The Exit Playbook: The human key to exits

You can't fix the team at Axi. It's something that you need to build an engineer at the start. Deal exhaustion is real. It's predictable and it's underpriced. Lock in the incentives for the talent in a way so that it helps with your long-term strategy, including your exit planning. Our perspective is you don't want to involve folks too early. Invariably, when they start thinking about a sale, they get distracted from their day job. Welcome back to Disruption Matters, a podcast mini-series produced by Private Equity International in partnership with Siri Sponsor Alex Partners. Every year, we delve into the forces that are reshaping our world and how private equity managers can best meet the moment. This is our fifth season and we're aiming to provide an exit playbook, essentially a series of strategies from industry leaders to ensure the kind of performance that made this asset class worth trillions. I'm Rob Kiteki, a deputy editor with PI Group and your host. This is a six-part mini-series and we'll be releasing a new episode here on Spotlight every week, but if you rather not wait, you can listen to the whole series right now. Just follow the link in the description. If you already have a private equity international account, simply sign in or register for free to access all six episodes. By the time you're listening to this fourth episode of the season, some things should be obvious. One, the buyer's perspective has to stay front and center. Two, the exit needs to be designed from the start of the investment, even if you shouldn't get attached to specific timelines. And third, the timing of an exit has to be based on a company's actual performance, one that specifically tied to the story being told to potential buyers. In short, no amount of spin can hide lackless results, so act accordingly, because like it or not, exits are the final word on the success of any fund. Now, exits can be reduced to a number. We bought company A for price X, and we sold it for price C. Thing is, there's a factor that matters enormously to that price Z that can't be found on a balance sheet. It can make or break any exit, even in the final mile of the process. And today, we're going to focus on that. It's people. AI boosters may be dreaming of a day when they never have to rely on humans again, but private equity managers can't afford such fantasies. They need to keep human capital issues front and center. Management is the priority, but in this episode, we're going to be reminded that they aren't the only people that matter. But they do matter. And unfortunately, management issues can't be addressed in the final hour. In many ways, management has to be a core issue from the very beginning of the deal. First, we'll hear from Ellen Hubdalla, a managing directorate equity group investments, founded by the real estate icon Sam Zell and devoted to mid-market control investments. She speaks to a common misconception among GPs. I just think that they don't value the fact that they are not buying a company. They're like getting married to a management team. And we as buyers, like walk into every single meeting saying, "Is this somebody who I want representing equity group and us?" Well, I'd be proud to say this is my partner. And then really, really listening to what they say. People sometimes get stars in their eyes because they see growth possibilities or they see how they can combine companies. And they forget that they're sitting across from the people who are going to own their company from an operational basis day to day. And that means taking a good look at who's sitting across the table from you. I was with a colleague. We were sitting in our initial meeting with management. And I was with two other colleagues who were junior colleagues, you know, smartest Helen and really great. And I was off to the side a little bit. And the CEO was talking. He was sitting in the middle of the table on the other side. And every time one of them would ask a question, he would turn and face me and answer the question to me. I wasn't asking a damn thing. I was just listening. And that gave me a signal. And I was like, wow, this guy, like, it was a little bit of a respect issue to my colleagues. I noticed. And then I watched him with his colleagues. And he would talk over them. And I was like, okay, that's troublesome to me. And then we asked why one of the very senior people on his management team wasn't there. And the number of garbled answers that came on top, like, I was like, oh my god, you're not going to remember this or maybe you will. But like, you know, the lost in space, danger will robinson danger, like that's literally what was going through my head. And like, we like left that meeting. And by the way, it was a fantastic company. I loved the company. But I was like, I don't feel good about this management team. You can't fix the team at exit. That's Marisa Moosey, a partner at being capital and ahead of the portfolio group for private equity in Europe. We back strong CEOs and management teams, but we often acquire businesses when founders of family are departing. Or we need to step up significantly, the capabilities to fulfill that initial bold ambition. And in every investment we front load, the capabilities building. So by the time we are settling, the team is proven and aligned. One example in an healthcare investment I've been working on, we have hired almost 50% of the top 150 new critical roles in the business in the first 24 months. Many of which are new capabilities really needed for the body creation of the journey. And that is going to be very important for that team to settle, glue together and be effective over the long term. And that only happens if the management team has truly bought into the vision of the company that's been laid out in the investment case. Here's who are up saying