Culture is key to success (and failure) in private equity deals

NEW YORK (March 17, 2020) – 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 market in the US, 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 by the global consulting firm AlixPartners, and Vardis, the global private equity search firm, found that PE firms and portfolio companies (portcos) 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.

Talking the culture talk, without walking the culture walk

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% 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 in order to deliver strong investment returns.

Critical role of the CEO

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 our 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.

Ted Bililies, PhD, global leader of the Organization & Transformative Leadership practice at AlixPartners, said, “This year’s survey findings make it clear that leadership and culture are critically intertwined, and that adept management of corporate culture plays a central role in private equity investment success. We identified several imperatives that portcos and their PE sponsors must meet to maximize IRR. These include the ability of portcos to quickly and effectively execute the strategy which in turn hinges on identifying leaders who possess a unique blend of skills. Recognizing that a strong culture with the right CEO and talent are vital to growth in their portcos, investors would do well to invest time educating themselves and taking specific actions at the outset of an investment.”

Dr. Bililies added, “We’ve all seen the headlines announcing household-name companies that paid a high price for allowing a toxic culture to take root and sabotage the company’s future. PE firms and portco management must take swift action to avoid these pitfalls or risk losing shareholder value, disrupting growth, and damaging reputation and brand. PE investors have been picking up on this development because they see how a portco’s strategy toward a liquidity event hinges upon its culture. Strategy without culture = nothing.”

About the survey

The AlixPartners Fifth Annual Private Equity Survey, conducted in conjunction with Vardis, the global private equity executive search firm, was administered October through December 2019. There were 108 total respondents comprised of 56 managing directors and operating partners from PE firms and 52 senior executives (primarily CEOs and CFOs) from portfolio companies. The largest share of portco respondents were with companies with annual revenues of $100 million to $500 million. The majority of PE firm respondents reported assets under management of less than $5 billion.

Please contact Ed Canaday for more detailed survey results.

About AlixPartners

AlixPartners is a results-driven global consulting firm that specializes in helping businesses successfully address their most complex and critical challenges. Our clients include companies, corporate boards, law firms, investment banks, private equity firms, and others. Founded in 1981, AlixPartners is headquartered in New York, and has offices in more than 20 cities around the world. For more information, visit www.alixpartners.com.