positioning the private equity portfolio company ceo for success

About Spencer Stuart

Spencer Stuart is one of the worlds leading executive search consulting firms. Privately held since 1956, Spencer Stuart applies its extensive knowledge of industries, functions and talent to advise select clients ranging from major multinationals to emerging companies to nonprofit organizations and address their leadership requirements. Through 50 offices in more than 25 countries and a broad range of practice groups, Spencer Stuart consultants focus on senior-level executive search, board director appointments, succession planning and in-depth senior executive management assessments.

the portfolio company career path private equity challenges: high debt, high risk, fewer resources freedom and greater reward potential traits of the successful private equity ceo finding the private equity ceo setting up for success board governance is uniquely challenging and rewarding conclusion

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The private equity and venture capital-backed portfolio company chief executive officer is a relatively new phenomenon, considering that the ownership model just started to evolve in the mid-1980s and picked up speed in the early 1990s. Firms such as Madison Dearborn Partners, GTCR and Willis Stein & Partners, which emerged in the 1980s and 1990s, had their roots in just a very few investment companies created in the 1970s, including First Chicago Equity Corp. and Continental Illinois Venture Corp. Since those early days, the private equity ownership model has set in motion dramatic changes in the ways businesses are financed, managed and built. Today, there are several hundred private equity firms in the United States with more than $1 billion in assets under management and many hundreds more smaller firms. The largest firms including Kohlberg Kravis Roberts, The Blackstone Group, Madison Dearborn Partners and others have bought and sold dozens of stand-alone legal entities and can have assets under management in excess of $10 billion. Reflecting the broad acceptance of the model, private equity funds include a wide range of investors, including the largest Fortune 500 companies, high-networth individuals, commercial and investment banks, pension funds, institutional investors and even smaller private equity firms. The rise of private equity ownership has had another effect on talented executives: it has created more than 3,000 CEO opportunities at privately owned portfolio companies. This has been a welcomed development for the growing number of leaders aspiring to the CEO role, whose career options in the past were limited to public companies and family-owned businesses willing to hire outsiders.
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The portfolio company career path

By the time the Roaring 90s arrived, investments were pouring into private equity at unprecedented amounts, and firms required a steady supply of strong leaders for their portfolio companies. One growing source of seasoned leadership talent for private equity firms and venturebacked startups was, and continues to be, from within the ranks of large, public companies. Organizations such as General Electric, Procter & Gamble and others with autonomous businesses and a decentralized organizational structure regularly produce effective leaders who have had opportunities to move into general management roles with monumental leaps in scale and increasingly complex responsibilities. While these organizations have provided a superb training ground for general managers and future business leaders, the entrepreneurial leaders within these companies often find themselves competing against a large pool of equally skilled general managers for too few opportunities at the highest levels of their organization. For many of these high-achieving individuals, private equity firms and their portfolio companies represent a more exciting entrepreneurial fit and an opportunity to advance their career to become a CEO opportunities they may never get if they remain in large, public companies.

The more time I spend in this business, the more convinced I am that the great CEOs are those who can identify, recruit, train and retain the best people.
Avy Stein, senior partner at Willis Stein & Partners

Unfortunately, a significant number of executives who thrive in a large public company environment ultimately fail in their first private equity portfolio leadership role, discovering too late that they are better suited for roles in larger companies with more resources and a different culture. Others apply the hard lessons learned from their first assignment and succeed in their next one if given the opportunity. The executives who most successfully make the transition to private equity portfolio companies, including management buyouts and corporate spin-offs, typically are change agents, problem solvers and have financial savvy. They also possess a sense of urgency about executing the companys mission. They are able to adapt quickly to new environments, evolving leadership requirements, unique ownership models and a higher degree of board oversight.

U.S. Based Venture Capital and Private Equity Firms 2006

Assets > $1 billion Assets < $1 billion 242 1,350

Source: Galante's Venture Capital & Private Equity Directory

Because of the unique challenges and opportunities inherent in running a portfolio company and the high risk of failure identifying and attracting the best and most appropriate talent can be a significant challenge. As private equity ownership has increased, Spencer Stuart continues to be called upon to assist private equity firms in finding the right talent for their portfolio companies. In 1990, approximately 5 percent of the CEO searches the firm conducted annually in the United States were for private equity portfolio companies. The number of CEO searches the firm conducts has increased three-fold since then, and about 15 to 20 percent of current CEO searches are for private equity and venture capital owners.

