Is team stability in PE firms overrated?

Given the lack of available research into this oft-discussed issue, Capital Dynamics set out to produce and analyse a data set linking performance to staff turnover in PE firms. Coller Institute academic director Francesca Cornelli and her team at the LBS have therefore studied anonymised data for 56 GPs, using information collected by Capital Dynamics over 10 years of due-diligence.

The data not only looks at various criteria related to the firms themselves – including funds' characteristics and performance of all individual deals – but also incorporates data for each member of staff ranging from age to joining and leaving dates, as well as their involvement on specific deals.

Contrary to popular belief, it turns out that investment staff turnover and team evolution can have a beneficial impact on performance – specifically when a team incorporates fresh talent with a strong operational background in-between investment periods. The study indeed shows that a 5% increase in staff turnover between funds leads to approximately 12% higher net IRR on average.

Furthermore, Cornelli's team argues that GPs with top-tercile staff turnover reap an average 26% net IRR whereas managers in the bottom-tercile average 14%. The effect is also magnified by the economic environment: according to the study, a 5% increase in turnover during recessions leads to approximately 6% higher net IRR whereas the effect is not statistically significant in non-recession years.

That said, staff turnover still appears problematic on a deal-by-deal basis: transactions where team changes are made over the course of the investment generate an 8% gross IRR on average, significantly down from the 17% recorded for deals with a stable investment team. While these statistics are striking, both Cornelli and Capital Dynamics managing director Katharina Lichtner argue that this correlation needs to be viewed with care: high turnover could be a result of bad performance rather than the other way around. But irrespective of the causality, Lichtner reckons it is an insight that is helpful during due diligence.

Sign of the times
More significant is the profile of individual deal-doers when assessing staff turnover's impact on performance. Professionals with a purely financial background leaving a firm between investment periods don't significantly impact subsequent fund performance – the data would suggest that this set of skills is easily interchangeable. Meanwhile renewing the operationally-focused talent pool has a positive impact on future performance. Team members with a strong PE background seem crucial in that respect, as the study suggests subsequent fund performance is negatively impacted when they leave the firm.

As Lichtner notes, these findings highlight the necessary evolution of the industry's model given the current economic environment. Gone are the days of good returns generated in a short amount of time and with abundant leverage available; GPs now have to work much harder and significantly impact the company's operations and top line if they wish to reap similar rewards.

There is therefore a case to be made for the virtues of flexibility – as opposed to the sanctity of stability. As the study also shows, a good number of newcomers to the industry over the past decade stemmed from a purely financial background. One can wonder whether these professionals have the right skill-sets to generate value in a cycle that will be driven by operational improvements and if they are sufficiently motivated to face a new, much more challenging era. In this new paradigm, getting fresh blood aboard – and preferably people with a stronger operational background – does make sense.

This joint effort between Capital Dynamics and LBS is still in its early stages – both parties ultimately want to at least double the number of GPs included in the database and analyse venture and buyouts separately. But in the meantime, Lichtner remains hopeful it will foster transparency between managers and investors on this issue: "These findings should prove tremendously helpful for LPs and GPs, and they should facilitate a much more open discussion on changes in teams. The issue of staff turnover shouldn't be taboo – but we do have to conduct thorough due diligence and further research, and understand the real impact of changes within a team."

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

• Topics
• Industry
• UK / Ireland
• Southern Europe
• Benelux
• France
• Nordics
• DACH