Is Leadership Capital the new frontier of private equity outperformance?

LCap Group’s new insights report quantifies the extent to which optimising Leadership Capital impacts performance in private equity-backed businesses. The findings show definitively that upper quartile businesses are more proactive about making key leadership decisions, making them sooner, and aligning competencies and behaviours with the value creation plan. Welcome to the era of leadership capital. 

In years to come, 2023 may be remembered as the year when market challenges sparked a new era for value creation in private equity. As interest rates have hindered borrowing and a sluggish economy has dampened growth, investors are digging deep for unexplored levers to drive margins and continue to deliver healthy returns to LPs. LCap’s latest report makes a strong argument that their ability to leverage Leadership Capital is central to that challenge. 

Leadership Capital 2023 is a study of every private equity-backed UK company that exited in the 2022/23 financial year, to assess how their approach to building and nurturing leadership, and the leadership team, correlates with financial performance on exit. The findings crystalise the role that a proactive leadership strategy plays in driving upper-quartile performance, particularly in the current tough climate. 

Faster leadership decisions, more impact 

In every role across the senior leadership team, we see the same trend, which is that the early alignment of leaders with the value creation plan and the wider team drives performance. Upper-quartile performers make leadership decisions on average 30+ months earlier than those in the lower quartile and are significantly more likely to switch key leadership roles within the first two years. A case in point is the CEO, which more than half (58%) of upper quartile and 67% of second quartile businesses optimised in the first two years. Amongst lower quartile performers it was just 37%. 

Optimising leadership teams from the word ‘go’ ensures investors have time to take a considered approach to leadership change, align competencies with the business and team needs, and have plenty of road left to focus on building out key commercial hires such as CCO, CMO and CTO. In fact, the report shows that, in upper-quartile businesses, 84% of new CEOs made further key leadership decisions within a year, thereby compounding the positive impact of early leadership decisions.   

In contrast, where investors are hesitating, whether that is due to a lack of direction, or a reluctance to have objective conversations with existing leaders, there is a huge opportunity cost in terms of potential value creation for the business. With a misaligned leadership team in place for longer, growth and impact are delayed and this ultimately leads to a longer hold period. For every month of delay in optimising the CEO, it takes a company on average one month longer to exit. 

Aligning leaders to the journey, not just the market 

But maximising Leadership Capital isn’t just about timing. The research also uncovers some vital differences in the composition, competencies, and structure of leadership teams of upper and lower-quartile performers. 

Perhaps unsurprisingly, top-performing businesses have larger leadership teams, giving them the ability to bring in a broader range of functional roles. Worth noting is that only upper-quartile businesses regularly have a CMO on the board, likely giving them an important advantage in differentiating and scaling in a tougher climate. Amongst upper-quartile leadership teams, the report also highlights a slant toward commercial competencies, such as marketing, sales, revenue, and growth, bringing greater agility to respond to market changes and opportunities. 

Critically, top performers are also differentiated by their prioritisation of situational experience when making leadership hires, which means they even sacrifice market (domain) knowledge to get it. In contrast, lower quartile businesses tend to hire leaders who enhance their sector experience, at the expense of both functional and situational knowledge. The conclusion? Bolstering the SLT’s experience of the value creation journey is a far better driver of performance than understanding the sector itself. 

Diversity of behaviours drives performance

Finally, behavioural fit and a diversity of behaviours are also critical. Upper quartile teams on average score more highly for the PACE behaviours of pragmatism, agility, curiosity, and execution, which have been proven to differentiate the most successful private equity-backed teams. Top teams also exhibit behaviours that are aligned and complementary across the group, avoiding significant outliers or crossover. Critically, they also display a high level of cognitive diversity, avoiding a concentration of behaviours in one area, ensuring the team can collaborate effectively while avoiding unproductive clashes, or groupthink. 

Leadership Capital delivers alpha returns 

The power of Leadership Capital to drive performance in private equity-backed businesses is well-known. What is less well-known is exactly how it drives performance and the power that investors now have to engineer leadership teams to deliver upper-quartile exits. Thanks to leadership analytics, it is now possible to analyse and dissect the blend of competencies that will drive top-level performance in a business and optimise the team accordingly. This is a game-changer for driving more objective, constructive leadership conversations, better decision-making, and ultimately outsized performance. Welcome to the era of Leadership Capital.