Most CEOs in a private equity-backed company must commit to a lifestyle and management style change, and they must think like the owner of the business on every issue they consider and act upon.
Mark R. Goldston, chairman, president and CEO of United Online

During the past 10 years, Spencer Stuart has conducted more than 1,000 searches for CEOs and other senior-level leaders of private equity-owned companies. Our interviews with more than 60,000 individuals during this period, including 7,000 candidates for private equity and venture capital clients, have given us insight into the demands on portfolio company leadership and how leading a portfolio company differs from leading a public company. It has helped us to identify best practices for success in this unique environment.

Private equity challenges: high debt, high risk, fewer resources

Because of its unique blend of risks, rewards, challenges and opportunities, a private equity portfolio company is not for everyone. For entrepreneurial executives, however, the lure of a portfolio company includes the opportunity to break free from the traditional corporate structure along with the potential payoff following a successful sale or initial public offering. I cant think of anything more exciting than being with a company thats doing well in a private equity situation, and, on the contrary, I cant think of anything worse than getting close to bankruptcy, said David L. Bere, former president and chief executive officer of Bakery Chef, formerly a Wind Point Partners holding. Bere led large divisions within Quaker Oats before making the jump to private equity. What specifically are the challenges? Very often, private equity companies have high levels of debt, requiring constant attention to cash flow, spending levels, debt repayment and financial targets in order for companies to achieve their exit strategies. There is always the issue of the owners exit in two to five years, which almost never exists in most public company environments,
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said Brian Kelley, who brought extensive experience from leadership roles at Procter & Gamble, GE and Ford to his current role as president and CEO of SIRVA Corporation, a private equitybacked relocation solutions company. As a result, cash is king at portfolio companies, so quickly increasing revenue and tightly controlling costs are top priorities for their CEOs. They often have to make quick and difficult decisions to cut costs and preserve cash. The attention to cost-cutting also means that portfolio company CEOs may have to do without the perks of the title. In the corporate world, you have private limos and the Falcon 50; in some companies in the private equity portfolio world, you have a seat on Southwest Airlines, observed one CEO of a $400 million portfolio company attempting a significant turnaround. Portfolio companies also have fewer human and financial resources. When pursuing new strategies or launching new products or marketing initiatives, these businesses do not have the deep pockets of a large corporation behind them. Furthermore, without the reputation and global brand of a major corporation, portfolio companies can have a more difficult time attracting top talent under the CEO.

A private equity portfolio company allows for the CEO to be more aggressive and make a more radical restructuring stance in trying to fix a company, which would be almost impossible to do with the same rigor and speed in a public organization.
Brian Kelley, president and CEO of SIRVA Corporation

You must have the desire and ability to thrive in a fast-paced, stressful situation where everything you do and every decision you make is critical. You also must have a very broad grasp of all the functions of a business as you typically dont have a lot of staff or experts in each discipline. As a result, the CEO is left to make many decisions that might be more easily delegated in a public company. You really cant make many personnel mistakes at the senior level as the results, both positive and negative, will be readily apparent, said David A. Jones, a former GE executive who is now CEO of a $2.4 billion, private equity-backed consumer products company Spectrum Brands. The company, formerly named Rayovac, was aquired by T. H. Lee and went public in 1997.

Freedom and greater reward potential

Despite the challenges and the risks, many entrepreneurial-minded executives are drawn to portfolio companies for the freedom from the constraints of the corporate world and the potential of much greater rewards. They are willing to exchange the relative security and longevity offered by
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corporations for the potential of greater wealth. In a portfolio company, fewer parties have large equity stakes in the company, yet a sale or IPO can provide a significant payout to top executives. Most CEOs in a private equitybacked company must commit to a lifestyle and management style change, and they must think like the owner of the business on every issue they consider and act upon. Private equity stakes for CEOs generally are long-term and relatively illiquid, versus the conventional annual vesting schedules of public company CEO stock options and the built-in liquidity of public common stock, said Mark R. Goldston, chairman, president and CEO of United Online (NetZero, Juno and Classmates.com), who also has been the president of Faberge, L.A. Gear, Einstein/Noah Bagel Corp. and was formerly a principal of leveraged buyout firm Odyssey Partners. The longer term horizon and inherent illiquidity characteristics of a private equity stake encourage CEOs to make decisions that are in the best interest of the company over a three- to five-year period. The overriding objective is to pay down the companys debt in a reasonable time frame typically five years and to get the de-levered value of the asset, several years out, to provide a 20 percent or greater annual ROI. A CEO with an equity stake in a company that achieves those goals can realize tremendous economic value upon execution of a variety of exit strategies, including an IPO, outright sale of the company, recapitalization or a merger with another company. The CEO of a private equity-backed portfolio company must be wholly committed to mediumterm value creation and be comfortable with a compensation package that rewards success in five to seven years, according to Avy Stein, senior partner at Willis Stein & Partners. Private equity CEOs get paid handsomely, but not until the play is completed. Along the way, the CEO is paid fairly, but the big upside comes only at the end, he said. Public company CEO > Greater depth of financial and talent resources to draw upon > Brand-name recognition > Access to public markets to raise funds for initiatives > Quarterly earnings pressure > Greater personal liability in current regulatory climate Private equity CEO > Equity stake provides generally greater upside potential > Focus on longer term financial objectives, rather than quarterly financial results > Greater autonomy, less bureaucracy to navigate > Highly leveraged, requiring unwavering attention to cash flow > Few internal functional experts to rely on

