HUMAN CAPITAL BEST PRACTICES: REAL WORLD CHALLENGES … · Systems and Structure –A company’s focus dictates the nature of its “systems and structure.” For example, Wal-Mart

Copyright © 2013 DHR International, Inc. All Rights Reserved. 1

WHITE PAPER • NOVEMBER, 2012

SUMMARY AND FINDINGS FROM DHR’S PRIVATE EQUITY CONFERENCE ON HUMAN CAPITAL

HUMAN CAPITAL BEST PRACTICES: REAL WORLD CHALLENGES WHEN CREATING VALUE IN PRIVATE EQUITY FUNDED COMPANIES

BY KEITH GIARMAN, GLOBAL LEADER PRIVATE EQUITY PRACTICE


Dear Private Equity Professional,

As global leader of DHR’s Private Equity Practice, it is my honor to present our summary report gleaned from our 2012 conference titled “Human Capital Best Practices: Real World Challenges when Creating Value from Private Equity Funded Companies.” As the fifth largest and fastest growing retained executive search firm in the United States, DHR has made a strategic commitment to the private equity industry. As a result, we have successfully completed hundreds of C-level search assignments – CEO, COO, CFO and many other roles – working with our private equity clients. These assignments have been executed working with small and mid-market, as well as larger private equity funds around the country and around the world. The assignments cut across all industry segments, including technology, industrial, consumer, retail, healthcare, aerospace, and many others. We pride ourselves in our partnering mentality working with our private equity clients. We are hands-on and quality oriented.

We hope you enjoy the conference report and look forward to being of service to you and your firm in 2013 and beyond.

Best,

R. Keith Giarman

Global Leader, Private Equity Practice


Introduction

Agenda

DHR International’s conference, “Human Capital Best Practices:

Real World Challenges when Creating Value in Private Equity

Funded Companies,” explored the role human capital and

organizational issues play in facilitating value creation and

investment success of private equity sponsored companies. The

goal of the conference was to provide a forum for approximately

50 investment and operating partners to explore value creation

challenges and corresponding human capital issues encountered

by their portfolio companies. Keith Giarman, Global Leader of

DHR’s Private Equity Practice, oversaw the event with support

from key members of the firm’s PE practice who served as

moderators of the panels. Like the conference itself, panels

consisted of investment and operating partners of various PE

firms, as well as successful operating executives with significant

experience working with PE firms.

The conference consisted of a keynote presentation, three panels that addressed specific

issues, and a lunch workshop. The daylong agenda included the following:

Keynote: Transformation in a Middle Market Portfolio

Gary Pinkus, Director, McKinsey & Company

Based on recent research from two McKinsey colleagues (Scott Keller and Colin Price),

Mr. Pinkus discussed the importance of understanding and measuring organizational

health to ensure effective and sustainable changes that result from formal transformation

projects (which fail 30% of the time). Measurement of organizational health is just as

important as clearly defined objectives, effective project management, and clear

communications from upper management in ensuring sustainable results for the entity.

Mr. Pinkus offered McKinsey’s 5-point framework – Aspire, Assess, Architect, Act, and

Advance – to structure a successful project and defined the firm’s organizational index as

a measurement vehicle to properly monitor and facilitate success.


Panel One: Value Creation: Theory & Reality

Panel Two: The View from the Executive Lens

Panel Three: The Ideal Operating Partner: Fact or Fiction?

Moderator

Craig Randall, Managing Director, DHR International, Chicago (Headquarters)

Panelists

Sean Cunningham, Managing Director, GTCR

Bill Drehkoff, Partner, Linden LLC

Mark Morris, Partner, Blue Point Capital Partners

Synopsis

This panel addressed leadership and organizational issues that may have contributed to a

portfolio company’s inability to realize the financial objectives defined in the PE firm’s

value creation plan for the entity. The panelists discussed specific deals where the

investment thesis was not realized and discussed the characteristics of CEOs and

management teams necessary to achieve investment success.

Moderator

Martin Pocs, Managing Director & Vice Chairman, DHR International, Denver

Panelists

Peter Weber, Chief Executive Officer, Carpathia Hosting

Chris Hunter, Chief Executive Officer, Special Devices

Jim Eberle, Chief Executive Officer, Critigen

Synopsis

In this panel, seasoned CEOs from PE funded companies described their experience in

evaluating firms and partners before deciding to join a PE funded company. They also

described their experience working with the PE firm and its partners, specifically both the

positive and more challenging aspects inherent in such situations.