a partner in private equity at Alex Partners. I would say right from the start, right, you need to have a management team along with you in the journey, which is really bought into this process of the journey and really believe in the mission because you would have to pivot multiple times during this process. The other thing which we have started seeing a lot of the companies have started doing it is lock in the incentives for the talent in a way so that it helps with your long term strategy, including your exit planning, right, like have an incentive structured in a way so that it's not just tied to maybe hitting your really target, but what you had in mind in terms of your exit. Who doesn't think about aligning incentives, but Ted Belili's the global leader of transformational leadership at Alex Partners notes that it's not quite so simple. So the mistake I see most often is that GPs treat alignment as a one time event at the deal close. They set the equity, they paper the management incentive plan and then they move on. But interests drift over the whole period, obviously, right, so the person who signed a package four years ago as a hungry number two is now a division president year she's got a different life, different risk tolerance, a different sense of what they are owed. So the first discipline is simply to re underwrite the alignment before the exit and not assume that those original terms still hold. And for that Ted suggests focusing on three key issues. First is the payout structure actually reward the behavior the exit requires so management team that best purely on getting a deal done. They're going to optimize for speed, but one that best on multiple will optimize for value. Those are two different exits second, and this is the one that people I find most often is the second tier aligned and not just the C suite. The CEO and the CFO almost always have economics that are clear and laid out and align. But the divisional heads, the commercial leaders, the people who actually hold the customer relationships frequently don't, and that's where flight risk lives. Third is the timeline, an honest timeline if you're asking a team to wipe knuckle through 18 months of dual tracking their day job and a sale, the incentive has to be visible enough to pull them through what is certain to be deal exhaustion. We'll get to deal exhaustion soon enough, but here's an example Ted gives for the value of updating that alignment. A few years ago, I worked with a sponsor on a business services platform and about a year out from exit, we went back and actually reread the management incentive plan against the exit that they were now running. The CEO and the CFO were fine, they were well aligned, but the plan had been cut at deal close and there were two divisional leaders who by that point held the largest customer relationships. They had the economics and they had barely moved. One of them was already quietly, quite frankly, in conversations to leave. We quickly recut the second tier retention plan, meaningful upside tied to outcome, not just to a deal getting done. Both of them stayed and when the buyer ran their diligence, one of those two leaders turned out to be exactly the person they most wanted to underwrite in the next phase. We not done that, have we not looked again? We'd have lost that individual for the price of the plan nobody had revisited in four years. So the through line here is alignment isn't just a document, it's not a one-time deal, it's a living read on whether the people who carry the exit can see themselves in the outcome. But when should those people be notified that an exit is coming? How should a manager handle the early stages of an exit process? Here's my collider, the manager. Director for the Finance and Technology Group at GTCR. Our perspective is you don't want to involve folks too early because invariably when they start thinking about a sale they get distracted from their day job. And so oftentimes what we do is start with a very small group of folks, the CEO, maybe the CFO, one or two other folks and let them know that we're thinking about the sale process. And sometimes you need to cultivate relationships with potential buyers. And so we have them do some of the conversations with buyers. But the rest of the organization continues to focus on business as usual. And so that way when you go into an actual sale process, you've already done some pre-work with the buyers and know who's interested, et cetera, and so there's a much higher probability of success. And so that's some of what we do to try to minimize that. And Micra calls a situation where keeping the circle of trust made all the difference in the world with a business in the mortgage tech space, a company called Optimal Blue. We on a business in late 19 started to get inbound interest from strategic buyers and a number of strategics, had dialogue with them and in March the world came to a halt in the strategic buyers, outreach stopped. And so it was great that we hadn't let the rest of the team know, but it had conversations to the CEO and several firms in the summer. The interest picked back up just because stocks rebounded so quickly. And at that point, we got some preliminary indications from folks and decided to involve more people in the process, have a more traditional sell-side process where we talked to handful of strategics and were able to also assign a deal very quickly, assigned a deal just after the 4th of July. And the reason that we were able to move that quickly is the buyers had done some pre-work with a small group of people and gained comfort around the growth opportunities in the business. And so we're doing that because folks get distracted. They start thinking about spending and the transaction proceeds. And then there is uncertainty where there's strategic transactions, oftentimes some folks will become