Comparing private equity and corporate ceo roles

While a portfolio company has to be far more focused on fewer goals and a well-defined end game, its smaller size makes it easier to mobilize the organization to accomplish those goals and make decisions quickly. A private equity portfolio company allows for the CEO to be more aggressive and make a more radical restructuring stance in trying to fix a company, which would be almost impossible to do with the same rigor and speed in a public organization, said Kelley. Despite the pressure to achieve financial milestones, CEOs from private portfolio companies traditionally have not had to contend with the heavy emphasis on reporting and preparation of quarterly financials required of a public company and, now, all the expense and preparation required for compliance with the Sarbanes-Oxley Act. With incentives freed from quarterly analysts demands, these CEOs typically can take a longer term view on the company. CEOs of private equity companies have the luxury to make decisions with a longer term horizon and, when problems arise, they can pursue solutions and resources without public pressure from shareholders on Wall Street, said Scott Schoen, co-president of Thomas Lee Partners, a Boston-based private equity firm with about $12 billion of capital under management.

You really cant make many personnel mistakes at the senior level as the results, both positive and negative, will be readily apparent.
David A. Jones, CEO of Spectrum Brands

Traits of the successful private equity CEO

Because of the debt load, portfolio company CEOs must possess in-depth financial knowledge and experience. They must know how to manage high debt and reduce costs, understand pricing strategies and be comfortable reaching out to capital markets. In fact, the private equity firms we work with routinely ask us to identify candidates who have had exposure to a high-debt environment and, ideally, experience in a private investor-backed business. Portfolio company CEOs also need broad experience leading every function, particularly product development, supply chain management, sales and finance. Successful portfolio company CEOs also excel at setting priorities and efficiently allocating resources, and are able to build an effective partnership with a more hands-on and financially astute board. John A. Canning, president of Chicago-based private equity firm Madison Dearborn Partners, commented that CEOs who are most likely to succeed are those who stay laser focused on capital management and debt reduction. For that reason, his firm looks for executives with financial
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acumen because they understand the consequences of the companys leveraged position. However, he emphasized that they need to have a risk orientation, which functional and public company executives often lack. Those he has seen fail typically had difficulty adapting to the relative lack of resources compared with public companies or were slow to make tough, but important, decisions. You must be ruthless and separate emotion from human resources decisions, Canning said. Equally important as the types of financial and operating experience they have amassed are their leadership skills. Private equity CEOs must keep the organization focused on executing key priorities, and must be willing to roll up their sleeves to get the job done. At the same time, employees look to the CEO for personal guidance and leadership much more often than within the traditional Fortune 1000 company and they frequently test the CEOs values, intellect and decisions. The private equity CEO often is reliant on a small, highly focused team that may lack the perceived star power seen in bigger companies. Thus, the CEOs passion and ability to sell his or her vision for the company both the strategy for building the company and the potential financial reward for success is crucial. The portfolio company CEO also must demonstrate a passion for the business, have a clear picture of the companys future that will excite others, and be able to spell out the compelling rewards stemming from a potential success. The more time I spend in this business, the more convinced I am that the great CEOs are those who can identify, recruit, train and retain the best people, Stein said. They are willing to revisit strategy, tactics and personnel on a regular > Strong financial expertise, including P&L, cash flow management, debt repayment experience > Broad general management experience and exposure to a variety of functional disciplines > Entrepreneurial and self-starting orientation > Ability to develop, execute and focus team on strategic vision > Risk orientation and sense of urgency > Thrive on change and solving problems > Ability to adapt quickly to new environments, different leadership requirements and the unique ownership model and board relationships The portfolio company CEO also must be flexible enough to run a streamlined environment without the resources of a large corporation and with few pretensions about the status or boundaries of the job. Successful portfolio company CEOs are not territorial about their role and willingly take on any task that needs to be accomplished.
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Core competencies of successful portfolio company CEOs

basis. They also are unafraid to make changes quickly where appropriate.

