February 22, 2016
Interviewed by: David Snow
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The Right Team for Growth-Stage Companies

Growthstage private equity investors need to back a team that is able to accelerate into a more mature business  a human capital challenge discussed by experts from 3i, The Riverside Company and ADP.
Among
 the topics:

  • The challenge of having one employee per function
  • Striking a balance between staffing up and matching that with revenue
  • The difference between titles and actual work performed
  • Separating star performers from good systems

Growthstage private equity investors need to back a team that is able to accelerate into a more mature business  a human capital challenge discussed by experts from 3i, The Riverside Company and ADP.
Among
 the topics:

  • The challenge of having one employee per function
  • Striking a balance between staffing up and matching that with revenue
  • The difference between titles and actual work performed
  • Separating star performers from good systems

The Right Team for Growth-Stage Companies
Optimizing Human Capital in Your Portfolio Company

David Snow, Privcap: We’re joined today by Richard Relyea of 3i, Chris Capko of ADP, and Michael Thompson of The Riverside Company. Gentlemen, welcome to Privcap. Thanks for being here.

Unison: Thank you for having us.

Snow: Human capital is a big topic in private equity; some might argue it’s the most important topic. All three of you are experts and have spent a lot of time trying to get human capital right from the investment perspective in private equity, so I would love to hear what you have to say. A major section of private equity is growth investing and growth companies have certain aspects and attributes that are different from, let’s say, later-stage buyout or venture capital or distressed. When you have the opportunity to invest in a company that’s at that inflection point, what do they often look like by way of their team?

Michael Thompson, The Riverside Company: So many of our businesses struggle with, “What I was doing was very successful. I grew a business and I penetrated a market. I’ve kind of fully done that right now.” Great. What’s your next platform for growth? That’s where a lot of our challenges come in and where, frankly, we usually identify new talent to implant in a company to help them out.

Snow: Mike…you’ve also talked about a lot of these companies at that stage of growth have, it’s called “the rule of one” or something.

Thompson: Right.

Snow: Can you talk about what you mean by “rule of one”?

Thompson: You’re a small business and you have one person entering orders. You have one person doing accounts receivable. Generally, you have one or two people in customer service. You have a product development person. You have your ecommerce manager. You have your supply chain or buyer. Your company overall is only as good as the weakest link in that chain. If you’re in a larger enterprise and you have multiple people taking on those tasks, there’s back-fill and redundancy of human-capital assets there. So, you’re not as much at risk.

You’re only as good as the individual who drives that particular function. For human-capital management in our portfolio companies, we look at which are these functions that are critical to drive what we’re trying to do? We may not have direct redundancy by having multiple people there, but we certainly have thought out how we make sure we have some oversight, or additional oversight, in those key functional areas. [That’s] very important.

Snow: Richard, does that sound familiar to certain situations your firm has invested in?

Richard Relyea, 3i: It does, very. There’s always a tricky balance between investing for growth, putting in additional overhead costs and allowing the business to pay for it. So, yes, [it’s] a common challenge where there’s not a single right answer because it will depend on, among other things, the transparency of that future growth. But we will often find that we’re investing in our businesses ahead of growth that’s to come. You need to get the balance right—that you’re not overburdening an organizational structure.

I think it’s critical that the management team…gets that balance and is able to make a distinction between a person who needs a compliment and a person who needs to be replaced. Because oftentimes you can find places to put legacy people that still have a cost associated with them when you’re bringing in a new person essentially to do their job. Really, you need the leaders of the business to understand what is truly critical within their business and what roles they need to genuinely replace. Getting that senior leadership with the right mindset around value creation, around growth, around the impact of cost structures so that they’re making those decisions because we’re not going to be close enough in the weeds of the business to be able to make some of those judgment calls. You really need that mindset right in the management team.

Chris Capko, ADP: From our perspective, are your people also doing what they were hired to do at a particular company? When we do an assessment, you realize that 85% of your back-office staff’s time is spent doing things that are not strategic to the company. So, you have this dichotomy where we’re in the middle of that as well trying to say, “Hey, the strategy is growth, but the time being spent is on things that you do because you’re in a business, not why you’re in business.” We spend a lot of time trying to bridge those gaps, putting things in place and helping talent assessment.

