”