Human Capital Pitfalls in Private Equity: Pre-Deal and Post-Close Planning Mistakes to Avoid (according to SpencerStuart)

In the private equity (PE) industry, the diligence process plays a vital role in assessing investment opportunities, securing deals, and establishing trust with management teams. While strategic, operational, and financial aspects are typically prioritized, the significance of human capital is often underestimated, despite its crucial role in deal success. To ensure favorable outcomes, PE firms must prioritize thorough talent diligence that goes beyond surface-level assessments. In this article, we explore six prevalent human capital pitfalls that can hinder PE deals and provide insights on how to mitigate them.

Pitfall 1: Insufficient Evaluation of Management in Private Equity Deals

Private equity firms dedicate substantial resources to evaluating a target company's business, market potential, and future growth. However, the scrutiny placed on management often falls short, whether due to habit or the challenge of quantifying its value. Nevertheless, savvy investors are increasingly recognizing that the success of an acquisition hinges on the capabilities of the management team. Therefore, gaining a comprehensive and unbiased understanding of management talent is vital to the success of any new investment.

Pitfall 2: Inadequate Speed in Connecting Talent to the Change Agenda: Implications for Private Equity Performance

Often, talent evaluation in pre-deal assessments oversimplifies the process. It goes beyond categorizing the management team as "good" or "bad" and focuses on whether it is the appropriate team to accomplish your operational objectives. Consider the context, including the operating environment, strategy, team dynamics, and ownership dynamics, which may differ from previous experiences. Neglecting to evaluate talent based on your value creation plan (VCP) can have long-lasting repercussions months or even years into ownership.

Pitfall 3: Excessive Focus on the CEO: Implications for Private Equity Performance

While much has been discussed regarding the CEO's contribution to value creation, experienced asset owners and talent managers recognize the significance of team dynamics and how high-performing teams can shape an environment that fosters accelerated performance. When considering new investments, it becomes crucial to identify the critical roles that extend beyond the CEO, understand the expectations associated with each role, assess the individuals occupying those positions, and evaluate their potential to drive the acceleration of the Value Creation Plan (VCP).

Pitfall 4: Falling Into the Trap of Over Reliance on Impressive Pre-Deal Advisors

While it's natural to consider pre-deal advisors for management and board positions after an acquisition, their appeal based on proximity, availability, and involvement in the due diligence process does not guarantee they possess the necessary experience or capabilities for the post-close phase. Therefore, it is crucial to establish independent hiring processes that distinguish between pre-close necessities and post-close decision-making to ensure the selection of the most suitable candidates.

Pitfall 5: Allowing the talent agenda to become an issue

Owners and management might become wrapped up in the talent agenda even when they are unified on business objectives. Sponsors may be concerned about being perceived as overbearing, management may feel intimidated, or the wooing process may preclude swift talent changes beyond the most apparent. However, incorporating a comprehensive talent agenda as a routine component of any strategy might assist in alleviating this strain. A systematic approach to human capital may immediately align and excite management around ownership goals, as well as establish trust and accelerate time to value.

Pitfall 6: Insufficient Leadership Accountability in Human Capital Management

Few portfolio company operators have HR business partners that have led strategic, enterprise-wide human capital change in the time frame that private equity investors anticipate. Furthermore, most PE stakeholders lack the bandwidth and time to perform the function of HR. As a result, the strongest human capital strategies are frequently the result of CEOs that value talent or depend on outside expertise. Even the best-planned talent agenda will fall short without program management and responsibility for implementation, regardless of strategy.

The human capital strategy needs the same level of research and planning as finance and business strategy. Firms that completely adopt this approach will have an advantage in an increasingly competitive PE sector and unpredictable market.