My latest article for South East Business Magazine on the issue of good governance
You can find the full article here SE Business article
You can find the full IoD report here IoD report
When a company decides to invest in another business, it’s expected that due diligence is undertaken to audit the finances of the business and that commercial potential is assessed before any decisions are made to proceed with an investment or purchase.
However, in addition to this, what methods do investors or purchasers use in evaluating the management teams of these businesses? Do they investigate and assess both the performance of the team and the way that key individuals work?
I recently conducted some research with colleagues at Ramsey Hall on this topic.
We wanted to explore whether assessments were conducted or if indeed they were conducted, how this was done. We talked to corporate finance professionals, venture capitalists and private equity investors to gain their views and what approaches they observed or utilised.
The questions we asked
When researching the study we wanted to find out how much research did they do to evaluate the Board and key executives during their investigations?
Prior to any investment being made how did the investor evaluate the performance of the incumbent management team?
If they did, did they base their investment decision purely on business performance and factors such as Intellectual property or did they buy into the current management and its potential or was it a combination of these factors?
Did they have one to one meetings with each of the executive team?
Did they conduct third party assessments of the team and individuals?
Assuming that they placed Board Observers on the company Board. How long did they take to evaluate the executive team in situ? Did they use third party evaluations or use the observations of their Board Observers?
When making changes to a company Board, which positions did they usually have to change and in what order did they generally proceed?
Additionally, how did they go about that process, particularly when the individuals may have a share of equity or have participated in the investment in the company?
Research before the deal
It was interesting to explore how investors researched the management teams prior to deciding to invest. It was clear in many PE investments, the PE house was often competing with many others for the deal against other investors and usually under severe time constraints.
This inevitably leads to them having to cut corners in evaluating the management team and in many cases they are not even given the opportunity for direct conversations.
Inevitably, although the PE investor is looking to get as much time as possible with the management team, it struggles to do so in a meaningful manner. This will usually involve the ubiquitous dinner to meet and start building relationships. They may even try and introduce the team to Directors of companies that they have already invested in.
Additionally, some will look at other touch points such as the opinions of suppliers, conversations with former staff or find some way of having informal conversations with those not involved in ” the deal” who have knowledge of the individuals and who may be connected to them in some way.
Evaluation of management teams prior to investment
As stated earlier, the traditional assumption of the investor meeting the management team over a dinner prior to investment still was the norm with some deals.
Some investors however were more sophisticated in their approach. One hired an external consultant to meet with the management team, interview them and create a “people ” report.
Another had an objective to find out if whether the management team were “buyers or sellers”, to discover if some individuals were just looking for an early exit. In this case if that person were valuable to the business they would be ready to engineer a “lock in”.
If a PE investor has gained an exclusivity agreement on the deal then some do undertake psychometric analysis of the management team members looking at individuals, team and some intellectual capacity tests.
Hogan, Myer-Briggs or sometimes Belbin were used to see particularly if there were “camps” in the team and to discover the team dynamic. Additionally in one case, in depth interviews that were structured over three hours were used.
In evaluating an individual’s performance within a business there may be up to ten to fifteen meetings held to establish that individual’s contribution. The buyer works on impressions gained from these. However one interviewee from corporate finance thought that lots of work moved forward on the basis of “impressions” and these are not challenged thoroughly.
Underlying the evaluation the objective would be to establish if there’s a functioning team operating within the business and if and why the owner is exiting the business.
Additionally, if the business has a sales led CEO/MD with an entrepreneurial spirit then some investors feel comfortable and confident knowing that that individual knows the calibre of people that they need around them.
As a second round of the process one PE house liked to get their people to spend a full day with each of the management team in order to try and get some immersion in the business.
Later on before completion they liked to take a good look at the second tier of leadership by looking at 360-degree assessments particularly searching for those that may be able to step up a level.
It was clear to several investors that they saw management team evaluation as a key part of their structured process and that the results would be shared across the investment committee.
