Succession planning at PE firms reveals risks of leadership change

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“What we’re talking about when we talk about succession planning is the preservation and perpetuation of the firm,” said Ted Bililies, a managing director at consulting firm Alix Partners. “But the fact of the matter is, the perpetuation of the firm means entering a world that’s entirely different to what it was even 10 years ago.”

The most successful plans are years in the making. In October of last year, KKR founders Henry Kravis and George Roberts stepped down as co-CEOs after almost five decades, replaced by Joe Bae and Scott Nuttall, completing a transition plan that began in earnest back in 2017. Blackstone is undergoing a similar process, and Stephen Schwarzman, who has been CEO since the firm was founded in 1985, is expected to pass the baton to his heir apparent, COO Jonathan Gray.

Elsewhere, some transitions to the next generation have been botched. Apollo Global Management found itself facing a leadership dilemma after founder and CEO Leon Black hastened his exit last spring following revelations over his connections with disgraced financier Jeffrey Epstein. What resulted was a very public power struggle between remaining co-founders Josh Harris and Marc Rowan, with the latter emerging as the top boss.

Much of the messiness can be avoided if firms put in the effort years in advance to groom a deep bench of future leaders. A survey put out earlier this year by Alix Partners showed that 67% of PE investors believe that talent recruitment is their biggest challenge in 2022. But the issue goes beyond finding the right person to fill the shoes of an outgoing CEO or founding partner. The generational shift in PE leadership highlights the need for an aging industry to evolve its approach to leadership development to ensure its longevity.

More firms have hired chief human resources officers, which Alix Parters’ Bililies said is partly a recognition of the role that a sophisticated HR function has in building the culture and talent needed for a smooth transition.

“There was a lot of eye-rolling around that in the early 2000s,” he said. “But now it’s de rigueur, and you’ve got some remarkable [HR] leaders at some of those big firms.”

Reputation risks

Leadership change is a high-stakes gambit. The sudden loss, such as an unexpected death, of a key person can be even more destabilizing. Much of a firm’s reputation is tied up with the track record and charisma of its founders. This is particularly true in a relationship-driven industry like PE, where many founders—people like KKR’s Kravis and Roberts, or Blackstone’s Schwarzman—also pioneered the asset class itself.

Limited partners, some of whom have long-standing relations with one fund manager, are deeply invested in who takes over, so they often actively monitor succession plans. Given the lifespan of the average PE fund, some LPs may be unlikely to re-invest in a future fund if they think a proper succession plan is not in place.

Ideally, an LP’s confidence will be tied to the firm itself, rather than hanging on the reputation of an individual CEO or a handful of senior managers. Yet arguably only a few firms have been able to separate their brand identity from that of their founding partners. Europe’s CVC Capital Partners is led by John Clark, who joined the firm as a managing partner in 2014. However, this recency often seems to be the exception, rather than the rule.

“There’s always sort of the implicit assumption that you’re not just giving money to that firm, but you’re also putting money behind a particular individual who you trust,” said Lisa Baird, a partner with an executive search firm Heidrick & Struggles. “And that’s a hard thing to bring in from the outside.”

The pitfalls of success

Many firms look internally for new leaders to take the reins, which can signal to LPs a sense of continuity.

Indeed, that has been the case with the most high-profile leadership transitions, such as the ascension of KKR’s Bae and Nuttall. Both joined KKR in 1996, with Bae leading the firm’s expansion into Asia and Nuttall taking charge of its public listing in 2010.

But even if a qualified person is found, there is no guarantee that those high-performing candidates are going to want to take over the business. Because of this, private equity is almost a victim of its own success.

“It goes back to the old question of how do you motivate a millionaire?” said Alix Partners’ Bililies. “A lot of people in the private equity sector are very wealthy, and at a younger age, too. Many people are saying, ‘I don’t want the top job, that’s too much stress, I have plenty of money.'”

This is why many firms are putting the emphasis on building a culture to attract talent and motivate teams toward leadership—regardless of the individuals’ wealth and success. This again speaks to the value of having a strong human resources function to set the tone for a firm beyond generating returns for investors. Good HR management also involves focusing on areas such as ESG and diversity, equity, and inclusion, which are high priorities for a new generation of investment professionals.

“There’s going to be more dislocation in senior-level talent,” Bililies said. “Right now, boards are really holding tight to their CEOs, but there’s going to be a lot of disruption in the CEO market. People are going to be moving around at senior levels for a long time, and this issue is going to be with us for a while.”

Source: Pitchbook

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