- No negative relationship between turnover and performance
- Turnover gives firms chance to sweep out underperformers
- Makes room for skilled, productive new talent
Talk to any limited partner and one of the major concerns about GP relationships you will hear is team stability: There’s nothing like a major departure from a private equity firm to keep LPs up at night.
As it turns out, turnover may be good for PE firms, as a way to flush out underperformers and bring in talent better prepared to take on the challenges of the shifting environment.
That’s according to a recent study by three professors: Francesca Cornelli, professor of finance and director of private equity, and Vikrant Vig, professor of finance, both of the London Business School; and Elena Simintzi of Sauder School of Business at the University of British Columbia.
Turnover “has, on average, a positive effect on PE performance,” the study found. “Thus, this obsession with team stability may be unwarranted.”
The professors gathered data on 138 fund managers, 5,772 individual deals in about 500 funds and 5,926 individuals over 20 years. Capital Dynamics provided the information through its due-diligence archive.
What they found is that turnover (people leaving and joining) can eliminate underperformers and help PE teams adapt to changing business conditions. Low turnover when changes are warranted could lead to increased friction and retention of poor performers.
“If a firm is not good at choosing the right team, investors may doubt the overall credibility of the manager to generate returns,” the study said. “These managers will, thereby, be more reluctant to adapt their teams to changing conditions, as compared to more reputable firms.”
The professors studied deals in which the lead executive on the deal left the team. Those deals indeed performed more poorly than deals without team departures. But the study concluded that team members leaving firms tend to be worse performing individuals, rather than turnover being disruptive to performance.
The study also found a positive relationship between turnover in a fund’s first five years and both the internal rate of return of that fund, and the average IRR of that fund and one or two subsequent funds run by the same manager.
“By the end of the fifth year, the first signs of performance are usually apparent and it is quite plausible that the fund manager can identify underperformers,” the study said. “As information is revealed about individuals’ quality, underperforming team members leave, resulting in teams with higher average productivity.”
Highly productive new employees could also positively influence the productiveness of the team, the study said.
The professors also found a positive effect of team turnover (departures and new hires) in the five years prior to the start of a new fund and the IRR of the subsequent fund or the average IRR of the subsequent two funds.
“No matter what definition or timing of turnover, measure or horizon of performance we look at, we never find a negative relationship between turnover and performance,” the study said.
Finally, the study concedes that certain departures can lead to negative outcomes. This is especially true in the loss of highly skilled, experienced and productive individuals, which “disrupts teams and decreases productivity.”
Action Item: Check out the study here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2778213
Photo of Francesca Cornelli courtesy of the London School of Business