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Buying vs. building people

Adding senior-level investment partners is crucial for a firm's growth, and a real challenge for GPs.

As is the case with most long-term relationships, personal chemistry is key when it comes to forming a solid, cohesive team at a private equity or venture capital general partnership. But in the current environment, which is evidencing more shifts among investment professionals than perhaps ever before, long-term relationships are becoming difficult to maintain and even more difficult to initiate.

?When an area gets sexy, you see money flow into it, and there have been staggering numbers for private equity funds,? says Simon Francis, a partner at executive search firm Christian & Timbers. ?Now there is pressure for private equity firms to deliver. They have plenty of cash and enormous management fees, so they can hire people, and they want to hire experts who can get the good deals.?

With more capital under management, private equity firms need more partners. They are promoting from within but also hiring laterally. Finding outside talent for private equity has been aided by the gravitational attraction of the industry.

These days, GPs take fairly customized approaches to managing their pipeline of senior level talent, but many still feel more comfortable with an organic growth approach to hiring senior level professionals.

For instance, Menlo Park- and Dallas-based venture capital firm InterWest Partners prefers to grow partners from the firm's pool of associates, principals, and executives- or entrepreneurs-in-residence. When InterWest announced the first investments made through its $600 million (€496 million) InterWest IX last November, the firm also promoted its four principals to partner. ?Each of them had been with the firm at least two to three years,? says Steve Bowsher, a general partner at InterWest's Menlo Park office. ?For someone to get a partner title, it's expected that they've demonstrated the capability to source, advocate, serve on the boards of investments without supervision or guidance from anyone else in the partnership, and that they have the confidence and trust of the partnership.?

Like many VCs, InterWest has entrepreneurs-in-residence and executives-in-residence who are typically operating executives that they have worked with in the past, and who are interested in trying out the VC life. The in-residence programs allow both parties to test the waters without immediately committing to a long-term partnership.

Bowsher himself joined as a partner in the InterWest VII fund in February 1999, after gaining operating experience at online stock brokerage E&#42TRADE and other startups. When InterWest VIII was raised in 2000, he was then promoted to general partner.

?There are lots of ways to bring people into the firm to give us a chance to know them before making a commitment to get involved. Typically someone has worked [as associate, principal, in residence] or at a portfolio company before they make partner,? says Bowsher. ?It would be hard for us to think about hiring someone off the street, no matter how impressive their background.?

According to Foundation Capital general partner Paul Holland, the venture firm's partners and general partners accumulate, on average, 20 years of operating experience before becoming venture capitalists. Meanwhile, Foundation, based in Menlo Park, doesn't have any associates, principals or vice presidents.

?We have a throwback structure – it's an all-partner firm,? says Holland, adding that the firm's structure looks similar to how venture firms looked two decades ago.

For finding new in-house talent, the firm takes on ?venture professionals,? who also possess a long track record of operating experience who join Foundation for one or two years, again testing how well the VC hat fits. During their stints with Foundation, these venture professionals make investments, sit on the boards of portfolio companies, and take on a role very similar to the partners', without the ?permanent commitment,? says Holland.

Scouting about
Other GPs, particularly the larger private equity firms, are now looking more toward external sources for help in injecting new talent and energy into their businesses. With the 2004 hiring of former Investcorp managing director Philip Yea, the first 3i chief executive to not be funnelled up the ranks of the firm, 3i made a significant shift in its approach to growing talent. Soon after joining 3i, Yea told sister news service PrivateEquityOnline that the firm would always look to find the best person for a particular job, be that outside or inside the organization.

Talent scouts are also seeing an increase in the private equity executive search area. According to Lee Hanson, managing partner at the San Francisco office of executive search firm Heidrick & Struggles, she sees the drivers for new hiring sprees as coinciding with new fundraising activities, larger fund sizes, expansion into new geographies or asset classes, and to some extent retirements from the business. ?A number of factors are coming into play right now, and it's a relatively active market,? says Hanson.

In responding to private equity and venture capital firms' reticence to inviting strangers into their fold, Christian & Timbers' Simon Francis says, ?Historically, that 's been the case, and many firms continue to do this. But if you think about it, if you look at the size of these deals and the amount of capital these buyout firms are sitting on – for example, Carlyle is sitting on $20 billion to $30 billion – it's really hard to put all that money to work.? Consequently, large GPs tend to tap headhunters for help in bringing in new people when they realize they have a scarcity of resources for managing the talent search process.

?We' re in business because people eventually become realistic and say, ?We think we know everyone, but we don't.? They overestimate their ability,? says Francis. ?Ten years ago, when there were only a few private equity firms in the business, there was not enough liquidity to justify bringing in a third party to find people for you. Now it's spread all over the world with thousands of people in the community, and most firms are not able to track all those people.?

When taking the recruiting strangers route, GPs should clearly do due diligence on the candidates. ?Once hired, they can be hard to dislodge, so you need to have a life history on the person,? says Francis.

Smoothing transition
Whether a GP looks inward or outward for its top talent, a poorly managed transition can waste resources and create instability for a firm, particularly with other firms and headhunters eyeing the industry's talent pool. Clear communication of the expectations of all parties involved is critical.

?Of course, when you hire people, you give them a certain outlook on what their career path could be,? says Helmut Schuhsler, the managing partner of German-US venture firm TVM Capital's life sciences team. He points to one of the attractions for joining a venture capital firm as being able to ?get in and work your way up.?

To support its investment professionals' desire for moving up the ladder, TVM Capital holds regular partner meetings to discuss issues of promotions and the performance of professionals. ?Based on agreement among the partners, we announce promotions,? says Schuhsler.

In order to retain talent, Schuhsler highlights the need for the firm's key decision-makers to stay close to the people on the team. ?Understand what their aspirations are, what they are happy with and unhappy with. If there is a problem that you see, communicate it openly,? recommends Schuhsler. ?Have as open of a conversation as possible, at least once or maybe even twice a year. You always want to be close to the team dynamics.?

Not only is it important for GPs to have a strong grasp of the candidates' goals and desires, it is important for the new person being brought in or promoted to understand what the partners' needs are. Hanson emphasizes that, particularly in the case of partnerships, it is important for there to be a strong ?buy-in? among the partners to bring in a new member to the team, whether on the investment or business side. In addition to that unanimous sense of commitment, the GP should be clear about what value it seeks to add through the hire and where the appointee fits within the organization.

?Let there be no ambiguity about their role and impact,? advises Heidrick & Struggles' Hanson. ?If someone comes in thinking they will have a seat at the table but in reality is relegated to the back office – if there's that type of disconnect, that's when you have problems.?