blackstroke

18/02/2022

The importance of culture and its impact on private equity strategy and returns has been a growing development over the past couple of years. As PE investment returns have lagged those of the stock markets, firms are feeling pressure to improve and deliver stronger results. This fact combined with some high-profile private company debacles, in large part due to cultural toxicity and leadership miscues, underscores the urgent need for PE sponsors and portfolio companies to prioritize a focus on culture.


A new survey has found that PE firms and portfolio companies (also named “Portco”) rated human capital, a key component of culture, as the top factor in predicting the success or failure of a PE investment. In addition, survey respondents in both groups -- private equity investors as well as operating CEOs -- chose “senior leadership team alignment” and “talent management” as leading factors in value creation.

Once a PE firm invests in a business, performance expectations intensify, as the sponsors usually seek to improve the management and operations of the company. To meet those expectations, the Portco management team and the rest of the workforce may have to modify how they do things on several fronts, such as establishing new organizational structures, collaborating in unfamiliar ways, and delivering results with greater speed. PE firm and Portco survey respondents agreed that it’s critical to consider the culture when building a company strategy. However:

  • Only 13% of PE respondents conduct a formal evaluation of culture.
  • Nearly 50% of Portco respondents reported that their culture is not fully aligned with their business strategy.
  • Although 71% of PE investors and 81% of Portco executives emphasize that company culture is critical to the successful implementation of strategy, on a weighted average, nearly 30% of Portco respondents noted that neither they nor their investors formally evaluate their company’s culture, despite its importance for driving positive IRR.
  • 57% of PE investors (an increase from last year’s 49%) indicate average-or-below ability to assess culture, which signals a significant need for improvement to deliver strong investment returns.

THE CEO GETS EVEN MORE IN FOCUS

The right corporate culture at a Portco is essential for generating the results expected by the company’s PE sponsor. And a Portco’s culture depends to a great degree on who’s at the helm. After all, the term “culture carrier” exists for a reason. Both cohorts in our study rated a world-class management team as the number-one predictor of a strong exit for a Portco. What’s more, a ‘disruptive or derailing personality’ was cited as the number one factor to avoid when onboarding a new CEO post-deal.

  • 75% of PE respondents report having experience with a Portco company failure as a result of a CEO’s being an ineffective fit for the company culture.
  • 68% of PE respondents reported hiring a CEO to purposely change a company culture, and 82% of those reported a high success rate as a result.

Interestingly, the majority of the survey participants also said they believe that a Portco’s culture can be transformed by promoting from within versus hiring an outside CEO. Either approach has pros and cons. For instance, outside CEOs bring proven track records based on the experience they’ve gained at other companies, but they lack deep knowledge of the Portco and its culture; for leaders promoted from within, the opposite is true.