Succession is something limited partners dwell on all the time, says investment advisor TorreyCove’s founder David Fann. When performing due diligence on a fund, TorreyCove will look at the names and ages of its primary managers, and if someone is nearing retirement age, whether there’s a plan for how to address that is the “most obvious question to ask”.
“A lot of these funds go well beyond 10 years, and so if you see something that starts with a six and you’re adding 10 or possibly 15 years to that number, you scratch your head and you wonder about the future of the platform. If there’s not an articulated succession plan it really does cause you to think twice about how that organisation will survive and thrive.”
Let’s not forget that LPs are often planning to be in it for the long term and are therefore thinking not just about the fund in front of them, but about the next two or three funds. “Nobody wants to be stuck in a succession problem, because sorting through the issues when it’s done badly is a big drain on time and capacity,” he says.
“You don’t want to be on a limited partnership advisory committee trying to sort out the general partner problems and be a marriage counsellor in trying to resolve the issues about the future of a firm. The last thing an LP wants to grapple with is making hard decisions when it becomes divisive.”
A sure way to mess up your succession is to ignore economics.
“The complicating factor is always the split of the economics. Private equity is an industry where the desire to make money, greed, is a driving factor, and the perceived brand equity or goodwill that a founder might have created often [makes rebalancing of the economics] a hard discussion to have,” says Fann.
Christopher Schelling, director of private equity at Texas Municipal Retirement System, stresses that economics remaining the same is “a big concern”.
“We’d like to see a step-down significantly there,” he says, adding that where this isn’t the case, the likelihood is the more junior members of staff who are taking on the majority of the responsibility will end up leaving the firm.
“Those two senior guys who may be in their mid- or late-sixties who wanted to keep 80 percent of the economics for themselves, they’re going to get 80 percent of zero because there will not be a subsequent fundraise, and the team spins out to go start their own shop.”
Hellman & Friedman
$15 billion for Hellman & Friedman IX
$8 billion for Strategic Partners VIII
In August Private Equity International reported that Stephen Can, co-head and a senior managing director at Blackstone’s Strategic Partners, would stand aside from the day-to-day running of the business, assuming the role of executive chairman in February before stepping down from the firm in the next couple of years.
This was followed by news that co-chief executive Philip Hammarskjold would be handing over the reins at Hellman & Friedman in January 2019, also taking up an executive chairman position.
Some key characteristics of these transfers of power stood out as examples of how to do a succession process right.
Enact the plan during a fundraise
Hellman & Friedman and Strategic Partners are in the midst of fundraising for their next flagship vehicles. This is the best time to enact a succession plan, says Schelling.
Making major changes to top management shortly after a fundraise has a whiff of ‘bait and switch’ about it – not to mention the potential for triggering a key-man clause.
“When you do it after the fact, I think in the extreme it could be viewed as duplicitous and often it could also trigger a key-person discussion,” says Fann. “The most senior person in the organisation stepping down shortly after a fundraising looks bad and provokes a lot of discussion amongst the LPs that the general partner should try to avoid.”
The ideal is to give your LPs plenty of warning about your orderly, considered succession plan – Hellman & Friedman began the process by promoting Patrick Healy to co-chief executive in January, while Strategic Partners informed its investors at its annual meeting in May – and certainly before they have made up their minds about the fund, to give them the opportunity to vet the successors or, if they so choose, to step away.
Those stepping aside remain in the business
Both Strategic Partners’ Can and Hellman & Friedman’s Hammarskjold will move into executive chairman roles, remaining involved in the business while stepping away from the day-to-day running. Hammarskjold, for example, will continue to run the firm with Healy, remain full time and continue to chair the firm’s investment committee.
Transitioning a senior partner into such a role allows the firm to continue to make use of that senior partner’s experience, skill set, network and advice, says Schelling. “That’s a great way to transition, and [will] make their ultimate departure less impactful.”
This also gives the firm’s LPs a sense of continuity, Fann adds.
Where possible, promote from within
Strategic Partners’ Verdun Perry, who will remain as sole head of the unit once Can becomes executive chairman, joined the year the business was started, while Healy has been with Hellman & Friedman for almost 25 years.
“The preference would be to promote internally because you want to show people there is a pathway to increasing their responsibility, increasing their economics and becoming a partner,” Schelling says.
“If someone were to come in more senior, leapfrog other people and then move up into that role, that would be an area of concern for us to do more diligence around.”
Fann agrees: “The primary concern LPs will have is about preserving the elements of the culture that made the firm successful, retaining the critical success factors. Oftentimes it’s the human capital that drove the good returns. It is more about continuity and a seamless transition than about a disruptive new influence.”
That is not to say bringing in new people is always a bad idea, but there needs to be a good rationale for it, such as enhancing the culture or bringing in an additional skillset that wasn’t present at the firm.
“It doesn’t necessarily mean it’s a bad thing, but it certainly can create ill will with other members of the team and if they’re not really a culture-carrier it could change the entire thesis [of the firm],” Schelling says.