Need a CEO for your private equity portfolio company? The data suggests bringing in someone from the outside is the popular choice.
Released by the National Bureau of Economic Research, the results found a whopping 75% of new CEOs of PE backed companies are external hires. This is in stark contrast to S&P 500 companies, which externally hired just 20% of their new CEOs. The sample came from 192 domestic private equity funded buyouts valued at more than $1 billion.
As an executive recruiting firm specializing in placing C-suite leaders at client organizations spanning several sectors – including private equity – we’ve seen firsthand the immediate effects these individuals have … at a price. The research goes on to say that PE Chief Executive Officers earn about twice as much as their public company peers.
Since the start of 2020, we’ve also noticed an uptick in our own searches in compensation for portfolio companies in manufacturing, tech and professional services. Our placements have had a median base salary of $400,000 plus a 60% bonus, bringing the median annual total compensation package to $640,000. Additionally, they all included some form of equity in the company. If the compensation data regarding public company CEOs is truly half, that would bring their median package to $320,000.
It’s a fair question to ask why bringing in a company leader from the outside in private equity has become more commonplace. The simple answer is that PE firms prefer to have their own leadership in place – often with the help of an executive search firm – running companies after they’ve been acquired, but it goes deeper than that. The qualities of those individuals are very specific to this environment and are vastly different than public companies because of the significant culture change and immediate transformation that’s required.
The portfolio CEO must be able to seamlessly fit into both the company where they spend every day and the PE firm. Those individuals need to spearhead a turnaround that helps accelerate growth, but are difficult to find without the proper connections and resources. As we noted in an earlier blog post, PE leaders thrive in this environment when they’re data-driven, move quickly, thrive in a risk-taking environment and have a “love of the game.” Finding executives that check all those boxes are rarely inside the company pre-acquisition, which explains why many turn to executive recruiting firms like Stiles Associates that specialize in this very specific sector. While they come at a premium, the cost is still far less than hiring or promoting the wrong CEO.
In fact, according to the U.S. Department of Labor, the average cost of a bad hiring decision can equal 30% of the person’s first-year compensation. This means if the total compensation is the aforementioned $640,000, then the total cost of the bad hire is nearly $200,000. This doesn’t even include the morale and efficiency loss that’ll surely follow, plus the additional time and cost to replace them.
The data indicates external hires are the preferred choice of private equity firms, driven by the unique demands and cultural requirements placed on them. While the upfront cost in bringing in a CEO from the outside might be higher than simply promoting from within, the ROI for doing so is largely beneficial come time to exit. With the current market for C-suite talent being incredibly high, reach out to us if you’d like to be considered for a role or in need of an executive for your PE portfolio company.