Important competencies for a portfolio company CEO are to have broad-based general management experience rather than intensive focus and experience in a narrow functional discipline. Its not enough to have a sales and marketing background. You must understand operations, product development, finance and the linkages between these disciplines. You must understand how to manage the balance sheet and cash flow of a business as well as the P&L, said Jones of Spectrum Brands. At the same time, you have to be entrepreneurial and self-starting because there typically is less help. You must create the vision and execute the strategy, in many cases simultaneously. Finally, you must endorse the notion of risk as something that you can live with, sleep with and use it to motivate an organization. While the risk could generate a big reward, a portfolio company is not for everybody.

Finding the private equity CEO

As demand for portfolio company CEOs grows, it becomes more challenging to recruit the best and most appropriate leaders for these positions. Experienced private equity CEOs who have successfully completed an exit and are on the hunt for the right opportunity are in very high demand and can be expensive to recruit. Meanwhile, a current portfolio company CEO has experience, but little incentive to leave before the exit strategy is achieved, due to the value built up in his or her equity stake. The supply of experienced portfolio company executives being limited, most investors must expand their search to the corporate world. Often, division heads or corporate entrepreneurs bring exceptional industry and management experience and, when they are a good fit culturally and their transition to the private equity world is well managed, they can become successful CEOs.

Due diligence is so critical because, for the most part in private equity companies, you dont have much room for error. A few hiccups and you get yourself into trouble in a hurry. I learned a long time ago that Im a lot smarter running good companies than troubled companies.
David L. Bere, former president and CEO of Bakery Chef Often overlooked are portfolio company CEOs who earlier in their career presided over a failed business. While it might seem natural to discount these individuals, we find it worthwhile to investigate the reasons behind the failure before doing so. If the reasons were beyond their control, they may prove to be viable candidates. To improve the odds of finding the right candidate, private equity or venture-backed organizations also should look for individuals who have demonstrated an entrepreneurial bent throughout their 8

corporate careers. For example, entrepreneurial individuals often are given international assignments, which tend to be much more decentralized and include full P&L responsibility and functional oversight. Frequently accepting new assignments within an organization is another sign that an individual has benefited from incremental leaps of opportunity and has achieved broader leadership success over all functions. Executives who have taken these entrepreneurial roles, which often are riskier and in less-than-ideal geographies, have tested their leadership skills and adapted to different cultures and environments. And, again, financial expertise is a must, Goldston said. Executives from large companies obviously can fit into a private equity environment, but the CEO must be extremely savvy about bank covenants, expenses and have an eye toward paying down debt. They must realize that cash is king and managing overhead is critical, he said.

I feel very strongly that including independent directors with operating experience on the board provides a useful business perspective because many of the venture guys have little operating experience.
John A. Canning, president of Madison Dearborn Partners

For some corporate executives, the culture shock can be dramatic when they find themselves operating without a corporate playbook or having to take on assignments outside the positions traditional scope. Bere is careful to make the trade-offs clear to any candidates who ask his advice about joining a private equity portfolio company. I say, I have great news for you and I have some bad news for you. The great news is that you are going to have access to the board of directors. You are going to help create policy for the company. You are going to be able to move a lot faster. Those all are things you dream about in bigger public corporations. The bad news is you may need to run the plant, even if you havent had to for 10 years. So, its trying to find that person who will be hands-on and will develop the strategy. Unfortunately, a lot of people coming out of the corporate environment do not want to go back to delving into details, running a plant or making sales calls again.

Setting up for success

First-time portfolio company CEOs, especially those who have spent their careers in the corporate world, often struggle with their first private equity assignment as they transition into a new environment with a vastly different set of expectations. CEO candidates can improve their odds for success by conducting careful due diligence on the company and the private equity firm for which they would be working. Due diligence is so critical because, for the most part in private equity compa9

nies, you dont have much room for error. A few hiccups and you get yourself into trouble in a hurry, Bere said. I learned a long time ago that Im a lot smarter running good companies than troubled companies. Due diligence goes beyond investigating the financial health and revenue projections for the company. It includes talking with the CEOs of other portfolio companies and getting a sense of the companys culture. It is important to assess the degree of cultural change required to sustainably improve the results of the company, experienced portfolio company CEOs tell us. In addition to assessing the culture, it also is a good idea to determine and get to know the partners who will serve on the portfolio companys board. Senior partners are more likely to be able to influence the firms decision making and win support for portfolio company proposals and funding requests. Experienced portfolio company CEOs also say that a firm with even a couple of struggling portfolio companies will have less focus and fewer resources to support the company.