synergies, and so there's some level of discomfort. And we don't want folks distracted by all of those dynamics. Ted says he expands the circle of trust gradually over time based on specific trigger points. The first trigger would be the emergence of a serious credible buyer. Not just indicative interest, but a counter-party who's earned real diligence. More than a tight core of the CEO, CFO, and the sponsor can carry it. Once a buyer genuinely shows up, is genuinely at the table. You need the functional leaders who will have to stand and deliver indiligence because a management presentation performed by two exhausted executives reading someone else's numbers is transparent to a sophisticated buyer. The second trigger is when the operating business starts to feel the strain. When you can see that keeping the process on two shoulders is causing real operating drift, that's the signal you need to widen the base of the earlier. And the third factor is capability driven. If diligence will go to two layers deep, and it now does really as a matter of course, the people at the second layer need to know before they're in the room and not surprised by it. And managers discount the value of that second layer at their peril. My work with a GP on a healthcare services company where the instinct was to keep the circle very tight. Just the CEO of the CFO, the sponsor, right up until a buyer was deep in the process. I pushed them to widen it one stage earlier than felt comfortable and bring the head of one of the operating divisions into the room before the management presentation and not during it. The sponsor was nervous about it, more people, more risk, but that division leader was the person who actually lived the numbers, the buyer would probe hardest on. So when the diligence team went to layers deep, as they now always do, she was the one who could answer in a way the CFO simply couldn't have second hand. It could have been a soft spot in the story, became one of the most credible moments in the whole process. So the lesson was clear that the trigger to widen isn't a date, it's the moment you realize the person who can best defend a part of the story isn't yet allowed to. So it's the art of sequencing, I like to say, wide enough that the story is credible and deliverable, tight enough that you haven't turned the whole leadership team into people negotiating their own exit. And short, it's about the manager putting themselves in the shoes of the management team and the core players that will help make the case for the buyer. It also means taking seriously the weight of negotiating a deal while still running a business. Here's Mateo Stefano, the managing partner and co-founder at APS Partners, a UK-based firm focused on financial services and infrastructure. That's two words, it's deal tiredness. I've seen it a million times and I feel very sympathetic to the management teams. This is our day job. It's not their job. They've got another day job. They need to run a business. And at the same time, it feels a bit judgey because most founders feel that these companies are the babies and the babies are being judged. The being judged in as rough away as for those of you that are parents, as your kid going through exams and getting a single grade and you go like, "But it's not fair, there is so much more." Well, but that's life. And so these founders go through this experience that is both emotional and actually really intense in terms of the amount of information that they need to produce and all of this on the side of the day job. And we've seen a million times actually when this deal tiredness has led management teams to come to us and say, "Look, I'm tired, I can't do it anymore. Can we just put a break on it? Can we just move on?" And you need to be a part psychologist at that stage. You need to actually sit down with them and say, "Hey, tell me how I can help. How I can actually lift some weight off you." Especially because the show often becomes, that if they become too tired and even worse, too focused on the deal, they lose track of the financials and nothing could be worse than having a downward slipping set of results in the middle of a deal. While you're selling the business, you're presenting to, you know, you presented a few months ago the projections and those projections fall short or the results fall short of the projection by 20%. That's a really awkward moment and it's just a spiral down. So how you manage it is help be understanding, be compassionate, frankly, be a good psychologist and also be ready to step in and to help out the management team. For Fahima Med, the CLO of BC Partners, this is what plain shrink looks like. I think it really comes down to transparency, communication, and awareness. And so on the awareness side, really understanding what it is that is going to be required of them, what they're doing and how are the ways that we can support them, whether through our own deal teams, whether through our portfolio operations team, whether through external advisors, setting that up the right way such that they can find that support through the process, being very communicative with them on what your, you know, ambitions, goals, what are the elements that are coming through during the process, right? Because again, processes themselves in any type of exit process that also tends to have quite a bit of uncertainty around it, especially these days. And so maintaining that very clear dialogue with management teams, we certainly find to be very helpful. And again, it's something that we've done to this point from entry all the way through exit because you do want to be aligned. But when it comes time to that point, I think also just being aware that, you know, people have their incentives under human beings, right? We like to think of everything as being highly analytical and everything really laid out in these