When I was a kid, my dad loved to take me fishing off the coast of Cape Cod in our little 13-foot Boston Whaler. Often, when the weather got rough enough to make me think we just might capsize, he would offer a reassuring smile and say, “don’t worry son, it’s just a little chop.”
Over the last few months, I have heard several private capital investors and their portfolio company CEOs describe current market conditions as “rough seas” or “unchartered waters.” It left me wondering, is this the optimistic language I remember from my dad, or a sign of something more severe?
While US and global inflation rates are easing and job creation rates remain resilient, investors are still anxious about the sources of choppy economic tides: the ongoing war in Ukraine, mounting tensions in US-China relations, the fragility of many US bank balance sheets, and the threat that stubborn inflation will force the Fed to resume its schedule of interest rate hikes later this year. Given that anxiety, it’s not surprising that, according to data services company PitchBook, the number of US private equity deals fell by over 9% in the first quarter of 2023, marking the fifth consecutive quarter of declining deal flow. At the same time, the prices paid on PE buyouts are down only marginally. With fewer deals to do and the returns on current investments pressured by the high cost of capital, many PE firms have adjusted by shifting their focus to improving the financial performance of their existing portfolio companies, and by looking for smaller, tuck-in acquisitions they can combine with existing investments to build scale and unlock synergies.
The shifting of PE and private capital investing priorities is also forcing a realignment in the core skill sets and capabilities of the CEOs and executive management teams leading those businesses. At the risk of oversimplification, private capital investors have historically built their investment theses around four central models: accelerating growth, improving operational efficiencies/reengineering balance sheets, creating new platforms through M&A, or turning around failing businesses. In turn, private capital wants to recruit or promote executive leaders whose backgrounds and accomplishments match their primary investment thesis.
Here at SRI, we evaluate potential private capital CEOs and other C-level executives in the context of those same investment theses. We’ve developed a methodology to identify and evaluate candidates around four distinct archetypes we call “growth pilots”, “margin hunters”, “platform builders” and “smoke jumpers” (see sidebar). Many C-suite leaders can legitimately claim skill and experience in more than one of those categories, but we look for an individual’s ‘center of gravity’ – the style and mode that an executive will fall back on, the place where they’d found the greatest success.
Given the rough economic waters of the past several quarters, it is no surprise that we’re seeing growth pilots take a back seat to the margin hunters and platform builders while recruiting for private capital sponsored companies. Growth is still very much on the agenda, but sponsors are looking for that to come along with improved profit performance or via modestly sized acquisitions that will be immediately accretive and deliver significant cost synergies.
The thing about rough seas is that they can change unexpectedly. Like the weather, if you don’t like the current investment climate, one option is to wait a minute because it will change. But for investors who must operate in the here and now, it’s critical to be clear and focused on the executive skills and capabilities that meet current market challenges. At the same time, our advice is to hire individuals and construct teams that give you a broad portfolio of skills, meaning you have a representative crew of growth pilots, margin hunters, platform builders and smoke jumpers all in the same boat.