Succession Planning for Private Equity Firms - not portfolio companies

How should private equity funds manage succession planning for their own organisation and how is it different from the process with their portfolio companies?

By: Leadership Dynamics team


5 mins

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While private equity firms work hard to maximise value creation by building high performing leadership teams in their portfolio companies, many forget to look within their own organisations. The principles of stable, high performing leadership apply to the management of PE funds themselves. Without a coherent succession plan, they are risking their ability to maintain existing value creation plans and to attract limited partner investments. It’s critical to practise what they preach.

This article will explore why succession planning is as important for private equity firms as for their investments, and how managing partners and investment directors can ensure the smooth running of their fund when it comes time for leadership change.

If you’re looking for the essentials, see our comprehensive guide to succession planning.

The succession planning process

While the succession planning process in a PE fund follows the same lines as for a portfolio company, the reasons are different. At a portfolio company with a time-sensitive value creation plan, leadership must maintain the capabilities required at each stage of growth. Private equity firms are more likely to go through a succession process when a founding partner retires or there is an unplanned exit by a principal. 

The succession planning process in private equity firms typically involves the following steps:

  • Identify key positions: The first step in the succession planning process is to identify the key positions in the firm that will need to be filled in the future.

  • Assess skills and competencies: Once key positions have been identified, the next step is to assess the skills, behaviours and competencies required for these positions.

  • Identify potential successors: The next step is to identify potential successors for key positions. This may involve assessing current employees or recruiting externally.

  • Make a plan for development: Once potential successors have been identified, make a plan for their leadership development. This may involve providing training, mentoring, or job shadowing opportunities.

  • Monitor progress: It is important to monitor the progress of potential successors to ensure that they are developing the necessary skills and competencies.

We have written more about the succession planning process for portfolio companies, and while this is based on the specific requirements and pressures of a value creation plan, the tips are relevant for all kinds of companies, including private equity firms.

How to manage founding partner succession

Although it may feel like private equity firms have been around forever, it is still a relatively new asset class in the investment world. Many of today’s firms were only started in the 90s or later, and the founding partners may only just be starting to relinquish control. A succession plan needs to be designed and agreed upon to ensure a smooth transition.

For those PE firms that have only ever known one CEO, they can look to the experience of their founder-led portfolio companies. As we argued in our article How High-Growth Companies Manage Founder Succession Planning, a company that is built on the personality of one person can only go so far. If they have been managing everything personally, once they are gone, they will leave a vacuum of capability.

While a PE firm has different pressures than a product or service-led company, the principles of succession are the same. Spreading responsibility across a team of cognitively diverse operators will allow a business to scale sustainably. 

The importance of succession planning for private equity firms

When a leadership exit occurs in a private equity firm, there is a risk the upheaval could have a negative impact on all parts of the business. It may trigger other key partners and employees to also leave the organisation, and can derail the firm’s strategic focus. 

Without a smooth transition, investors will feel the consequences in their returns and look elsewhere to invest, especially if they feel the impacts could have been avoided with better succession planning. The reputational damage will also make it harder to attract new limited partners.

  • Impact on firm stability – Succession planning contributes to the long-term stability of the firm. Effective succession planning can help firms maintain the momentum of the firm's growth and strategic direction, ensure leadership continuity when inevitable changes occur and identify gaps in the current leadership team, allowing firms to address the need for specific skills development or external hires.

  • Maintaining investor confidence – Investor confidence is essential for any private equity firm, and an established succession plan plays a significant role in attracting and retaining investors. More and more, limited partners are emphasising succession planning in their due diligence when picking funds. Some may have been burned before when a key partner has left a firm due to poorly planned leadership transition, and they have been stuck in a contract in an underperforming fund. 

Investors are often reassured by a robust succession planning process that shows the firm is prepared to navigate leadership changes without disrupting operations or the firm's long-term objectives. In addition, understanding the firm's effective succession planning strategies can lead to increased investor confidence in the firm's ability to manage future challenges and opportunities.

It’s not only important to have a succession plan ready, but also to communicate it well to potential investors.

Challenges to succession planning in private equity firms

Succession planning is a crucial process that ensures the continuity of a business by identifying and developing potential successors for key positions. However, the unique characteristics of private equity firms pose several challenges to effective succession planning.

Resistance to change

As we discussed earlier, private equity firms are often led by strong personalities who have built the business from scratch. As a result, they may be reluctant to give up control and delegate responsibilities to others, including potential successors. This resistance to change can impede the development of a robust succession plan and may result in a lack of clarity in roles and responsibilities.

Lack of clarity in roles and responsibilities

Private equity firms are often structured as partnerships, which can make it difficult to define the roles and responsibilities of each partner. This lack of clarity can lead to confusion and conflict when it comes to identifying potential successors and delegating responsibilities.

Lack of diversity

Private equity firms are often led by individuals with similar backgrounds and experiences, which can limit the pool of potential successors. This lack of diversity can also lead to groupthink and a reluctance to consider alternative perspectives and approaches. From our work building high performing leadership teams in high-growth companies, we know that diversity is one of the most important characteristics of effective leadership teams. Considering leaders with varying cognitive abilities, experience and behaviours.

Best practices for private equity succession planning

Incentivise talented junior partners

Long-term stability requires a healthy pipeline of talent. However, if the senior partners refuse to relinquish economic interest in the fund even as they start to step back, the junior partners working long hours running the day-to-day may look elsewhere for appropriate reward for their efforts. Founding and managing partners who want the fund to continue long after they are gone, need to ensure that their successors have economic incentive to stay.

Letting go of the day-to-day

Private equity funds have evolved into complex organisations that are too much for any one person to manage. Senior leadership are best placed to steer its strategic direction and culture and leave the dealmaking to their juniors. This is easier said than done, but it is necessary to ensure the firm can continue to grow without the founders. A key mindset shift for leaders is to move from dealmaker to mentor.

A culture of succession planning

Developing a culture of succession planning is critical for the long-term success of a private equity firm. This involves creating a mindset among employees that succession planning is a continuous process that requires ongoing attention and effort. By embedding succession planning into the firm's culture, the firm can ensure that it is always prepared for any potential leadership changes.

Coupled with a culture of open and honest communication, and a feeling of ownership and accountability, junior partners will act in the long-term interest of the firm and their investors. This will help a smooth transition to future partners.

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