Moderator

John Baker, Managing Director & Global Leader Life Sciences Technology

DHR International, Boston

Panelists

Tom Nolan, Operating Director, Berkshire Partners

Fred Lunger, Operating Partner, Linden LLC

Chris Behrens, Operating Partner, Baird Capital

Hal Strong, Operating Partner, Genstar Capital

Synopsis

This panel addressed different types of portfolio support functions, which vary depending

on a firm’s structure, and the best way to support their portfolio companies. The panelists

also discussed challenges faced by operating partners as they made the transition into

their role and the type of issues faced when working with portfolio companies.


Lunch Workshop: Predicting Investment Success: A Clarifying Model

Dr. Kevin Somerville, Ph.D., Chief Executive Officer, Somerville Partners

Dr. Amanda Foster, Ph.D., Senior Consultant, Somerville Partners

Dr. Somerville and Dr. Foster put forth a 5-point model where investment success

correlates with strong leadership and culture as much as favorable markets and

strategies. The degree to which portfolio companies approximate the high performance

model is directly and strongly correlated with financial returns. The model consists of five

elements, which can be assessed at any time during the life of the investment. The five

elements are:

Leadership – A widespread belief in the CEO and that the company is well-led,

coupled with a clear understanding of the strategy and how individuals fulfill their

specific missions, was the most powerful predictor of financial success.

Focus – The concept of “focus” is frequently discussed as a determinant for success,

but research suggests there are really only three types of focus applicable to any

business: (1) operational excellence; (2) innovation driven; and (3) the premiere

provider of tailored solutions.

Common Culture - Just like focus, the concept of “common culture” is often a victim

of ambiguity. Simply put, culture defines the way “we behave and treat each other

and our customers in our struggle to succeed.”

Systems and Structure – A company’s focus dictates the nature of its “systems and

structure.” For example, Wal-Mart is an operationally excellent company that runs on

metrics. They “worship the altar of efficiency,” where everything is clear, specific,

exact, and measured. In an innovation-driven company, there is a higher tolerance

for ambiguity and risk-taking. The company is “creative” as it strives to conceptualize,

build, and deliver something the world may have never seen before.

Constituent Relationships – This element refers to the real value the company

offers its customers, which varies in terms of focus as defined above. “While the

approach may vary in terms of a company’s focus,” according to Dr. Somerville,

“when it comes to the leadership attributes of the CEO, he always needs to affiliate

with customers. I connect with them. I am highly empathic with them. I am humble

because the customer constantly educates me about their needs so I can

continuously improve in myself, my employees, and my company’s service to them.”


Overall Summary &

Findings

The panels, presentations, and subsequent discussions that emanated working with the

audience yielded a plethora of useful insights. These insights are categorized by “theme”

and captured below.

Characteristics of Successful CEOs

The key to strong financial performance really does start at the top. Dr. Somerville

described the effectiveness of the CEO in terms of the “followership” and “belief” evident

throughout the organization. “There is absolutely nothing more important in terms of the

financial well-being of a business than the widespread belief that we, as an organization,

are effectively led, but what does that mean? It means there is a clear strategy that

articulates a way to win in the market. As an executive or employee, I understand and

support that strategy. Importantly, I am clear about what I need to do to advance that

strategy and I trust my CEO.”

1. CEOs can come from various backgrounds, but will have a proven track record of

directly attributable value creation in a prior company as a C-level executive

regardless of whether the company was private, public, or PE funded.

2. The best predictor of success when evaluating a CEO is proven value creation in a

prior PE funded company where value creation mapped to the firm’s original or

modified investment thesis.

3. The demand for great CEOs, especially ones with proof points of success in PE

funded companies, far exceeds supply. Thus, it is critical to search widely to ensure a

sizable pool of strong executives.

4. When searching for executives from other arenas (e.g. public companies, etc.), it can

be helpful to source in entities that have a track record of producing proven general

management and leadership skills based on the entity’s focus on developing

leadership talent.