very, very detailed plans with numbers behind them. All of that is true and is necessary. But at the same time, there's a human element too. And just being aware of that and giving a little bit of the support where it's needed and required, sometimes a little pat on the back, sometimes a little kick in the behind, whatever it might be that is required at that moment to support whichever stakeholder it is. That's true of advisors as well, right? There, yes, they may be working for a fee to help a process. But as people working through it, I think being aware of that can really help get to a bit of answer by taking that into account. In Ted's eyes, this effort and focus is worth it. And these things also always go longer than anyone ever promised them. And exhaustion doesn't hit evenly. It concentrates on exactly the handful of people you can't afford to lose. So there are three things I advise our clients, you know, first name it in advance. Leaders who can tell their team honestly, this is going to be a grind. Here's roughly how long we think it's going to be. Honestly, here's what we're protecting you from. It's ambiguity that exhaust people. It's not actually the workload itself. So communication, honest communication is critical. But he explains that it can't end there. The instinct is to pile the process on top of the CEO and the CFO and hope that the operating business holds. The better move really is to consciously push operating decisions down one level. Oh, if you're not. If you do it right, also builds the bench of credibility that buyers looking for. Exhaustion management and succession planning are really the same project. And that's a very hard thing for our clients sometimes to understand, but you're killing two birds with one stone. You're managing the exhaustion of the team by pushing it down a level and you're also preparing that next succession generation. And third, you've got to protect the operating cadence, really. You've got to treat the operating cadence as sacred. When management attention drifts, it shows up in the data room, churn, a pipeline slippage, survey trends, the buyers read it instantly. And he saw this phenomenon up close. So to give you an example of this, I work with a technology-enabled business where the CEO and the CFO were frankly running themselves into the ground, I mean, seriously, health risks. They were operating the company by day. They were selling it by night, turned it to a nine-month process. You could see it in by month four. What turned it around wasn't a pep talk, it was structural. We deliberately pushed a band of operating decisions down to the next layer, real authority, not just delegation theater. So the top two were the only shock absorbers for both jobs and two things happened with that. First, the CEO and the CFO got their heads back above water and the buyer, watching that second layer actually run the business, got more confidence in the talent bench, that the move we made to prevent burnout doubled as the move that strengthened the equity story. And that's usually how it works. Student management and succession planning are the same project wearing two hats. And by the way, exhaustion isn't a stamina problem. It's a design problem and it's solvable the front bed. And maybe there's another route to minimizing deal exhaustion, speed everything up. Here's Ellen again from Equity Investment Group. So the most recent sale that I was involved in directly happened within the last year and a half. And it was seven months start to finish. We signed the banker over the Fourth of July weekend. And we signed the deal in December and we closed six weeks later. And the reason that that's really important, I think, is because it's a lot less disruptive. The shorter you can get that time frame, then it's less disruptive on the management team, less disruptive on the company. And so for me, if we had been doing that for 12 to 18 months, that would have made me nervous. But the exit process doesn't just impact senior management. It can trickle down throughout the organization and that can threaten retention and performance. Here's Ted. I mean, the layer below senior management really decides whether the value survives the process or not. The C-suite has aligned economics. They've got a seat in the room. The people below, the divisional leaders, the commercial heads, the engineering leads, the ones who actually hold the customer relationships and the delivery, they have neither. They read the tea leaves, they sense the process, and they start taking recruiter calls, unfortunately, because nature accords a vacuum and they start wondering things. The first move is to explicitly have a retention design for that second and third tier. And it has to be in place early, minimum 12 months before the close, not announced it's signing. By the time you're announcing, the flight risks has long been decided. Money isn't necessary, but it's actually not sufficient. And the next step is addressing the very human vulnerabilities in play here. People don't need to know everything, they can't. But they need to know enough on a regular basis to stay oriented and engage. So leaders who go quiet under sale pressure aren't protecting confidentiality. As I said, they're letting fear fill the vacuum and fear is what makes good people leave. But fear isn't the only element here. There's another that Ted feels is the most neglected. It's the need for meaning. What do I mean by meaning? During a process, work can start to feel purely instrumental. Everyone's just running out the clock, running to a transaction. The leaders who hold onto their people give them something to be proud of that isn't the deal. It's a product milestone, it's a customer win, it's a standard of execution. Something that says the work still matters on its own terms. For Ted, it can work wonders in even the toughest