It’s Not About the Numbers: The Human Impact on Private Equity Buyouts

The-Human-Impact

Satu Teerikangas
Senior Lecturer in Management at University College London


Private equity investors boast a better performance rate in acquisitions than their industrial buyer peers, who have a 50% failure rate. While the rapidly emerging Private Equity sector is attracting more attention, it’s usually focused on the financial dimensions of Private Equity activity. What’s missing is an in-depth exploration into the management of the buyout process, particularly around the impact of human dynamics.

This is the second in a 4-part blog series on exploring and understanding the human dynamics in private equity buyouts — presented in conjunction with the change management consultants pmX — based on the research findings from an academia-industry partnership between University College London and Mercuri Urval International. We interviewed senior professionals from UK, US, continental and North-European mid-market private equity firms considered leaders in their respective countries.

Our research revealed the importance of the human element across the private equity buyout process.

Here are five reasons why:

Insight #1: The Private Equity business model relies on the human element

The following quotes are taken from interviews we conducted with Private Equity executives:

“It is about people and only people.”

“It all starts with people, business is all about people.”

“People are at the heart of the Private Equity business.”

“People are everything in the deals that we undertake.”

“This is a people’s industry.”

  • The centrality of the human element in Private Equity buyouts stems from the fact that Private Equity players invest in, develop and sell organizations (i.e. tangible and intangible assets — including people!): “We are buying a life or a proud tradition, not buildings and machines. Thus, our work cannot be reduced to numbers only.”
  • The success of managing the investment depends on people: “It’s all about the human factor, as organizations depend on people and management.”
  • The human element is visible throughout the Private Equity buyout process – from the “find and buy” phases to “owning and selling” the portfolio firm. Each phase is dependent on the activity of the talent involved, be it on the side of the private equity (PE) owner, the portfolio company (PC), or the board. See the figure below for details.

 

Buyout_process

 

Insight #2: Success criteria in Private Equity buyouts are people dependent

Based on our research, success criteria were identified as:

  • Being a different Private Equity player: creating one’s own playing space and approach
  • A professional and disciplined approach to firm purchase and ownership
  • Buying right in terms of target firm identification, price, and timing of purchase
  • Securing and executing active ownership
  • Securing capable and motivated managers and talent in the portfolio firm
  • Selling right in terms of value, timing and new owner
  • Talent and capability on the Private Equity side and fit with the portfolio firm

While this set of success criteria depends on numerous factors, it is clear that these success factors all relate to the human element. On the one hand, success requires excellence on the side of the Private Equity firm, be it with regard to the Private Equity professionals’ talent bases to be able to manage the buyout process, from purchasing, owning to exit. On the other hand, success also requires talent, capability and high engagement in the portfolio firm.

Insight #3: Many mistakes are people-related

Interviewees highlighted how most mistakes made in buyouts are related to the human element. Experts admitting to these failures also stated how they had become more appreciative and careful vis-a-vis the human element: “It has been a costly process to find out the significance of the human side.”

Mistakes were traced to occur across the entire buyout process:

  1. Pre-deal, are the purchase criteria and purchase-related decision-making correct?
  2. Post-deal, is the management team capable of delivering? Is there competence beyond the top management? Is the relationship with the CEO/founder a healthy one? Do the key stakeholders, e.g. the Chairman of the board, the board and the founder have sufficient time for the company? Does the target maintain its positive and innovative spirit throughout the ownership?
  3. Are early warning signs taken seriously, e.g. changing the CEO, the board, reacting to macro-economic circumstances? Is the impact of changes in the macro-economic context considered early enough?
  4. Is exit considered from early on?

These mistakes all boil down to people-related issues. They concern the quality of the decision-making and ownership management on the Private Equity side, the quality of the portfolio company’s management, and the quality of the board.

Insight #4: The human element impacts results

The human element in buyouts impacts success in Private Equity buyouts. As one interviewee put it – “The human element can make and kill a deal.”

  • The human element largely rests on the portfolio firm’s incumbent management (CEO and team) in that they are responsible for executing post-deal restructuring. An interviewee observed that “the quality of people is possibly the biggest determinant of value creation.”
  • The quality of the management team makes the difference between mediocre and excellent investments. Excellent results going beyond expectations could only be reached with an excellent management team: “Excellent management teams correlate with excellent returns. Yet, we can get a good return with an average management team working with a good asset.”

Insight #5: The human element as the future source of competitive advantage

In the post-2008 context, wherein Private Equity firms are under increasing pressure from investors, financers and regulators for more responsible and active ownership, the significance of the human element is on the rise:

  • The significance of the human element increases under stringent economic times: “Mediocre managers succeed in times of growth; we need excellent managers in times of economic distress.”
  • Some of the interviewees went as far as arguing that the human element is at the heart of the sector’s future competitive advantage: “The Private Equity house that solves the human puzzle to Private Equity deals will be a front-runner.”

Want to learn more about trends in private equity? Stay tuned for the next in my four-part series in partnership with pmX on the increasing importance of the human element in private equity buyouts.

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