5. Executives should be fully assessed to ensure they can “think like an owner” of the

business. Such qualities would include, at a minimum, a capacity to:

Think strategically and, in parallel, tactically with a hands-on approach as

required

Thrive in a company with a leveraged balance sheet where intelligent

spending is critical

Manage and effectively communicate financial health, notably cash flow and

EBITDA

Build and manage according to Key Performance Indicators (KPIs)

Align with, respect, harness, and effectively manage sophisticated investors

Enjoy or adjust to accelerated velocity and fact-based decision-making

Operate in an open, transparent, trusting, and predictable manner


Prioritize time in the field working with employees and customers

Embrace change and continuous improvement as a daily condition

Build and top-grade the executive team (and key players throughout the

organization)

It is difficult to perfectly assess for these qualities. When attempting to do so, it is just as

important to employ informal venues (dinner, drinks, etc.) as well as more formal interview

techniques, testing and scorecards, and simulation exercises where the executive is

exposed to peers and the board in a “case” addressing real-world issues facing the

business. In addition, the use of operating partners when assessing CEOs is critical to

establish fit from a functional as well as leadership and interpersonal perspective tied to

the inflection point and challenges facing the business.

Working with PE Firms

CEOs evaluate PE firms and their partners as much as PE firms evaluate CEOs. When

considering an opportunity to work with a PE firm, CEOs should have a well-defined thesis

regarding what they are looking for in terms of industry, entity size, and other parameters.

They must also make sure these parameters map to the expertise of the PE firm.

CEOs should do due diligence to understand the cultural norms of the PE firm and be

mindful regarding the style of the lead director and how the firm shares wealth with

executive teams.

There are pros and cons working with PE firms. The more positive aspects of working

with PE investors include:

1. Decision-making is accelerated and more effective. Panelists noted the energy,

urgency, and increased velocity of the business.

2. Decision-making is more efficient based on alignment amongst the parties.

Everyone is clear that they are part of an “investment” scenario where the goal is

return on investment.

3. Accountability is a priority and that mentality at the top typically pervades the

organization. Accountability drives fact-based decision-making. Rigor of process

is emphasized.

4. Investors have experience that leads to effective brainstorming on key initiatives.

PE resources can be effectively harnessed to make better business decisions.


The more challenging aspects of working with PE investors include:

1. Alignment is not perfect. PE firms can apply shorter-term thinking that might not

make sense if the CEO were running an entity with a longer horizon for results to

occur.

2. The PE firm is very focused on ROI, but the CEO also has to deal with other

stakeholders. PE firms do not always prioritize these other constituencies as

much as they should (or the CEO needs to).

3. More focused on financial performance, the PE firm’s definition of success is

metric-oriented when more balanced and qualitative measurements, like

organizational health, are also important.

4. The CEO needs to “manage up” when PE staff members are deployed to set

boundaries, establish clear timelines tied to objectives and make sure everyone

wins.

Reflecting on their own experience, panel members suggested the following for CEOs to

achieve their goals and work effectively within PE funded companies.

Be maniacal about the mission and the plan.

Improve your game where it makes sense, but do not try to change and conform.

Stay confident, listen, and understand what the mission is at all times. Be nimble.

Be prepared for a very performance driven experience where you think like an

owner. It will likely be more intense than one experienced in the past.

Use all the resources available via the PE firm to realize business and financial

results.

If you see misalignment coming, do not wait. Be open and honest with your PE

partner and reset expectations quickly.

Trust is a two-way street. CEOs must practice as much transparency, candor,

and openness as the PE firm.

It is contingent on the CEO to do their own due diligence across multiple vectors

before deciding they can succeed driving value in a specific company with certain

investors.

Board Structure and

Governance

Board structure and effective governance are important to support the CEO and increase

probability of success. Ensure a structure that includes:

1. Strong independent board members who can serve as an effective coach to the

CEO.

2. A chairman who can build a mentoring relationship based on trust.


3. Independent board members who have specific skills to supplement deficiencies

in the CEO or more generally in the business.

4. An operating partner as a primary interface to ensure more regular and in-depth

interactions to reveal issues the investment partner might overlook.

The panelists and audience all agreed that the topic of effective Board structure and

governance would be worthwhile to address at a future conference.

Portfolio Support Structures & Process

The most critical element of creating value in the portfolio company is the establishment of

a value creation plan. Each firm has a different mechanism for creating such a plan,

including which issues are most prominent based on their investment thesis, but the plan

itself grounds everyone on the key issues for focus. Without a plan, there is little likelihood

of aligning the parties in a way that drives economic success. More specifically:

Prior to acquisition, develop an investment thesis and signal as much as possible

to the management the key elements.