Companies that were purchasing 100% of the equity in a business had a slightly different approach, particularly if it meant buying out the shares of individuals who would be remaining in the business. In this case they effectively became the new owners of the business bringing it into their corporate group.
Typically if a business is brought into a corporate environment and taken over they buyer normally demotes the incumbent executives and only the MD and FD remain as Directors. The key thing of utmost importance for these investors is building trust with the team of the business they are investing into as there will be a wholesale change of ownership and the investor wants to maintain a longer term relationship with the business over at least a five to six year period.
Third party assessments
It was surprising that apart from psychometric assessments, how few buyers brought in third party assistance in evaluating the management team. These usually consist of “people reports” written after one-to-one interviews.
Interestingly one investor waits until the investment is complete before conducting any psychometric evaluation.
Using Board Observers post investment
Once an investment or purchase has been made nearly all investors use Board Observers or Monitor Directors. More often than not they are often part of the investor team that did the deal or brought it to the investor.
Within this, a new chairman is placed 80% of the time
Most PE houses have a panel they look to for non-execs or they have relationships with key executive Search partners with extensive networks databases to find them. They may approach third parties such as banks, lawyers or accountancy firms to find suitable candidates.
Obviously they look for people to help drive the business forward and who are complimentary to the team. The non-execs are usually paid a fee funded by the business itself, they may also be an investor or an individual who will work for “sweat equity” in the company
The observer usually monitors KPIs and reports back to the investor.
Changing the management team post investment
When investing in an existing team we saw a lot of evidence where the investor tries very hard not to have exits from the existing owner managers. On an initial view this seems counter intuitive but it’s worth reflecting that the investor will have decided to back that management team before investing in the first place. The investor usually adds Non-Executive Directors to make up for leadership deficiencies or skills gaps in the Boardroom.
On the whole, the investors tend to take around a year before dealing with poor performers with the business they have invested in. Some investors conduct “Board Effectiveness” reviews at this time to reflect post investment and plan and changes or enhancements that they think are necessary.
Not surprisingly, MDs and FDs are closely observed followed by Operations. Commercial and technical team members are left well alone. One investor was of the opinion that there was a dire shortage of “strategic” FDs in the UK with “bean counters” being the norm.They also thought that there was a dearth of talent in HR and Commercial and this is usually a gap in most management teams
They also tend to dance around those who are major investors and perhaps focus more on the second tier and work around the investor incumbent.
If they do exit an investor member of the management team it’s usually via a one to one chat, fully open with cards on the table. This is usually a task for the Chairman. We did however come across an instance where an MD was removed immediately post-deal with the investor obviously not seeing that individual in their plans for taking the business forward.
If a structured exit is difficult, a compromise agreement will be made and if the person involved has equity within the business this will be compensated for or they may able to keep their shareholding but not be part of this business moving forward.
We found from our discussions exploring this topic that there’s a very mixed picture. A huge factor hanging over the process, particularly with PE investments, are the time constraints involved. The investor simply isn’t given time to meet the leadership of the company it’s investing into and when and if they are given exclusivity the deal must proceed in haste. This inevitably leads to the acceleration of processes so that corners have to be cut when evaluating people.
This is acknowledged as not an ideal scenario. Of course a “heavy hand” in evaluating the leadership of a business by the investor prior to completion of the deal could be seen as a threat leading to that leadership within the business seeking investment doing their best to scupper the deal.
Therefore, a distinct trend observed was for investors to address any issues post investment by firstly bringing in non-executive talent. They would then appropriately managing the executives in that business and as a last resort, part company with those in leadership positions holding equity in the business. The best option was certainly to recruit external talent paid for by investee.
Notwithstanding this, it’s clear that subject to the financial expectations of the business making it an attractive proposition to an investor and them seeing the opportunity to make a difference and grow it further, the issue of evaluating the team and key individuals, is seen an important factor by investors and one that the majority seek to address in whatever way they can.
My colleague David Arscott has written an interesting article on the future of water services along with colleagues from Ricardo-AEA and WSP.