CEOs of private equity companies have the luxury to make decisions with a longer term horizon and, when problems arise, they can pursue solutions and resources without public pressure from shareholders on Wall Street.
Scott Schoen, co-president of Thomas H. Lee Partners

Board goverance is uniquely challenging and rewarding

In addition to recruiting the right leader, private equity firms can help position the CEO for success through decisions about the board composition and role. Private equity company boards tend to be more hands-on and, as a result, can provide the CEO with more insightful input, Schoen said. In fact, many portfolio company CEOs and private equity partners say that CEOs, particularly ones who are new to private equity, benefit when a board member serves as a mentor or sounding board. Private equity company boards should have at least two or three independent directors with CEO and/or industry experience something few portfolio companies do today. Boards of S&P 500 companies average about 10 directors with 80 percent to 90 percent of the board independent. Portfolio companies, if they include outsiders at all, typically have five or six directors usually with one or occasionally two directors who are independent of management and the investing firm. Furthermore, because most private equity partners come from investment banking, commercial banking or the legal profession, they often lack the industry knowledge and operating experience that can be an invaluable resource for a new portfolio company CEO. Historically, private equity 10

firms have been reluctant to bring outside directors onto portfolio company boards, in part because of the cost of an outside director and because they want to maintain their control. There appears to be a growing consensus, however, that outside directors can provide industry perspectives that can be invaluable to the CEO and serve an important check-and-balance function. I feel very strongly that including independent directors with operating experience on the board provides a useful business perspective because many of the venture guys have little operating experience, Canning said. Increasingly, more portfolio companies with public debt or those looking ahead to an IPO or sale to a public company may have little choice but to add new independent directors in light of the greater scrutiny being placed on the governance practices of all companies and the demands of the Sarbanes-Oxley Act.

Conclusion
First-time portfolio company CEOs, particularly those who have spent their careers in the corporate world, often struggle with their first private equity assignment. Managing in a high-intensity environment with fewer resources and cash constraints than they are used to requires skills that are not necessarily learned or rewarded in corporations a desire to seek out and drive change and a willingness to live on the edge. While private equity leadership roles can provide dramatic rewards for those who are successful, they are not for everyone. Executives new to private equity need to understand the trade-offs and evaluate whether their experience and preferences represent a good fit for a private equity role. Those who are most likely to succeed in the private equity environment are individuals who possess in-depth financial knowledge and experience. They thrive amid challenges, are comfortable with risk and can quickly adapt to new environments. Before they accept a portfolio company role, CEO candidates should conduct thorough due diligence on the portfolio company and private equity firm, improving their chances for success in the position. By choosing a CEO with the appropriate experience, core competencies and passion for the companys success and working collaboratively with the CEO private equity firms can improve the odds that their investment will pay off.

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Spencer Stuart Private Equity Practice

The Spencer Stuart Private Equity Practice supports private equity firms and their portfolio companies in their quest for partners and principals, finance, marketing and administration professionals and experienced senior-level operating executives. During the past 10 years, consultants in the practice have completed more than 1,000 assignments for clients ranging from megafunds to startups. As strategic advisers to clients covering the full spectrum of investment stages and disciplines, Spencer Stuart consultants provide a range of specialized advisory services in addition to executive search, including: > Board services > Pre-acquisition human capital due diligence > Post-merger integration > Executive benchmarking > Management assessment

About the author

Gilbert R. Stenholm joined Spencer Stuart in 1980 after five years with Booz Allen & Hamilton in Chicago. Previous experience included roles in human resources, management development and sales with General Foods, Baxter Travenol Laboratories and Masonite Corporation. A senior consultant of the firm since 1985, Gil serves a wide variety of clients in consumer goods, media, industrial and healthcare products/pharmaceuticals. Gil founded the firms Consumer Goods & Services Practice in the late 1980s and continues to be deeply involved in the practice. He also has authored a study and published findings on Rules of the Road for the New CEO. His clients include large, multinational companies as well as a number of smaller, more entrepreneurial businesses. He conducts searches for CEO, COO, division president, board director and toplevel functional roles. In addition, Gil conducts consulting projects that involve organizational and compensation benchmarking projects, and is a member of the Board Services Practice. Gil can be reached at 1.312.321.8338 or gstenholm@spencerstuart.com

2006 Spencer Stuart. All rights reserved. For information about copying, distributing and displaying this work, contact permissions@spencerstuart.com

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