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‘Falling in love’ with management can send investments off track research reveals

Kiddy & Partners has undertaken research with 19 of the UK’s top private equity houses (12 mid-cap and 7 large) that identifies a range of issues preventing firms from maximising the human capital side of investments.

The research, conducted by Kiddy’s Head of Research and Chartered Psychologist, Dr Zara Whysall, consisted of 23 interviews with a range of senior private equity professionals, including investment directors, CEOs and portfolio directors. Dr Whysall’s findings show that a number of key unconscious decision making biases are common place in deal teams, investment committees and portfolio reviews, which can undermine decisions around leadership performance and consequently, result in the breakdown of leadership teams within two years of the deal being made. The reality is that 58% of CEOs are replaced within two years during the investment lifecycle.1

These factors include:

  • sunk costs fallacy; persisting with a course of action because of the money, time and effort invested so far, despite the low likelihood of recouping those costs;
  • personal liking bias; if we like someone then we are likely to view them as more capable than they actually are;
  • and attribution errors; a biased way of providing reasons for the causes of events, typically biased in a way which is self-serving, so we’re more likely to attribute negative events to external and uncontrollable factors.

There is an unspoken emphasis for deal teams to form strong relationships with senior management teams in order to secure the deal and therefore, the management team’s capability can often be overlooked, as it would be challenging for those involved to take a step back and be objective in evaluating their performance.

Dr Whysall commented: “A common dynamic with the investing team is that they fall in love with management. There’s a pressure to be net positive to get a deal through. So when a deal drags on and the pressure is on to get it over the line, people can convince themselves that the leadership teams are better than they actually they are.”

Kiddy’s research found that 61% of interviewees admitted that they find it difficult to be decisive when it comes to making decisions relating to performance with 43% revealing they have often made the wrong decisions and appointed or retained a leader who was not right for the role. Reasons given for this included ineffective assessment, or no assessment at all, poor decision-making regarding selection and assessment, and decision-making biases, such as optimism and personal liking.

Kiddy’s research also demonstrates how optimism biases can influence portfolio performance beyond the signing of a deal, by hiding the need for more proactive human capital management. Dr Whysall continued: “When doing a deal it is natural for investors to be positive about things, they wouldn’t make the investment if they weren’t positive, so this often leads to giving people the benefit of the doubt.

“Our research highlights that there needs to be a fundamental shift in the investment cycle to focus on human capital management pre-deal, and failing that, immediately after signing. Unconscious biases are part of human nature and difficult to avoid and there is always the fear of ‘rocking the boat’ at the crucial part in the deal. However, ensuring proper processes are in place to assess the leadership team is vital for the success of any business moving forward, in order to minimise disruptions further down the line that will come at the cost of the firm.”

Furthermore, the research identified a lack of investment in executive development (like executive coaching, onboarding or team effectiveness interventions) due to fixed assumptions about leadership effectiveness.

As increasing numbers of PE firms look to maximise value through human capital, Kiddy predicts that those who begin to challenge prevailing assumptions within PE around how to manage human capital to achieve superior performance, will be those who reap the most benefits.

There is an upward trend in the Corporate deal market for private equity backed deals and these are key to the business economy, therefore, getting the right management team in place early and accelerating its effectiveness are vital to any business. Last year, Gateley’s Corporate lawyers advised on more UK lower mid-market (EV £5-£100m) private equity transactions than any other law firm2 with a 53 per cent increase on the previous year.

 

1 Alix Partners (2017), Annual private equity survey: replacing a portfolio company CEO comes at a high cost, Annual Private Equity Survey

2 Experian Market IQ M&A Full Year Review

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