It seemed like a tremendous opportunity. Private equity firm Frazier Healthcare Partners was seriously considering a carve-out of an international publicly traded company for its $800 million ninth fund. The price was in line with recent deals in the sector, and the growth projections looked promising.
But the firm’s view of the deal changed after its human capital team, led by Andy Caine, completed their work. In conducting due diligence on the company’s organizational and talent development needs, Caine informed the deal team that the costs associated with changing the organizational design, setting up new support functions, and recruiting additional talent, among other issues, would put the deal’s projected returns at risk. According to Caine, the “full multiple”—which includes not just the purchase price but also the subsequent investments required to achieve the deal’s projected returns— would sap resources and drain the upside. Because of the needed investments in talent, organizational infrastructure, and culture development, “we put in a less aggressive bid and the seller passed, which was probably the right outcome for us,” says Caine.
Private equity firms didn’t always evaluate talent this way. They focused instead on driving value through operational improvements. If they thought of human resources at all, it basically amounted to hiring a search firm to replace an executive or two at a portfolio company after acquisition.
Now, however, that view is starting to change. With more than 3,500 active private equity firms globally—an increase of nearly 150% since 2000—that combined have more than $3 trillion under management, the intense competition for deals is driving purchase prices higher. Increasingly high prices, coupled with rapid technological change, are eating into investment returns.
Dan Kaplan, a senior client partner in Korn Ferry’s Chief Human Resources Officers practice, says private equity firms are taking a broader approach to talent to generate returns and accelerate time to value. “With private equity, value comes from how quickly firms can get their money back and turn a profit,” says Kaplan, who recently launched Korn Ferry’s Human Resources in Private Equity specialty practice. “Investment teams are becoming more focused on matching leaders and senior team members with the business thesis.”
Focusing on talent retention and development is somewhat new territory for private equity firms, which have earned a reputation for acquiring companies and laying staff off en masse to cut costs. But as the industry grows and evolves, it’s critical to get the human capital part of the deal equation right.
“It used to be that firms did deals first and solved for their human capital needs only after the company missed a quarterly forecast or two,” says Caine. “But that’s like a football team hiring a new coach in the eighth game of a 16-game season and expecting to get to the playoffs. It is often too little, too late."