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ESG and PE: A Surprising Symbiosis

Winning the talent game is essential for success, and ESG policies can play a central role.

While at times it seems like environmental, social and governance priorities can be at odds with financial outcomes, the implementation of ESG practices is actually a key driver of financial returns in a world with increasing competition among investors.

In fact, actively employing ESG operational practices guided by the framework within a private equity portfolio gives the fund its best chance of outsized returns. By using an ESG mindset in operating businesses, the private equity firm makes its portfolio companies attractive places to work in a world where the labor force is increasingly wary of working for PE firms. We believe that winning on talent is the best way to win on investments.  

Put People First

“PeopleFirst” is a double entendre that means putting people and values first, as well as putting people first sequentially by recruiting great people prior to making an investment, and ensuring that you have strong leaders on the bench before buying companies. This guarantees that your portfolio companies aren’t left with poor leadership or no leadership during some of the most critical days following a majority transaction.

A majority transaction, by its very nature, is a change that can disrupt and destabilize even the best organizations, and you’re only doing yourself a disservice if you lack strong social alignment throughout. An internal talent team that identifies executives and leaders with high emotional intelligence, leadership and adversity quotient that ultimately will be paired with companies undergoing a transaction to help stabilize and align the culture is an invaluable tool. Getting the right team on the bus is Step 1 in prepping a business to hit its performance targets.

The costs of misaligned or disrupted culture in a PE transaction are real. If not managed well, the culture of a company can erode with new ownership. Employees worry about job security; there’s a divide between incumbents and new hires, and strategic direction changes causing confusion. PE investors almost always experience employee turnover at the outset of a hold due to these things, and turnover is costly. Do all in your power to minimize these disruptions. For example, we use a bucket metaphor for customer retention that also applies to employee retention: Focus on plugging the hole in the bottom of the bucket first, then start filling the bucket. It’s hard to make progress with a leaky bucket. We try to make sure we’re not losing employees or customers out the bottom of the bucket.

Solve the initial culture crisis by avoiding it. Employees generally have given a lot to an organization, and the worst thing is not to acknowledge that and come in with only pithy strategic goals in mind. Good leaders know how to manage these situations, and one of our guiding principles is, “first, don’t break anything.” Entering the investment with a socially aware mentality saves a lot of operational and financial headaches and treats the employees in a way that gets them excited about the new ownership. From there, it’s crucial to ensure high employee engagement and low turnover. We measure our employee engagement quarterly at the management company level and share our employee net to promote score practices across the portfolio. Make sure employees are happy, or you’ll deal with the costs of the leaky bottom of the bucket. Make the company a “best place to work” so the best employees want to work for you and don’t want to leave. Our aspiration is to have at least 50 percent of our portfolio companies be formally recognized on third-party “Best Places to Work” lists. 

Another key focus is injecting diversity and inclusion into industries and companies that historically have lacked creative thinking on how to attract and retain diverse talent. Women account for only 16 percent of executive teams, and 97 percent of companies have senior leadership teams that fail to reflect the demographic composition of the U.S. labor force and population, limiting the ability of companies to relate to key populations and adapt to changing conditions.

PE firms have a broad reach and strong influence on leadership teams within their portfolios and can directly influence both (1) the composition of business leaders across an array of businesses and (20) the future leaders of businesses by creating a ripe executive training ground within the portfolio. Using a CEO-in-Training program can help change the composition of executive teams in your future portfolio and across the business world. Instead of recycling the executives that have already found success in business, identify and attract high potential individuals who otherwise may have struggled to receive recognition in sectors that are entrenched with unconscious bias and develop/train them into executives, growing a new crop of business leaders with a high bar on diversity and inclusion.  

Lastly, while we recognize that many PE firms have achieved financial success by primarily leveraging cost-cutting measures, the inverse can also be true. In a society in which PE is generally one of the most abhorred industries in the country, we have the opportunity to demonstrate the true value proposition of PE and its ability to add value to the economy at large. We believe it’s people who drive topline growth, and so it’s crucial to get the people part of the equation right and build the right team to support sustainable growth. Of course, all this is moot if you can’t attract top employees to fill the roles you’re creating—and top potential employees are increasingly intentional in selecting socially impactful roles with competitive benefits.

So What?

Taking an active role in implementing ESG-like operational policies is one of the most important things your PE firm can do, because it puts you in the best position to win the talent game, which, in turn, best positions you to win the returns game. Beyond being the right thing to do, it’s the right way to win.

Public markets benefit from notoriety and pizzazz that attract strong talent. Private markets often struggle to entice top talent, due to limited scale, a narrow spotlight, tight resources or all of the above. In looking for predictors of success, seek fresh talent in a sleepy industry. Real value can be created with consistency by bringing top talent to businesses that are looking to grow.

Talent is the best leading indicator for success in an investment, and it’s nearly impossible to overweight its benefits. In private markets, investors have the luxury of longer timelines versus public markets that must cater to quarterly earnings reports, affording private investors the chance to ensure the right people are on the bus. So, as part of your diligence in assessing where to allocate your portfolio, look for: (1) a focus on management talent and (2) structural investment in ESG-like practices that will ensure the persistence of talent arbitrage.


This is an adapted version of the authors’ original article in the September 2018 issue of Trusts & Estates.

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