Private equity firms emphasize the importance of competent management in driving portfolio value creation. In a previous article examining leadership challenges in the private equity space in Africa, Africa Advisory Group (AAG) spoke to private equity leaders who singled out the challenge of evaluating the capabilities of management teams to execute investment strategies in their portfolio companies. Standard Chartered Private Equity, for example, sought to mitigate this challenge by engaging with its human resources department and industrial psychologists to develop a proprietary assessment tool for senior leadership teams at investee firms.
In this article, we seek to understand the strategies and approaches that firms have in place to ensure robust assessments of management teams. How do firms conduct these assessments, both in terms of process and individuals or teams driving the process? How are recruiting and talent-related activities handled, and what are the biggest challenges in managing these activities? We spoke to a number of senior private equity professionals, particularly in the small to medium enterprise investment arena where investors tend to be even more involved in operational matters than in the larger investment firms, to answer these questions. Our overall findings, based on these discussions and our experience of working with a wide range of private equity firms, indicates that while there is no universal strategy, several key factors shape an approach including deal size, ownership stake, and specific elements of an investee business such as scale, stage, and whether the business is family or professionally managed.
In smaller businesses, the quality of management is even more important, because these organizations have not had the time or the need to establish formal systems and ways of workingTom Adlam - Managing Partner, Pearl Capital Partners
Toward a structured approach
Private equity firms use both formal and informal approaches to assess the management capabilities of senior teams at their portfolio companies, typically during the due-diligence process before capital is deployed. A common strategy involves investigating whether businesses have established management teams with the competence and depth of experience to execute investment plans.
Musa Capital, which focuses on mid-market Africa private equity, utilizes scorecards to grade companies and identify leadership gaps to be filled. In addition to human capital, the scorecards contain several factors which are of equal priority to the firm, including financial, operational, and Environmental, Social and Governance metrics. Importantly, potential portfolio companies are made fully aware of these factors at inception to ensure a clear alignment of interest.
In contrast, Tom Adlam, Managing Partner at Pearl Capital Partners (PCP), observed that his firm carries out leadership assessments more informally than formally, and generally follows the aforementioned common strategy. PCP is a specialist investment firm focusing on investing in small and medium-sized enterprises (SMEs) in the agriculture value chain in East Africa. Noting the vital link between the quality of people and implementation of investment plans, Adlam acknowledged the potential benefits of a more structured approach. “In smaller businesses, the quality of management is even more important, because these organizations have not had the time or the need to establish formal systems and ways of working,” Adlam explained.
Mustard Capital Partners (Mustard), a private equity fund management company focused on investing equity and debt in SMEs, has a set of consistent practices and metrics that they follow when evaluating senior leadership teams, allowing the firm to identify areas to add value. According to Christian Opoku, Partner and Team Leader at Mustard, the evaluation covers both senior teams as well as the board. Mustard’s geographical focus includes Ghana, Liberia and Sierra Leone.
Recruiting as a core component of investment management
For a majority of private equity investors, recruiting and talent management in investee companies is considered part and parcel of core investment activities. AAG’s experience and engagement with larger private equity firms as well as the SME focused investors highlights a common agreement that talent management and investment execution are inextricable. Therefore, in many firms, investment professionals and portfolio managers actively drive and manage talent-related activities, including overseeing leadership performance.
When it comes to the profiles of investment professionals and portfolio managers handling recruiting and talent engagement activities, Richard Akwei, an Executive Director at Musa Capital, emphasized a combination of financial, people and operations management skills. “They have to be mature and have a strong understanding of how to manage people and deal with different personalities to achieve desired financial results. They need to have worked with different kinds of people and be able to recognize areas of sensitivity,” Akwei stressed. “We see the development of human capital as a core function and as important as any operational or financial metric we focus on,” he reiterated.
Investment professionals and portfolio managers need to have a combination of financial, people and operations management skills. They need to have a strong understanding of how to manage people and deal with different personalities to achieve desired financial results.Richard Kwei - Executive Director, Musa Capital
It is also important to have teams composed of individuals with specific industry experience and a proven track record. Based on the experience of one firm, it is not unusual to find teams that include former CEOs with extensive experience in industries that are central to the investor’s focus.
It is worthwhile to note that firms with relatively large assets are financially positioned to have a specific value creation or technical assistance team in addition to an investment execution team. In this situation, regular contact and effective communication between the two teams is paramount. According to an investor AAG spoke with at one of the larger pan-African focus multi-sector firms, the value creation team should be involved early on in the deal process. When it comes to talent and performance management, the investor stated that his firm typically seeks to assign the task to a well-balanced group of people, including individuals familiar with P&L responsibilities.
Even as firms develop in-house capabilities to manage the performance of senior investee teams, they still turn to third parties for additional support and advice under certain circumstances. Firms seek external advice in situations such as recruitment and selection, remuneration reviews, rightsizing and review of competences, and when tackling transition of businesses from family-led to professional management.
The decision of whether to use individual experts, local firms or global firms hinges on the size and the scale of the investee business and transaction. For example, Opoku noted that Mustard uses local firms and individual advisers with a good grasp of the regions that constitute Mustard’s investment focus. According to Akwei, Musa Capital typically turns to local firms for recruiting support as these firms are better positioned to find people who understand and are connected to the local environment.
Key challenges and way forward
Recruiting and managing performance, whether driven by in-house teams or external parties, is accompanied by a unique set of challenges. A dominant challenge underscored by several investors is resource constraints on the part of both investors and investees. Investees, and in particular small businesses, cannot always afford to hire and retain the necessary talent.
Investors also reiterated the oft-expressed challenge of scarcity of skills and inadequate training in Africa. “It’s extremely difficult to source good quality people in East Africa, especially outside Kenya, and then to retain them, particularly for smaller businesses which require a hands-on approach,” expressed Adlam. According to Adlam, there is no shortage of raw talent, but there is a dearth of proven, experienced people.
To mitigate these problems, PCP is placing an increasing importance on assessing investees’ willingness to invest in people. Adlam stressed that the benefits of offering long-term incentives, both financial and non-financial, should not be understated. A readiness from portfolio companies to accept and implement leadership changes is critical especially in cases where businesses are family-led and may not have had formal recruiting and performance management systems in place.
Musa Capital encourages interaction, knowledge-sharing and cross-fertilization of ideas among portfolio companies. Akwei mentioned that the firm holds an annual event that brings the companies together. He also pointed out that firms benefit from increasing investment in training and developing talent internally within a group. Akwei accepted that this in itself is challenging given the pressure for investors to deliver results quickly.
Another challenge that emerged is finding good leadership advisors and search partners who fully understand investment priorities and specific investor needs. Drawing on AAG’s experience working with private equity clients, it is important for investors to work with firms or advisers who not only have a deep knowledge of the Africa private equity landscape, but who also have an expert understanding of leadership implications both from an investor and portfolio company perspective.
Given the importance of management teams in determining returns on investments, Africa-focused private equity investors ought to regularly assess their own strategies for influencing and engaging with leadership teams to drive portfolio value creation. Structured and systematic approaches are beneficial and more effective in detecting weaknesses early-on during the pre-investment stage. Investors also need to have the flexibility and expertise to tailor approaches to address specific leadership situations. Although the private equity industry in Africa presents distinct leadership challenges which may not be resolved in the near term, these challenges are not insurmountable. The ultimate test for both investors and investees is to focus on mutually beneficial ways to invest in management teams while maximizing value creation.