Transition Management: Planning for the next generation

by Carmen von Nell-Breuning, Senior Manager – Private Equity, EY Luxembourg

Most founders of the major PE firms are near or past retirement age, with many aged 70 or over. They must consider not only how to pass on the reins to the next generation of leaders in the best way, but also how to ensure that their organisations have the right talent and culture to meet future challenges. This could be tricky for some founders who built these organisations as extensions of their own personalities. The PE industry is still very personalised, with most of the big businesses still run by their founders.

Developing a successful transition plan

In order to make a successful transition from one generation to the next, PE firms need to consider three main aspects: first, operational control; second, money; and third, governance, which is the hardest one to resolve.

Strong career-path management is as much part of effective succession planning as mutual trust between people running the firm. The allocation of carried interest and pay plays an important role however; according to a study by Professor Josh Lerner of Harvard University, the industry has “not yet been serious enough” about managing internal compensation issues. Professor Lerner cites a study by his team of 750 PE firms that the split of carried interest among the partners had a strong influence on the firms’ stability and ability to survive in the long term. “We saw that there was an enormous amount of inequality within the groups; typically for larger firms, the founder got at least twice as much carry as the average senior partner,” Lerner says. “Groups with more inequality tended to be less stable. Partners with good track records but a lower share of the carry tended, not surprisingly, to be footloose.” Making sure there is fair compensation for and recognition of the contribution of the next generation is crucial for retaining younger partners, the future lifeblood of the business.

Cultivating an enduring culture

Another key aspect of transition for a PE firm is the task of ensuring  that its culture persists while seeing that it does not remain identified solely with the founders, who are very often still active but due to retire shortly. Several PE firms started with a staff of around 3-5 people and are now at 1,000. In such a context, PE firms need to strive for a good balance between depersonalising the business while maintaining its individual corporate and entrepreneurial culture.

Making sure the firm has the right talent

In the past, skills in financial and company analysis, deal making and financial engineering might have been enough. But the future will require PE firms to nurture a wider set of capabilities, including knowledge of and experience in industrial sectors, digital transformation, smart technologies, risk management and global markets. They also need to ensure that they hire talent with the right interpersonal skills. “Always hire the best people”, says a PE executive in an interview with RoubiniThoughtLab. “All of us have hired people smarter than we are. PE has this allure so that we are able to continue to upgrade the caliber of people. Our founder’s joke: we couldn’t get a job here now. The truth is, we couldn’t,” he says.

The article is based on the EY study, conducted by RoubiniThoughtLab: “How can private equity transform into positive equity? – Perspectives on the future of private equity from industry pioneers”.

«Fair compensation and recognition are crucial for retaining younger partners.»