Insight Out (LPEA), September 2018

Transition Management: planning for the next generation

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Most founders of the major PE firms are near (or past) retirement age, with many in their 70s. They must consider not only how best to pass on the reins to the next generation of leaders but also how to ensure that their organizations have the right talent and culture to meet future challenges. This could be tricky for some founders who built these organizations as extensions of their personae. The PE industry is still very personalized, with most of the big businesses still run by their founders.

 

Developing a successful transition plan

In order to make a successful generational transition, PE firms need to consider three dimensions: First, operational control; second, money; and third, governance, which is the hardest one.

A strong career path management is as much part of an effective succession planning as mutual trust with the people running the firm is. The allocation of carried interest and pay plays an important role though – according to a study by Professor Josh Lerner of Harvard - the industry has “not yet been serious enough” about managing internal compensation issues. Prof. Lerner cites a study his team did of 750 PE firms showing that the split of carried interest among the partners had a strong influence on their stability and ability to survive in the long term. “We saw that there was an enormous amount of inequality within the groups; typically for larger firms, the founder got at least twice as much carry as the average senior partner,” Lerner says. “Groups with more inequality tended to be less stable. Partners with good track records but a lower share of the carry tended, not surprisingly, to be footloose.” Making sure there is fair compensation and recognition for the contribution of the next generation is crucial for retaining younger partners, the future lifeblood of the business. 

 

Cultivating an enduring culture

Another key aspect of the transition for a PE firm is to ensure that its culture persists while it does not remain identified with just the founders, who are most often still active but will soon leave into retirement. Several PE firms started with around 3-5 people and are now at 1,000. In such a context, PE firms need to strive for a good balance between depersonalizing the business while maintaining its individual corporate and entrepreneurial culture.

 

Making sure the firm has the right talent

In the past, skills in financial and company analysis, dealmaking and financial engineering might have been enough. But the future will require PE firms to nurture a wider set of capabilities, including knowledge and experience in industrial sectors, digital transformation, smart technologies, risk management and global markets. They also need to ensure that they hire talent with the right interpersonal skills. “Always hire the best people”, says a PE executive in an interview with RoubiniThoughtLab. “All of us have hired people smarter than we are. PE has this allure so that we are able to continue to upgrade the caliber of people. Our founder’s joke: we couldn’t get a job here now. The truth is, we couldn’t,” he says.

 

The article is based on the EY study, conducted by RoubiniThoughtLab: “How can private equity transform into positive equity? - Perspectives on the future of private equity from industry pioneers”.