In the first 90 days, launch a value creation planning effort that generates

agreement on the key drivers and prioritization of those drivers.

In the first year, work on key initiatives and refine the value “drivers” into 3 to 5

year potential; within 6 to 12 months, have a fully articulated 3 to 5 year value

creation plan.

The sooner a firm can clarify the value drivers the better. If a firm is moving much slower

than described above, it is likely their investment will not see the appropriate level of

return.

Support groups grapple with different issues at various stages of their own development:

nascent, developing, and mature.

Nascent

1. Firms need to research what support structure and strategy makes sense for

them based on fund size, investment thesis, partnership structure, and other

parameters.

2. There is no need to reinvent the wheel, so learn from others with existing and

successful programs. Do not underestimate the importance of the culture

and legacy of the firm as one’s approach is implemented.

3. Exercise a “change management” process to align partners and others inside

the firm to galvanize support and ensure smoother implementation. Do not

take the time and effort associated with this alignment effort.


Developing

1. It is easy to get stretched thin and not add value. Use a “rifle” approach and

look for key wins early to solidify support amongst partners and management

inside the portfolio companies.

2. Prioritize activity based on resources available in your model. Pick situations

where the group can add real value; do not try to be all things to all teams.

3. Continue to solidify support for the model, potentially concentrating on newer

investments where the relationship can be built more effectively versus

portfolio companies funded prior to the implementation of the support group.

4. Deepen relationships with a core group of outside service providers who

allow for “leverage” to address the needs of as many portfolio companies and

specific issues as possible.

Mature

1. Leverage is often the key in the model at this stage based on the internal

resources and/or external parties utilized to effectively handle a range of

portfolio company requirements.

2. If using a model that employs outside resources, ensure there is a

measurement system in place to evaluate all providers and deepen

relationships with those deemed most effective working with the portfolio. The

ROI from development and implementation of a portfolio support function is

not driven by cost control. It is driven by the ability of the team to stimulate

increased valuation of target portfolio companies.

3. Do not be fooled into thinking that you will save money by employing your

own versus using outside resources. The firm will spend more not less on

outside consulting support even if the firm decides to build a more extensive

support organization inside the fund.

A great portfolio support group filled with talented operating partners will never

compensate for a weak CEO / management team. The board must be proactive in getting

the data to improve a team and take action without much delay. The visibility yielded by

more active involvement with the company in the first 100 days in particular will better

reveal management and other issues that require immediate actions and areas to monitor

closely during the life of the investment.

Transition Challenges for Operating Partners

No matter what their background (consulting, former CEO, etc.), high performance

operating partners know how to build trust. Without trust and followership, an operating

partner will never be able to create meaningful improvements. The panel referenced a

style that consisted of the “velvet glove coupled with an iron fist.” Whether transitioning

from CEO or some other role, operating partners need to adopt a coaching and mentoring

style where they have less control. This involves adjustments in terms of personal and

professional style.


You are no longer “in charge” in a manner where people accept your views with

little questioning.

PE firms are full of highly analytical people who often accept less in the way of an

intuitive approach. You need to defend decisions with data.

Operating partners should not expect the “adrenaline” and excitement that

accompanies a truly successful operating experience where one grows and exits

a business.

Rewards come in different forms. The panelists highlighted flexibility in their

schedule, more varied work experience, coaching younger members of the firm,

and the same feeling of teamwork that they enjoyed in operating roles.

All the panelists agreed it was critical to develop a style that utilized lots of

questions in their efforts to help CEOs and their teams perceive the best path for

an issue at hand.

On Boarding Operating Partners

Different firms have different portfolio support models that frame the way they

assess and on-board operating partners. Formal on boarding of operating

partners seems less common than other hires inside PE firms like associates.

One firm attracts and assimilates operating partners deal-by-deal. The executive

is expected to source, analyze, and then, assuming a transaction can be

concluded, jointly develop the value creation plan with the partners and assumes

a position on the board.

One firm hires operating partners and makes them part of the firm culture, which

emphasizes a high level of collaboration. In this model, everyone evaluates deals

and the operating partners are treated similarly to investment partners.

Some firms expect operating partners to assume board seats; others do not.

