Investec unearths PE succession contradictions

Succession planning is a long-standing issue in the private equity industry. Given the average 10-year fund lifespan and the long-term view taken by many LPs, assurances that a firm's success will continue beyond the involvement of its founder or current management team is a key priority for investors before committing to new managers.

In recent years, two examples stemming from tragic circumstances have illustrated the extreme consequences of losing key people: the untimely deaths of Doughty Hanson founder Nigel Doughty in 2012 and Clessidra founder Claudio Sposito in 2016. In both cases, the founders' respective firms were plunged into uncertainty after losing a key man, with Doughty Hanson eventually going into wind-up and Clessidra eventually acquired by Italmobiliare after drawn-out negotiations.

Under less dramatic circumstances, succession issues have also been a dominant theme at Swedish buyout firm Segulah, which raised less than half the initial target for its most recent fund after a swathe of management changes raised questions among LPs.

Given the impact that unclear or lacking succession planning can have on a firm's continued operations, the results of Investec's annual GP survey of 35 UK buyout firms and 18 EU firms are surprising. Among non-UK firms based in the EU, 78% say a succession plan is critical for the success of the firm, while the figure is 83% for UK firms. However, while 67% of EU firms have a succession plan in place, only 46% of UK firms do. The survey also shows that only half of UK firms say their LPs are happy with the succession plans in place, while 61% of EU firms say the same.

You see what happened with Doughty Hanson and Clessidra, and it's apparent that firms can – for one reason or another – disappear overnight if a key figure goes" – Jonathan Harvey, Investec

"Everyone considers succession planning critical, but only just over half of respondents have actually got a plan in place, so there is a clear disconnect there," says Jonathan Harvey, partner at Investec. "If it is critical, more than half would have a plan in place. You see what happened with Doughty Hanson and Clessidra, and it's apparent that firms can – for one reason or another – disappear overnight if a key figure goes."

Harvey says succession is a potential key differentiator for LPs when choosing a manager. Investors, he says, are taking long-term views and want alignment with the people in the firms they invest with – from founding partners to seniors, to juniors and the future talents to invest in. "If you are a manager that doesn't have a succession plan in place, then I struggle to see how that's an attractive proposition for LPs when raising a new fund."

His view is shared by the CEO and founder of placement agent MVision, Mounir Guen, who says succession is one of the most integral parts of the diligence process when choosing GPs to invest in. He says LPs are looking at "who is on the bench, who the leaders of tomorrow are, [and] who is performing at a private equity firm", adding: "Across the board, the investor community is very focused on succession."

And succession is becoming ever-more important to investors: "LPs are committing more money, but to fewer names," Guen says. "So they want to know the business is well-run and want to make sure some of the stories there have been in recent years, where certain partners have structured their firms oddly and created awkward situations for investors, don't happen again."

Different strokes
In addition to showing the perceived importance of succession among GPs and LPs, the Investec survey also shed light on differences in the approach to succession planning.

Asked who in the firm has the most influence in the succession planning process, 78% percent of EU firms answered the senior management holds the most sway, with 22% saying the process was founder-driven. In the UK, the split is more equal with 54% of GPs having founder-driven processes and 46% driven by senior management.

While the exact reasons for this divergence in approach are difficult to determine, one possible explanation could be the relative size of the local European private equity industries, Investec's Harvey says.

"The UK private equity market is much deeper, in terms of the number of funds concentrated here, than in continental Europe, so if you work in the London private equity industry, it is quite easy to move jobs from fund to fund. Maybe it is the case with some UK fund managers that succession planning is less relevant because there is a higher level of workforce mobility."

"It is different in the EU," says Harvey. "If you are working for a fund in Stockholm, it may be more difficult to move to another fund because there is not the same volume of employment opportunities at other private equity firms. When you're in a European fund, the motivation for you to ensure there's an extensive succession plan in place is higher as a junior team member, because there is that potential pressure of limited new jobs locally if your firm goes under."

One hurdle faced during the succession process is junior employees buying into the management company, which can be prohibitively expensive due to the income generated from managing previous funds. Harvey says his firm's activity in facilitating buy-ins supports the suggestion of a higher level of motivation for succession planning in European firms.

"The type of lending Investec has done in the past three years to recap management companies to enable junior partners to buy in has predominantly been in the EU," he says. "We have seen very little in the UK, and the survey stats back up the notion that the EU-based firms have less of a founder-driven culture when it comes to succession planning."

Structure switch
MVision's Guen highlights a trend in private equity of LPs pushing for highly institutionalised corporate structures at their GPs. Indeed, many of the largest buyout houses are already well into the process or have completed the transformation, but the trend is present across the private equity industry.

However, Guen notes any structure can create success: "I've been in the business for quite a number of years. There is no right or wrong. I've seen consensus-driven businesses, pyramid-structured businesses, individual-dominated businesses – and they've all made money. However, investors do probably prefer consensus or corporate structure-type lookalikes." As implied by Guen's comments, the institutionalisation trend does not necessarily extend to the investment process.

LPs do not want to give their money to a single person, but rather put it behind a team of people who know each other and are prepared to disagree" – Graham Elton, Bain & Company

Bain & Company partner Graham Elton leads the firm's EMEA private equity practice and says LPs generally still take the view that committing to private equity is investing in a group of individuals, as opposed to an institution or brand. "The best-performing funds have a small group of three to six people on the investment committee that have a very large number of accumulated years doing deals together. LPs do not want to give their money to a single person, but rather put it behind a team of people who know each other and are prepared to disagree."

He says his firm has seen an increase in demand for its services from GPs and LPs needing advice on strategy and organisation. "As the firms get bigger they need to have efficiencies and processes of a large financial institution," says Elton. "They also have to find a way to cash out founding partners, so new partners can come in and create a new set of economics."

Elton generally sees private equity firms structured in two ways. The first is where founders retain rights to management company profits, even after they withdraw from the company, while the second sees exiting partners lose their share in management company profits as new partners take the helm. He says the latter is more common in Europe, whereas the former is predominant in the older US firms. "The 'European model' allows for easier succession planning, as the founders' economics issue has already been resolved."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• GPs
• Restructuring
• Top story
• Investec
• Succession
• MVision Private Equity Advisers