When and how should portfolio companies change CEO?
- Peter Keller
- 21 hours ago
- 5 min read
The decision to bring in new leadership during an investment period is one of the most important and difficult a private equity partner will have to make. How do firms know when the time is right to shake things up? What are the risks involved, and how can sponsors ensure they find the right replacement? Pete Keller, Head of our Private Equity practice, outlines his thoughts.
Buyout firms are no strangers to changing portfolio company CEOs. Over 70% of organisations under private equity ownership hire new leaders – but while research may suggest that replacing a portfolio company CEO is a routine exercise for private equity, the reality is anything but.
The decision to change a CEO midstream can have serious repercussions for investment timelines and target returns. Identifying, recruiting and putting a new CEO in place can take up to six months, which can represent a significant chunk of an investment period for many managers. Removing leaders also has knock-on implications for the business. When a CEO departs, it is not unusual for other senior figures to follow. Changing one person can end up involving an entire management team reset, further delaying time to exit and diluting IRRs.
It is also important to factor in that the quality of a management team – with the CEO front and centre – will be one of the key reasons a private equity firm chooses to back an asset in the first instance. The management team’s growth plan, and ability to deliver it, sits at the heart of an investment thesis. Replacing the CEO is thus not exclusively a human resources matter, but a fundamental strategic one.
Expecting change
As integral as an incumbent CEO is to a PE firm’s growth plan, the nature of the private equity model means that there will inevitably be situations where a GP will have to bring in a new CEO. The impact of the rising interest rate cycle on private equity hold periods, for example, has also seen CEOs choosing to step back. Higher rates have led to stasis in exit markets and extended hold periods.
Average hold periods have stretched beyond seven years – the longest in more than two decades. With bonuses for CEOs tied to securing exits, financial incentives for can seem out of reach for many as hold periods are prolonged. Some leaders may also proactively opt to leave a private equity portfolio if they decide that the business is carrying too much leverage, or a planned exit route has been compromised due to changing market conditions.
Re-energising leadership
There will also be occasions when private equity dealmakers have to replace CEOs themselves. PE investment strategies are predicated on delivering transformational change and growth. The business a private equity firm invests in on day one will be very different to the one it sells on exit.
This can often lead to tension with an incumbent CEO. They might have successfully built a company into a profitable business, but they may not have the skillset or personality to lead the organisation as it grows – not to mention handle all additional pressures of managing larger, more complex teams and dealing with institutional investors. The skills and leadership qualities that brought a company to a certain point may not be the same ones needed for it to succeed under private equity ownership
Private equity investors want to grow businesses at scale, and accordingly they require ‘scalable’ CEOs to do so. Often this requires a change at the top, as the demands placed on the CEO and senior management evolves throughout the hold.
When is the right time?
Building a picture of whether a CEO is equipped to handle the pace of change demanded by a private equity investor, however, is not always clear cut. Falling earnings and missed targets are obvious signs that a change might be necessary, but decisions to replace a CEO will often involve assessing more intangible elements, such as a willingness to take direction and collaborate with a sponsor.
Bold decision-making is a necessity if there is a sense that a CEO is not going to work out in the long term. It can be challenging to make these calls early. The natural tendency – given the significant impact a change can have on company performance – is to ‘wait and see’ in the hope that a situation improves, or until it becomes obvious that it is time to make a change.
A sponsor must have complete faith in a CEO, and when that faith fractures, however marginally, any delay will only result in a period of prolonged inertia, long-term disruption, and bottom-line impact. The direct financial impact of not refreshing senior leadership quickly enough is difficult to quantify, but research by McKinsey & Co indicates that CEO leadership and decisions can account for up to 45 percent of a company’s performance, illustrating the potential costs of delaying a necessary CEO change.
Sponsors’ judgement will be paramount, but there are clear signals that a CEO change should be considered. If senior C-suite executives start exiting a company, this could be a warning sign of deeper leadership issues. Other red flags include a business consistently trading below target, or failure to execute an M&A deal or restructuring.
Be prepared
Whether a CEO exits for their own reasons, or it starts to become apparent that they won’t have the toolbox to take a business where the sponsor would like it to go, private equity firms should be prepared in advance to respond at speed.
GPs will benefit from having a backup shortlist of potential candidates who can be approached if necessary. Building these networks and relationships with CEO candidates takes time and resources but is invaluable when there is an urgent need to fill a CEO vacancy.
Our clients’ feedback has highlighted the value that sponsors have derived from our executive networking services, which include prospect mapping and assessment. Relationships, compatibility and style matter. It is much easier for both sides when personal context is already in place, rather than starting from scratch. GPs should also turn to portfolio company chairs, who will be close to the nuts and bolts of an investment strategy and be able to offer direction on the personal qualities and experience a replacement candidate will require to hit the ground running. Advisers will also be able to offer valuable counsel.
Search consultants as your company's intelligence arm
Executive search consultants, meanwhile, serve as a valuable source of CEO candidates and can also counsel on what represents the ‘right fit’ for a portfolio company. Executive search firms will have experience placing several new CEOs into portfolio companies, and understand the dynamics demanded of the situation. They also bring deep contact books of curated candidates with private equity experience to the table.
Private equity firms do not necessarily have to replace the CEO at the start of an investment but should acknowledge that it is always a possibility. Being prepared in the event of a change goes a long way to managing a difficult situation as swiftly and effectively as possible.
