In Private Equity, leadership is a vital aspect of value creation. Leaders and their leadership teams, along with the culture and the environments they create, have the potential to deliver exceptional returns. Whether wartime or peacetime in leadership style, the Covid crisis’ effect on portfolio businesses has only amplified this fact.
As an ex-accountant myself and now in a leadership role, one area that particularly interests me is how we view the role of CFO; not from a CFO or headhunter’s perspective but through the lens of the CEO. After all, the CFO and CEO relationship is THE key relationship in PE organisations, arguably (as or) even more business critical than that of CEO and Chair.
So, what makes a good CFO?
Over the last few weeks I have been interviewing dozens of Private Equity CEOs across different sectors, business models, markets and turnover / EBITDA to understand just that, and their opinion of what they need post-crisis.
One CEO recently changed his CFO, and only then realised what he had been missing all those years. For him, it is having a proactive business partner with good judgement, who is able to engage the PE house and not just to generate reams and reams of financial reports and data; he [CFO] would understand what the PE House is asking and find a more effective way of answering their question, and in some cases help them frame different questions to improve their understanding of the business performance. For another CEO, it is about having an intellectual sparring partner to test out ideas before “going in to bat with the PE House”. Yet another said it is the need for an intellectual powerhouse who is very different to him and could “do all the things I couldn’t or didn’t want to do”.
Some of the feedback from CEOs highlights behavioural traits, some situational or domain experience, and some (especially for the CFO), functional expertise. Opinions differed (not surprisingly) based on the experience and background of the CEO themselves; other variables also include the bench strength of other leaders in the business, what markets and jurisdictions the business operates in, as well as what stage of the value creation journey the business is at. However, some traits came out as desirable across all these variables and are illustrated in the diagram below:
Behaviours are even more important
If you look at every single transaction over the last ten years and the leaders that conducted those transactions, across the 3,428 PE- backed organisations in the UK you get two things: tens of thousands of data points, and some very clear trends.
When leadership teams have a clear strategy (PE value creation model), within a set timeframe (typically 3-5 years), and a stable and supportive capital structure (private equity) to work within, then we can measure, model and predict what success looks like. We call this the Leadership Success Propensity Model (LSPM).
The LSPM components Domain, Situation and Function provide an evidential perspective on the capability and skills of a leader; in this case of the CFO, we can use it to reflect back and project forward their propensity for success.
The fourth component, Behaviour, is arguably the most important factor. We use a scenario-based psychometric developed by drxDATA called the PACE tool (see below diagram). PACE provides a perspective at an individual level, which offers an insight that wouldn’t readily be apparent from simply looking at the candidate’s Domain, Situational and Functional data.
This data obtained through the PACE analysis was also played out in my numerous conversations with CEOs. Every single CEO I spoke to ranked Pragmatism (consistency, transparency, trust, open communicator) at the top of their post-Covid wish list in a CFO.
The other elements on the wish list varied depending on the situational bias, specific to the scenario that the particular business was facing. For example, if operational effectiveness was high on the agenda, the CEO favoured CFOs with high Execution (driving pace, leading by example, accountability, people focussed decisions) as well as Pragmatism. If M&A activity was a priority, then Agility (complex change, ability to read situations, strategic, verbalising vision) was alongside Pragmatism.
Conclusion
The landscape post-Covid, is uncertain and changing; the PE-backed businesses that not only survive but thrive will have the CFO (and Chair, and CEO and broader leadership team) that exhibits the right capability, skills and behaviours collectively.
We can now predict how leadership teams and individual leaders can add accretive value to a Private Equity business and how potential changes to the leadership team will alter the particular value creation strategy; for decades this has been the holy grail within PE.
