Leadership Strategy Services

For an industry that traditionally worships hero-leaders and where success is inextricably linked in the minds of investors with the mystique of its founding partners, the new urgency with which some private equity firms are beginning to address the issue of succession planning is an interesting trend.

Of course, investors and limited partners have always been acutely conscious of the risks posed by succession in private equity firms: With investments often tied up for a decade or more, investors need to be certain that their funds are being managed by people with a proven track record. But for two key reasons many of the firms that make up this rather unique industry are taking a more transparent and structured approach to managing succession. First, the industry has matured to a point where many founding partners are approaching retirement age, making succession planning a real issue as opposed to merely a theoretical one. Secondly, with many private equity firms now seeking to monetize the value of the management company itself by selling equity, they are turning themselves into permanent financial institutions. As a consequence, they now recognize that they will require a long-term succession of skilled leaders if they are to survive and grow.

So what models can private equity firms look to when addressing the issue of succession planning? The problem for private equity firms is that there can be no one-size-fits-all solution, since in terms of history, size and culture, each firm is unique. However, by analysing the recent experience of leading private equity firms and hedge funds, it is possible to come up with a checklist of proven best practice succession principles. First and foremost among these is the need for firms to ensure that succession planning is seen as a coherent system that maximises efforts to attract, develop and retain top talent, thus ensuring that what investors perceive is a company with a reputation for endurance and stability. Furthermore, this talent management process should be applied at all levels, so that it also nurtures decision-makers who may not emerge until 15 or more years down the line. Once they have been identified at an early stage, next-generation leaders must be given significant opportunities to build relationships with potential investors and develop the experience they will one day need to lead the firm. Furthermore, given the length of investment cycles required by private equity, firms should not merely send implicit signals of a succession plan to investors, but publicly state the firm’s intentions – together with a list of potential successor-candidates – some years in advance of the transition. Finally, firms need to ensure high-potential leaders are given a loyalty incentive by spreading wealth through larger percentages of carried interest. The ultimate incentive, however, is to offer an equity stake in the management company itself.

Above all, succession is not necessarily about carrying out a professional search for the “all-star successor”. By integrating into the firm’s culture a succession plan that ensures a steady stream of top talent and also provides reassurance for investors, even firms that have traditionally relied on hero-leaders can survive changes at the top.

Note: This article is an abridged version of “The New Urgency in Succession Planning” which was first published in Buyouts (January 2008).