The ever-increasing value of human capital

Businesses have long touted ’people’ as their greatest asset. But labor actions in multiple industries across the US show that not everyone is buying it. Against this backdrop, private equity GPs are appreciating the value of culture and workplace satisfaction more than ever.

A market as volatile as today’s will do that. As financing becomes less accessible and more expensive, value creation becomes the primary route left to generate returns. And who creates value? The right talent, properly deployed. That’s why GPs are hunting for human capital experts to cultivate talent at their portfolio companies and firms.

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These GPs don’t discount the work involved in managing people. If anything, it has them contemplating automation and outsourcing as much of the firm’s activities as possible so they can devote their time bringing aboard the highest impact players – as in hiring a CFO instead of a trio of fund accountants. But as GPs outsource basic activities, they still need to treat those service providers as an actual extension of their office to ensure a good culture fit with a genuine rapport.

GPs in the past might have rolled their eyes at the idea of culture as a value driver, or such New Age theories as work-life balance. But they now see human capital issues as one of their core challenges. In the most recent PE Leadership Survey from global financial advisory and consulting firm AlixPartners, the war for top talent is one of three key human capital concerns, cited by 41 percent of respondents. In the same survey, 81 percent of portfolio company executives identified recruiting and retaining talent as their biggest challenge.

“Our research shows that private equity firms now see the human capital lever as the number one lever for value creation,” says Ted Bililies, partner, managing director and global head of transformative leadership at AlixPartners. “They now know the ‘who’ matters, and that puts an emphasis on training, development, employee experience and even succession planning.”

As a result, GPs are investing in human capital expertise. “PE firms are hiring a lot more talent acquisition staff at the firm level,” says Shawn Cole, president and co-founder of Cowen Partners, which recruits senior executives for portfolio company roles on behalf of PE clients. “These hires are becoming core part of the overall value creation model.”

Looking inside

But GPs aren’t simply investing in talent at the portfolio companies. “Human capital initiatives were historically devoted to external needs for portfolio companies but now that’s an opportunity for the firm’s internal staff as well,” says Sean Mooney, founder and CEO of BluWave, a PE-focused B2B network offering access to vetted service providers, consultants and interim executives.

The war for talent isn’t anything new for the private equity space, but the current market is having a contradictory impact on that war.

“The competition for talent has slowed some with the inflationary headwinds and the rising cost of debt,” says Bililies. But that said, he notes that the tougher the environment, the greater the premium for the talent to navigate those rough waters. As Cole points out: “There’s this realization that people are going to drive the next couple of years of growth, especially where turnarounds are necessary.”

Bililies also notes that the competition for talent isn’t the same across the industry. “The bigger firms, the $15 billion firms and above, are feeling it worse than
the smaller ones. At the smaller firms, more of their key roles are covered, and that’s just a reflection of the dry powder that the large firms have to put to work.”

Hot topic

So what are PE firms doing to win the right people? “They’re widening the aperture and looking beyond the same six schools for junior investment professionals. They’re paying attention to the employee experience and value proposition,” says Bililies. And treating human capital management as its own discipline.

“The number one hottest hire in all of private equity is a head of human capital,” says Mooney. “And while they might be tapped initially to look at portcos, eventually they shift their focus to the firm’s own staff as well.” Bililies finds the competition for CHRO to be quite intense, and its increasingly difficult to fill that role.

This all amounts to a greater appreciation of the time and effort required for recruiting and retaining talent. Little wonder that so many GPs have outsourced tasks like fund administration given the limitations of their own manpower and budgets.

“A private equity firm, in some ways, is a much smaller business than the portfolio companies they own, with that management fee on, say, a billion-dollar fund only amounting to $20 million in revenue,” says Mooney. “So that means there’s only so many chips on the table, and every bet on internal resources needs to be an educated one.”

Outsourcing can be quite an educated bet. “We take the human capital risk of fund administration off our client’s plate,” says Luis Gutierrez, a managing director at Gen II Fund Services. “Finding, training and developing talent is incredibly time consuming and if that employee leaves, it’s back to square one. Not to mention the cost savings of not having to provide a separate salary and benefits package.”

Even without major savings, there’s another asset. “Outsourcing allows a client to have a fixed cost versus a variable cost. That’s music to any CFO’s ears, since they can now budget for this. I know what to expect. And if there are additional costs, say relating to upskill training of staff, that’s the responsibility of the administrator, not the client,” says Dautanya Strachan, a managing director with Gen II Fund Services.

However, GPs would do well to evaluate and manage their service providers with the same rigor as their internal staff. “Treat [any outsourced service provider] like a full-time employee,” says Mooney. “Outsourcing isn’t some magic fairy dust that automatically ensures the provider does the work perfectly.”

Most outsourced service providers sell themselves as that extension of the office. But they’ll need to be more than just an extension of their clients’ culture if they’re to continue attracting the talent they need.

“For professionals under 35, compensation is necessary but not sufficient. They will not do what the older generation did so often, which is to say, ‘Pay me a lot of money, and I’ll kill myself for the firm,’” says Bililies. “They want compensation and culture, and they will make certain individual trade-offs, but by and large, they won’t stay at a firm that doesn’t understand that, and that’s the difference between attracting and retaining talent.” And of course, what good is the best talent if it leaves?