Over decades they built and dominated the private equity world, engineering multi-billion-dollar buyouts and guaranteeing healthy returns for investors.
But with more than $1 trillion in dry powder and investment plans stretching years into the future, the issue of who replaces the likes of Henry Kravis, 71, Stephen Schwarzman, 68, and David Rubenstein, 66, is preying on investors’ minds.
The untimely death of Nigel Doughty in 2012 and the subsequent problems suffered by the eponymous firm he co-founded with Richard Hanson offers a poignant reason why it’s never too early to start planning for a firm’s succession.
In July, Investcorp announced the appointment of Mohammed al-Ardhi to executive chairman with Mohammed al-Shroogi and Rishi Kapoor named co-chief executives, following the retirement of Nemir Kirdar, who had served both positions at the Bahrain-based investment bank.
A spokeswoman told sister publication Private Equity International that “changes to its management structure are a natural evolution and are necessary to maintaining a robust and stable institution, in line with corporate governance best practice.”
For many LPs this is also an area that is becoming increasingly important as they make their investment decisions.
Jon Grabel, chief investment officer of the Public Employees Retirement Association of New Mexico, says that he looks closely at how a firm manages its portfolio companies and the way the commitment committee operates.
“Those are precursors to see if a firm is capable when a time comes for an effective, smooth transition,” he says.
He also observes the key-person provisions, the mentoring environment and the firm’s culture in relation to the decision-making process; whether the junior associates can grow talent and “run with the ball,” and if firms learn from mistakes.
“A good firm should avail itself on all of the above with the expectation that the CEO is there for a finite amount of time,” he says. “We want to understand the culture. Is it capable of moving onto the next generation?”
GPs have to confront this succession issue, which is made more complicated by the fact private equity is a long-term vehicle.
“You have to think in [terms of] a decade every time there’s an investment,” Grabel says. “You should be thinking out 10, 12 years.”
Some GPs who have already implemented a long-term approach to succession planning agree.
“Private equity firms focused on doing what’s best for their investors should be thinking about succession planning from the beginning,” says Sarah Bradley, partner of Dallas-based Kainos Capital. “We were being asked by LPs about succession planning during Fund I.”
In July, Kainos hired Kevin Elliott, former president of Nash Finch, as partner in an effort to continue adding operational talent and strength to the firm.
“We don’t need new hires today as we’re fully equipped for our current portfolio companies, but we’re building for the future; so we’ll continue to add people,” Bradley said. “We’re very focused on making sure from the very beginning we build an organizational structure that is very deep and team oriented that can carry on the investment strategy well into the future.”
Different approach
Palo Alto-based HGGC takes a slightly different approach by focusing on home-grown talent, according to Rich Lawson, chief executive, co-founder and managing partner, but it also takes long term succession into consideration.
“A lot depends on the culture, but I’d tell you that you need to be mindful of succession strategies as you interview and focus on who you’re bringing on,” Lawson says. “You have to be constantly thinking, ‘Can I cultivate this person to be part of the DNA of this organization?’ versus waiting to see how someone does eight to 10 years later.”
He also emphasizes that LPs want to get to know the team well. At HGGC’s annual meetings, he puts the younger professionals up front so they can interact with LPs directly: “I don’t suck out all the air of the room as CEO.”
He says LPs are focused on looking at each individual at the firm, asking questions such as: are the people in the seats today responsible for the outcomes in the past?
Richard Jaffe, partner at Philadelphia-based law firm Duane Morris, co-heads its private equity practice group and acknowledges the careful observations LPs make on firms’ environment and culture.
“They’re being much more selective in the funds in which they invest,” Jaffe says. “They want to make certain that the team that’s in place when they make the investment will be the team that’ll be there over the term of the fund.”
LPs are looking more at the emerging managers and recognizing that, since they’re younger, they have more staying power and have more incentives to build their track record, Jaffe says, citing the California Public Employees’ Retirement System’s initiative reported last year to allocate more of its funds to emerging managers.
“It’s a threat to existing GPs because if teams break off, then LPs may be less inclined to invest in them,” he says. “So the strategy is to share the carry and give people more responsibility and make them feel like they’re partners, not just in name only.”
So what happens if GPs fail to keep succession in mind?
Jaffe says there is more than one scenario that can play out: some wind down; some become zombie funds; and some participate in a strategy called stapled secondaries, in which new investors buy interest in a fund from existing LPs.
“The challenge is keeping the team intact and convincing LPs that the next generation will be there,” he says.
The key, then, seems to be to continue maintaining a stable team while keeping the LPs’ views in mind. “It’s our view that succession should be an evolution, not a revolution,” Jaffe says. As one managing director at US GP First Reserve puts it, LPs don’t like surprises.
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