situations. There was an industrial company that we worked with just last year. And the sponsor and the CEO had done careful retention work at the top. But essentially nothing, a layer down. 10 months before they went to market, we built explicit retention for the divisional and commercial leaders. But the part that mattered most wasn't the money to them. It was that we set a communication rhythm, short honest cadence where those leaders were heard regularly, roughly where things stood and why their work still mattered without reaching anything of a confidential nature. Before that, the silence had been filling with rumors and two strong people were already fielding calls. Once they could see that they were being treated as principles, rather than being kept in the dark, both of those individuals recommitted. The whole middle tier held through a long and difficult process. People don't leave only for a better number. They leave when the silence tells them they don't matter. You retain that second tier with the same three things that retain anyone. Economics, honesty and meaning. But you have to design all three before people start looking. Management and employees aren't the only people whose needs and concerns need to be addressed. There's also the little matter of the customers. Customers are a forgotten constituency. So the golden rule here is customers are a constituency in the sale, whether or not you decide to treat them as ones you better decide and you better accept that they are very much a constituency. The sale process generates signals, senior people are distracted, decisions slow down, rumors can travel through the industry faster than anybody really thinks they're going to. So if you don't shape the narrative that the customers are hearing, they're going to construct their own and that's not one that any GP wants. The governing principle that what I advise our clients is that the customer message should be about continuity of value to them and not about the transaction. They don't really care about the transaction. They care about continuity of value. Customers don't care that you're running a process. They care about their service, they care about their pricing, they care about their relationships and all of those things are probably going to change or they fear that they're going to change. So the messaging has to answer the question they're really asking, but how does the messaging cadence work? So timing and tearing really matter, your largest most strategic accounts should hear from someone very, very senior, ideally before they hear it from anywhere else and it should be framed as confidence and not damage control. The broad base can be handled with a lighter touch. What you can't afford is for a major customer to learn about the process from the market. That's how a customer narrative the GP spend five, six, seven years building starts to unravel at just the moment that couldn't be worse. And here's the part that the GP's underway. Customer stability is diligence. While sophisticated buyer is reading churn, he or she's reading customer sentiment as a direct proxy for the durability of the asset. So every customer you keep confident and engage through the process is underwriting your multiple. That sounds sensible, but that doesn't mean it feels natural for the humans involved. I worked with a sponsor on a, it's kind of like a subscription based business where a handful of large accounts represented a real slice of the revenue and word of a process started to move through the industry rather than go quiet, I advise the client to do exactly the opposite. The CEO personally reached out to the top accounts very early. They heard from him before they heard the message anywhere else and his message was your service, your terms, your roadmap are not going to change. You have my word on that. Was customer state confident? The retention numbers came into the data room clean, which mattered more than the reassurance itself because the buyer had been prepared to use any sign of customer waffling or wobbling as leverage on price. So there was none of that and price stage, stage strong customer stability, you know, handling it like that protects the relationship. So customer communication isn't defense, it's part of the value that you're actually setting. And yet another forgotten constituency here is, hold on to your hats, the buyer. Now hear me out, it's not that the buyer isn't top of mind per se, but the necessity of vetting the buyer for leadership and cultural issues can fall by the wayside if say the number is flattering enough to drown out such concerns. But it shouldn't because if a buyer ends up being a wrong fit for the company and the company falls into disrepair, that can damage the manager's reputation. The taeoset it in early. episode and let's play that again. We are all repeat by design by definition. We're all repeat exhibitors, right? That's what we do for living. We invest, but we need to return the capital and what you cannot afford is to pull a fast one on the buyers. You can't and we're all very clever people. We can all, you know, present things in the best possible light, but there is a there is a line between presenting in a good light and having buyers remorse at a later stage. You know, I had in buyers regret that they actually bought an asset from you. This is super important. And what I cannot believe is that LPs, when they diligence us, when they they are considering investing in our funds, they don't actually find out whether we're good sellers or bad sellers. They only focus on the financial return. But the market is small and you will be found out if you're, you know, a selfish seller. He's only talking about the quality of the asset, but it extends to ensuring that the asset lands in good hands. A trail of exits that underperformed for a variety of reasons can still erode a