As the PE sector looks towards a fall in interest rates to unblock the backlog of unexited assets, there is a talent timebomb that could make a big difference in a buyers market.
It won’t surprise anyone associated with the private equity investment sector that Bain & Company’s 2024 review of the industry does not make for good reading.
Bain found that ‘deal value fell by 37 percent [in 2023]. Exit value slid by almost half. Fund-raising dropped across private capital, and 38 percent fewer buyout funds closed’. An uptick in deals is contingent upon a stabilisation and decline of interest rates.
Backlog of unexited assets
One aspect of this picture stands out: private equity investors are currently sitting on $3.2 trillion of unexited assets. Moreover, PE companies are holding on to assets for 20 percent longer. The report concludes that, ‘Barring a sharper-than-anticipated drop in rates, sellers will continue to face high hurdles to unloading companies to strategic buyers, other sponsors, or the public markets.’
The stagnation in the exit sector has created a situation where, when deal flow unlocks, buyers are going to be able to pick and choose. Which means a major challenge for investors: in a buyers’ market, any weaknesses within a portfolio company that could impact performance and value are going to come under forensic scrutiny.
The portfolio talent timebomb
Hopehead’s experience suggests portfolio talent is going to be a critical factor in these assessments. The longer PE firms hold assets, the higher the turnover of key personnel is likely to be. In fact, management churn increases exponentially when exit horizons fail to materialise: real talent often gets itchy feet and less able leaders have more time to be exposed, especially in tough economic conditions.
Replacing lost talent therefore becomes a greater challenge: recruiting up in order to boost the performance of the business and make it stand out at sale. Failing to spot a senior leadership shortcoming at hiring has the potential to undermine the attractiveness of a portfolio company at the exit-point.
Over the last 18 months, Hopehead has seen C-Suite hires into portfolio companies subjected to ever more in-depth scrutiny, often going significantly beyond the selection process carried out by executive search companies and interviews by the GPs. Detailed management team due diligence conducted by an independent party is increasingly standard practice.
Effective diligence in a downpour
Effective management due diligence is not just a matter of confirming degrees and checking for negative indices. It is also a question of drilling into the portfolio of skills that the new hire will bring to the business, usually by referencing peers and former colleagues.
How good is the candidate at speaking to investors? Can they also relate to employees on the shop floor? Have their strategic choices made a real impact in past roles, or have they relied on others to do the heavy lifting? And do they have the specific skill set for success in the current market?
These are all questions that become critically important in an economy where buyers can choose to be fickle about which companies they back.
The majority of such hires will be intelligent, hard-working and well-rounded characters who will spur portfolio companies on to greater heights. But when the backlog of unexited assets does break, it would be a mistake to underestimate the importance of portfolio talent as a decisive factor in achieving returns and driving future performance.
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