It details how the delivery of water services could be reformed by democratising, integrating and optimising the delivery of those services and how the case Integrated Water Resource Management can be driven.
The article can be found here Article on the PyTerra website
Recently the new Uk Parliament published a paper on productivity www.parliament.uk/briefing-papers/SN06492.pdf in an attempt to further raise the importance of the subject with our politicians (who probably aren’t the most productive bunch themselves – but that’s another story). Jonty Bloom’s recent paper on the BBC website probably goes a long way to explaining how this actually happens.
However, a recent article I read on the Guardian website made me think about one of the strangest paradoxes of the productivity debate, that is, why are the French more productive than us brits?
Having spent time working in France, albeit a while ago, I must admit that the lunches used to be fantastic! Additionally the pace of work seemed to be slower and more considered perhaps even more bureaucratic. People seemed to stay in the same business for much longer and really enjoy their work.
Why could France be more productive than the UK?
I remember having a conversation with an HR Director of a business with virtually identical operations in the UK and France. When I asked them if the UK was less productive he concurred.
The next question had to be how?
The answer was one that flabbergasted me at the time. They said that because of the restrictive employment law regulations in France it was virtually impossible to dismiss a worker. Consequently this gave the worker confidence in the employer to such a degree that they were much more flexible in the workplace. The typical example was the French employee coming into work and doing many totally different jobs during the week without question. They were also far more willing to be trained to do different work and to pick up additional skills. The corresponding UK worker was much more suspicious when asked to do another job, even wondering if they were in the process of being “constructively dismissed”.
This struck me as very disappointing that in the UK business, the leadership was treated with suspicion and even distrust, whereas in France there was a trusting relationship which aided workplace flexibility and productivity.
Of course, I’m not espousing increased regulation in the workplace, however the challenge for Uk businesses must be to increase cooperation and trust in the workplace to enhance flexibility and increase productivity. I know of a company on the South Coast which has done this to great effect. The majority of employees in the company have been trained to do a multitude of roles and jobs. This means that when they fulfil an order it can be done to dramatically reduced timescales, in essence, nobody waits for someone to do a task, if it needs doing it’s done there and then.
Therefore one of the answers to the conundrum seems to be meeting the challenge of creating a harmonious, trusting workplace and then reaping the rewards of increased productivity.
My latest article in South East Business magazine sets the scene for the upcoming debate over the UK’s continuing membership of the European Union. The last survey of IoD members over a year ago though our “Policy Voice” programme delivered some very interesting results. The opinions are clearly different from the views of members the IoD say fifteen years ago, when the UK was debating whether to join the Euro.
It was interesting to see various business organisations making their opinions heard in today’s FT . No doubt that we will see a lot of this over the coming months.
The full article in the magazine can be found here
This month saw the launch of a major project to provide renewable energy for up to 300,000 homes on the South Coast of England. The 400MW “Rampion” project will use 116 wind turbines to save up to 600,000 tonnes of CO2 emissions per year.
Further details can be found on my article here http://smerocket.net/2015/06/12/massive-investment-in-renewable-energy-on-the-south-coast/
With a similar development being planned further along the coast near Poole it will be interesting to see what only the build programme has on the local economies but also the sustainable impact in terms of jobs supporting the wind farms in service.
An interesting day spent at the Local Enterprise Network conference for 2015
Some very interesting discussions were held particularly in the breakout sessions in the afternoon.
I even got interviewed in the conference video – not sure about the beard though! (since removed)
My recent article in South East Business magazine makes a plea for some simple tax reforms
More information on the IoD tax position can be found here within the “Big Picture” magazine
The full article can be found here http://www.southeastbusiness.com/print-edition/april-2015
My latest article in South East Business Magazine.
The full article can be found here http://www.southeastbusiness.com/print-edition/february-march-2015
The original article can be found here http://www.southeastbusiness.com/print-edition/january-2015
Further information from the IoD on the topic can be found here http://www.iod.com/influencing/press-office/press-releases/let-people-earn-tax-free-in-the-sharing-economy
and the report here Share the Wealth-3