reputation. Here's Ted on the value of vetting buyers for their culture fit. This is the one sellers are least disciplined about because at the finish line, the highest number is enormously seductive. Let's face it, but price and fit are not the same question. And the gap shows up after the close. In the management team, you spent years building and in the reputation, the GP carries into the next deal. So the vetting is is actually symmetrical to what a good buyer does to you. You're running the reverse diligence on them. And there are three key questions in that diligence. First, how is the buyer actually treated management teams they've acquired before? That's rule number one. You know, not what they say in the meeting. What the departed CEOs of their last three deals would tell you privately. That's reference checking. And if it's done well, if it's done thoroughly, it's the single most revealing thing you can do. Second, what's their operating model? Are the partners who back a management team or operators who install their own? Are the operators who install their own and then clear the deck? Both are okay, but your team's retention economics and expectations were built on an assumption and a mismatch where it right is going to like detonate six months in. And third is something I call cultural tempo. Like how do they make decisions? How do they handle bad news? How do they treat people when a plan slips? Culture is most visible under stress. So probe the stress behavior, not the courtship behavior. And Ted seen the power of this diligence first hand. I was involved in a situation where the seller had two credible bids and the higher one came from a buyer with a reputation. If you actually call the CEOs of their last few deals, which we did for them, they had a reputation for installing their own people and clearing the deck within a year. The slightly lower bid came from a firm that genuinely backed their management teams. They did exactly what they said they were going to do. So the founder's CEO and his leadership team were central to why the business worked and their retention economics had built entirely, we're built on the assumption of staying and running it, we counseled them to take the lower bid. And two years on that team's intact, the earnout was paid out in full. The business had outrun what I'm confident the top dollar buyer would have delivered once their integration label collided with that culture. And the highest bid, the highest bid isn't always the highest outcome. Not when the thing that made the asset valuable can easily walk out the door. You're not just selling an asset. You're placing the people who made it valuable into someone else's hands. A great price with the wrong buyer is how a good outcome becomes a bad story for the team. And you know, for the GP zone next fun. Brian Cassidy, the president of Crestview, has his own case study on recognizing the right buyer. We invest in human capital intensive businesses like asset management, wealth management, and Hollywood talent agencies. So this is a very acute issue for us. Just to give you one quick example, we invested in a Hollywood talent agency called ICM back in 2019. We bought co-control with the management team owners and they were the assets of the business. They went up and down the elevator every day. So we always thought the eventual exit would be to another private equity firm, you know, given the age of the management team owners. And then also they're desired to remain independent. But there was one strategic to whom they're willing to sell. One with a similar strategy, a similar culture, you know, the people got along very well. And this opportunity presented itself like very early in our investment period. We like to hold our investments maybe in the longer side for private equity, maybe four to seven years on average. And this came about in the first 18 months. And so management team thought it was the right time to engage in the cell of the business. Obviously we were focused on price. We had a very lengthy anti-trust review, but we were able to sell the business to CAA for 750 million. We cashed out 100% of our stake. And the management team wanted to continue their role. They were such believers in the story. And they rolled their entire stakes in the combined company. And everybody walked away very happy. What might get lost in the shuffle is that Crestview assumed that ICM wanted to stay independent. But the channel of communication stayed open so that when CAA came knocking, they learned that the right shooter could change the calculus. The real takeaway from this episode is that open lines of communication and managing the human capital element can make or break that exit. Issues with senior management have to be addressed as early as possible, and aligning incentives is an ongoing process. Those company leaders right below senior management need to be properly incentivized to, but they can help relieve the burden of deal exhaustion that's a reality almost as persistent as gravity. Customers can't be ignored, but the messaging must be around assuring them that quality and price won't suffer due to the change in ownership. And yes, even the buyers need to be vetted for the same character and culture issues that the senior management team was at the beginning. As we've stressed, the successful exit isn't just about price, but reputation as well. In our next and final episode, we'll be addressing what to do when an exit process falters. Thanks for listening. To make sure you get all the episodes from the season of Disruption Matters as they're published, subscribe to private equity Spotlight wherever you get podcasts or at private equity international.com. This episode was produced by Natalie Novakoba and edited by Eric Fish. Our music is against the clock by Rhythm Scott. I'm Rob Kitecki with PEI Group. See you next time.