In praise of churn

Conventional wisdom holds that turnover at private equity firms is a red flag for investors – but should it be?

“They have a very unique culture; they basically fire 10 percent of their people every year. [They] want to make sure there is always room for the junior guys to move up and get carry. If you have a bunch of guys in the seats by virtue of historic success who’re worrying about their Swiss chalets, that’s de-motivating for the younger guys.”
That was what one limited partner told us about Apax Partners, the subject of this month's Privately Speaking interview.
You may recall that Apax hit the headlines a few months back over the level of turnover within its senior team; in May, PEI reported that more than 30 partners had left the firm since its most recent fund close in 2006, including the likes of Stephen Grabiner, former global head of media investments, Alex Fortescue, former head of the firm’s retail and Max Burger-Calderon, former chairman of Apax Asia.
Staff turnover or churn tends to be a touchy subject in private equity (and indeed the corporate world more generally). Firms are often nervous about discussing senior departures, perhaps because they're worried that investors might interpret it as a vote of no confidence in their future prospects. And to be fair, it's often viewed by LPs and subsequently portrayed by the media that way; if a firm is losing partners in large numbers, the general tendency is to conclude that there must be something wrong. But that isn't necessarily true; turnover can sometimes be a positive thing.

In the case of Apax, some of its churn over the past six years has simply been the result of structural changes – notably the winding down of its venture activities and the merger of Apax’s US operations with US buyout firm Saunders Karp & Megrue. Some partners have also left because (unusually), the firm has a compulsory retirement age of 60 for everyone.
But Andrew Sillitoe, co-head of its telecoms team (and one of the favourites to replace Martin Halusa as CEO in a few years), also suggested it was a consequence of the firm's approach to talent management. “I think LPs would say that we have moved the firm furthest in terms of the processes we have in place for assessing people, and the rigour with which we sometimes take tough decisions… Inevitably, that will lead to changes in the team over time,” he told us.
Not surprisingly, Apax was reluctant to say that it's more aggressive on performance management than its peers. But some LPs certainly take that view – and in many cases see it as a strength, not a weakness. After all, this is a model that's widely used elsewhere in the upper echelons corporate world; McKinsey, Goldman Sachs and GM are just a few examples of institutions that have pursued fairly vigorous 'up or out' policies.

The advantages of such an approach are obvious. It makes the firm more meritocratic and prevents a 'bums on seats' mentality – which, significantly, opens up opportunities for new talent coming in. In firms where junior staff looks up and sees an entrenched partner group – not exactly an uncommon phenomenon in private equity – it's easy to see why they might get itchy feet. So churn can – perhaps counter-intuitively – be a good retention strategy.

There's also a compelling argument that turnover benefits the investment team: the addition of fresh perspectives can mitigate against group-think (a frequent issue in small firms where –  as recruiters will tell you –  the inclination is for the existing team to expand by hiring people like themselves).
Of course, it's also true that there's a point at which churn becomes a bad thing; a sign of weakness, instability, even decay. And it can be very hard to know – internally or externally – when an organisation has gone beyond that point.

What is clear, though, is that perception is crucial. If the market thinks there's a problem, that can be just as damaging as an actual one (and become a self-fulfilling prophecy). Communicating to investors and other stakeholders is critical: in the absence of an explanation, the market will be inclined to put a negative spin on things that isn’t necessarily deserved. For if a firm is managing performance properly, and this leads to a certain level of turnover, that can be a sign of strength, not weakness – and LPs, such as the ones we spoke to about Apax, will recognise that.

Premium subscribers can click HERE to read the full interview with Apax CEO Martin Halusa and four of his likely successors, in which they address turnover, succession and other key issues head-on.

P.S. Private Equity International's inaugural Awards for Operational Excellence will take place later this year. Details, together with a submissions form, can be found HERE.