With respect to the latter, the operating partner’s role is to work closely with CEOs

on various issues and use leverage in the form of outside suppliers like

consultants and recruiters to solve specific issues.

The panelists recommended that a more formal on-boarding process be

developed and deployed for operating partners regardless of model. Specifically,

operating partners need to understand the perspective of the investment partners

to perform their jobs well.

If and when operating partners assume a specific role, like chairman of a portfolio

company, the expectations are clear. When it comes to due diligence and other

matters like crafting the value creation plan, operating partners are less clear

upon arrival and need to understand the expectations of the firm to perform their

duties effectively.


Measuring Operating Partners

Beyond the alignment of interests achieved via equity participation, there did

not appear to be especially formal measurement mechanisms in place to

determine the performance of operating partners.

One firm surveys CEOs who critique the entire firm, including the operating

partner. That same firm surveys investment partners for their evaluation of

specific operating partners associated with their companies.

The panelists agreed that a more fact-based measurement system linked to

specific goals would be ideal, but noted the difficulty in establishing the direct

value provided by the operating partner.

Panelists discussed “lack of control” even in situations where one is clear a

bad decision is being made. Operating partners can lose credibility quickly

and must exercise stellar judgment when deciding whether or not to

challenge a CEO.

Every team and every situation is different. As such, operating partners must

stay sensitized to the individual needs of management and adjust along the

way. The goal is to improve value, not necessarily do it in a way that is

homogenized the same way for all portfolio companies.

The role of the operating partner must be well defined and good operating

partners must set expectations well on both sides. It is important to be clear

with management on what level of support is being provided focused on what

specific issues with an agreed-upon timeline. Likewise, the operating partner

needs to be clear with the investors on what can actually be achieved based

an honest assessment of the situation


This white paper was prepared by

This report was prepared by Keith Giarman, Global Leader of the Private Equity Practice at DHR International. Please contact Keith Giarman at (415) 617-6234 or [email protected] for more information related to the report, DHR’s services or future events.

Keith Giarman serves as Global Leader of the Private Equity Practice in the firm’s San Francisco, CA and New York, NY offices. Mr. Giarman typically focuses on search assignments in portfolio companies from $0 to $1B in revenue where the investors are seeking growth, profitability, and liquidity. Working closely with top Private Equity funds around the country, Mr. Giarman has successfully executed multiple Board and C level assignments inside portfolio companies, including CEOs, COOs, CFOs, CIOs, and others. He has also completed assignments for internal fund hires, including General Partners, Operating Partners, Talent Partners, Executives-in-Residence, COOs, CFOs, and sales / IR , marketing, and HR professionals. Mr. Giarman has worked extensively with investors in prior operating roles in companies at various stages of growth. Most recently, as President and CEO of the start-up Clarus Systems (acquired by OpNet), he raised more than $20 million to launch the company. Mr. Giarman has also been involved in several other start‐up and PE sponsored companies, including IAsia Works (IPO), NightFire (acquired by Neustar), Cygent (acquired by Convergys) and Sintec (acquired by Riverwood Capital). Prior to his executive level experience in Silicon Valley, Mr. Giarman was the Vice President of Sales, Service, and Marketing at Citizens Communications (NYSE: CZN); today a $3 billion full‐service communications carrier called Frontier. He was one of 5 executives on the senior leadership team and was responsible for an organization consisting of 800 employees, $1 billion in revenue, and $200 million in operating income. Mr. Giarman earned his BA at UC San Diego (where he played 4 years of varsity baseball as a catcher) and his MBA from Harvard Business School (where he was recruited into the HBS PhD program in organizational behavior). He is a member of the Board of Trustees for Schools of the Sacred Heart in San Francisco, where he is currently Chairman of the President’s Evaluation and Compensation Committee and previously Chairman of the President’s Search Committee in 2012. He is a former member of the Board of Trustees at the Hopkins School in New Haven, CT and the former Chairman of the Western Region Board of Jumpstart. Mr. Giarman is also an advisor to several tech companies and funds, including Zapoint, Aktana, Factor Lab, and Taldan Capital.

Keith Giarman Global Leader, Private Equity Practice

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Documents

HUMAN CAPITAL BEST PRACTICES: REAL WORLD CHALLENGES … · Systems and Structure –A company’s focus dictates the nature of its “systems and structure.” For example, Wal-Mart