“We knew it was coming, but we didn’t know when it would come and who it would be,” a New York-based principal at Carlyle said the day after the 30-year-old firm announced its succession plan at the end of October. Effective 1 January, co-chief executive officers David Rubenstein and Bill Conway and chairman Daniel D’Aniello will step back and Kewsong Lee and Glenn Youngkin will become co-CEOs.
As the private equity industry matures and some of the firms’ founders reach retirement age, it makes sense firms are considering their future. KKR appointed Joe Bae and Scott Nuttall as co-presidents and co-chief operating officers, and in mid-November, Apollo Global Management expanded its executive leadership team by naming Scott Kleinman and James Zelter as co-presidents, with the three initial founders keeping their current roles.
But timing a transition can be tricky. If it is done too early, the culture of the firm might not be fully established and identifying the next generation might be difficult. But done too late, and a firm runs the risk of losing key partners who want clear expectations regarding their future there.
PASSING THE BATON
Finding the right timing to announce a succession plan is not the only challenge. How a plan is drafted and executed is also critical.
Co-founders Henry Kravis and George Roberts at KKR and co-founder Leon Black at Apollo will continue to lead their firms, albeit as co-chief executives, showing this is only the first step in passing the baton to the next generation.
It is understandable that letting go of the day-to-day management is a difficult task for the businessmen who have grown these firms from a few million dollars in assets under management and a handful of employees to AUM in the hundreds of billions of dollars and several thousand employees.
But to ensure the future of their firm, and with it their legacy, a robust succession plan is paramount.
“Succession planning is like trust estate planning,” says Eric Zoller, founder of Sixpoint Partners, an investment bank that offers placement and investor relations services to mid-market private equity clients. “When you’re younger you tend not to think about putting a will in place and managing your estate, also because you’re smaller. As you get older you start to have a bigger family, or a bigger team around you, and you start thinking about succession.”
But many firms have not addressed succession issues publicly. According to the Thelander-PitchBook 2015 Investment Firm Survey, nearly half of 446 surveyed US investment firms, including 160 private equity firms, said their firms didn’t have a succession plan in place (47 percent), while 62 percent said the top person at the firm was involved in creating that plan.
When putting a plan together, there are several aspects firms need to consider: the economics in the firm; the culture founders want to pass on; and the firm’s governance.
“Firm leaders need to recognise their role at the firm, and this is the first step toward succession,” Zoller says. “They have to identify who the future leaders at the firm are going to be. They have to set the business plan and the path to communicate the vision to those individuals. Then they have to make sure that the team they have in place can execute against that vision.”
Concretely, a firm must figure out how founders can fade out and share the carried interest with more junior partners.
One way to transition out older partners is by gradually decreasing the amount of participation in the carried interest generated by new funds being deployed after they retire. Peter Laybourn, a private investment funds partner at Ropes & Gray, explains firms with these types of models often set aside a fixed pool of carried interest available to pay out retiring partners.
He notes the tension around sharing the economics with the junior partners, who should also progressively be added to the firm’s investment committee.
“One of the challenges in structuring succession plans is to make sure that there’s enough economics left to compensate the next generation of dealmakers to properly run the business,” says Laybourn. “They need that to attract and retain talent in the business.”
Then there is the competition between the younger generation over who will succeed. This can result in those who are overlooked making an exit. Alex Navab, who headed KKR’s Americas private equity practice and was not picked for the top job, left shortly after the succession announcement.
Laybourn notes that in addition to some founders in the industry naturally reaching retirement age and considering the future of their firms, funds of firms which specialise in buying minority stakes in GP management companies have also accelerated the succession discussion.
A handful of firms including Neuberger Berman’s Dyal Capital Partners and Goldman Sachs Asset Management’s Petershill are dedicated to buying these minority interests. This adds another variable firms need to take into account as they think about how to transition ownership.
With four of the industry’s biggest players leading the charge, it’s likely more succession planning announcements will follow. One thing’s for certain: firms that see a future for themselves in the industry cannot afford not to have a well-considered plan in place.