Behavioral pitfalls that can derail an LBO’s performance

December 20, 2019

As published on Smart Business on December 20, 2019

Private equity boards and their portfolio company CEOs generally presume alignment through financial elements such as incentive compensation, equity participation and co-investment.

However, three specific behavioral challenges can still fester beneath the surface when CEOs are unclear on private equity expectations with regard to balancing risk management vs. risk tolerance, prioritizing strategy vs. execution and balancing detail orientation vs. a big-picture focus. Many CEOs are unaware of the intensity of these specific sponsor priorities. When CEOs and boards are uncoordinated on one or more of these behavioral expectations, returns are usually depressed and the risk of executive derailment skyrockets. 

Many CEOs and management teams incorrectly believe they should prioritize risk mitigation when leading a portfolio company. PE firms purposefully take risks in order to deliver targeted returns. CEOs must be on the same page as the board to ensure not only survival, but a great outcome. In this regard, the most important trait for a private equity CEO is the speed and volume of action-oriented decision-making. 

Despite operating in constant ambiguity and pressure, CEOs must lead in a “risk on” manner that boldly drives a company’s operating agenda and accept that mistakes are a necessary element of moving quickly. In this regard, managerial courage is a highly valued trait within CEOs. High-velocity decision-making carries as a natural consequence micro-mistakes by CEOs that ultimately deter macro-failures of the investment thesis.  

It’s all about execution, and yet many CEOs prefer to focus on strategy. Driving execution with urgency is where elite CEOs add significant value to their portfolio companies. In a typical mid-market leveraged buyout, an ideal breakdown would be to spend roughly 80 percent of your time on president-level execution and 20 percent on CEO-level strategic initiatives.

Strategy in an LBO is often fairly straightforward, meaning that a majority of value creation must be realized through execution. In private equity, a simple, well-executed strategy will almost always outperform the alternative. Sponsors crave break-neck execution in their portfolio company leaders, and the best CEOs deliver. 

A final friction point between boards and CEOs is the appropriate level of detail orientation. Too many CEOs believe they can achieve success without having total command of the details. Sponsors relentlessly evaluate the underlying details of each platform company and can quickly become frustrated if their CEOs aren’t equally informed. 

Great CEOs pore over key metrics and immerse themselves in the operations of the company. Insatiable intellectual curiosity is an essential trait. Curious, detail-oriented CEOs inspire confidence in their boards and typically outperform their bigger-picture counterparts. 

Portfolio company CEOs and their sponsors improve their odds of maximizing their multiple on invested capital when alignment is both financial and behavioral. 

The three behaviors detailed here can unravel rapidly and result in derailment (or worse) if left unaddressed. Conversely, CEOs who master these traits greatly improve their odds of delivering a winning exit. Rather than presuming alignment on these issues, sponsors and CEOs should engage in open dialog on these topics as part of their broader governance model.