When you’ve got a staff that doesn’t necessarily buy into the growth strategy, Day 1, it takes time. That is a struggle and…we work with companies to help bridge that gap and put things in place so they can focus on more of a value-creation piece or the growth strategy of the business.

Thompson: At Riverside, we utilize a tool called a SAGE document, which is an acronym for Strategic Acceleration of Growth and Earnings. What that does is keep the entire team—all constituencies and some of them you mentioned outside board members. It keeps our lender community, the company and, more importantly, the often-dysfunctional resources of the private equity firm all on the same page to say, “Look, here are the things we’re trying to do.”

Capko: Yeah, they’re busy, but they’re not focused. Certain teams will look back—and it takes 180 to 360 days to go back and figure out, “Hey, we really got off track a long time ago.” That’s where I think people process all of that alignment is key, especially early on in the investment.

Thompson: Yeah, great point.

Relyea: On the manufacturing shop floor, and businesses that are doing things well, is the culture of continuous improvement. Whether it’s always implemented the right way is another question. The point you just made about the challenges that businesses have in other functions to make sure they’re doing their day jobs and also focusing on the value creation actually can be addressed with a continuous-improvement culture implemented beyond just the standard operating functions you think about for a manufacturing center. Back-office culture is a continuous improvement, a way to eliminate that extra bit of waste in your time and find time to do the things that are going to really create value. So, we often find that there’s a lot of opportunity to bring that culture to multiple parts of the organization.

Thompson: It goes back to, in the original growth phase of a business, you’re an individual contributor. Any order is a good order and life’s pretty good and you’re moving at light-speed. All of a sudden, you get to a mid-cap world and you look back and say, “Oh my gosh. I don’t have basic elements, basic building blocks of human-resource management. I don’t have job descriptions. I don’t have pay classes and pay grades. I’m not able to put those pay grades into a quartile type assessment. I don’t have an assessment of my talent right. I don’t have annual reviews.”

But, when somebody buys that business later on and you’re a $125 or $200-million business, they expect those basic building blocks to be put in place and to have that performance management system engrained, probably even all the way down to a cultural survey being done. You may need to have two to three years of results of that survey to be able to sell a business in the future to maximize that value. So, I would say there is a great deal of energy and effort applied, when we acquire businesses or invest in them, to put that human-resource management process in place.

Snow: Are there benchmarks or approaches you can use to say, “All right. We know what a company that is successful in a certain sector at a certain size should look like by way of its team. Therefore, let’s apply that metric against this potential investment we’re going to make.” I mean, is that something your firm does? What tools do you have at your disposal?

Relyea: Yeah, we look at it in terms of the individuals, the org structure… and processes. It’s easy to benchmark the org structure against other similar companies with similar theses and stages. So, if there are major holes in the senior leadership team because they don’t exist, that’s reasonably easy to identify. There may be reasons for it, so it’s not necessarily as easy to fill, but org structure is an easy one. Processes also tends to be a very good benchmark for how the management team is stacked to deliver the thesis. If they’re doing things in a way that got them to where they are but aren’t what they need to do in order to deliver the next stage of growth, that’s reflective of either a team that needs to continue to grow in themselves, or a team that needs to be supplemented so that they’ve got the installed processes to help make the business most successful.

Capko: Being a third party, we have access to a lot of data, and one thing that we’ve spent a lot of time working on is how to quantify and disseminate that data. Benchmarking, as you brought up, is a great point. We’re able to benchmark first a lot of the clients that we already have. But, instead of benchmarking client to client, we’re actually breaking down each human-capital process. It might just be human resources on one side; it might be recruiting or talent management on another.

Snow: What’s the interplay between the team and making sure that team is not just run by rock stars, but actually has a process in place? How do you even determine that that’s the case when looking at a potential investment?

Relyea: Evaluating processes is reasonable—it is an iterative process itself because there are best practices, but those best practices in different disciplines can vary company to company based on what the company’s needs are, what their resources are and what works best for the team. So, you’ve got to spend time understanding HR processes is a great example. I mean, there are several different frameworks for good talent management and development systems. Our perspective is, we see multiple best-in-class processes and you need to make sure that the company has the right one that fits their needs.

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