Human capital due diligence de-risks private equity investments

Advanced people-focused solutions implemented early in the investment lifecycle can mitigate risks of today’s virtual environment and offer a competitive edge in an aggressive market, writes Matt Brubaker, CEO, FMG Leading.

By Dr. Matt Brubaker, CEO, FMG Leading

In early 2021, private equity firms are looking to quickly deploy their accumulated dry powder with incredible focus. Pipelines are full of deal activity, and diligence is happening on many fronts simultaneously. Yet this urgency must not come at the expense of vigorous due diligence, especially with the illusion of COVID-era bargains waning. Instead, GPs must bolster their approach to due diligence, adding layers to their valuation processes to ensure they can accelerate the pace of value creation after paying a premium for investments.

Complicating diligence efforts are social distancing requirements that continue to upend traditional processes. Fewer opportunities for face-to-face interaction make it more challenging to assess and align individuals and teams, preventing GPs from capturing the people-centric insights ordinarily gleaned through real human engagement.

With all their complexities, people – especially those in senior positions – represent some of the most significant risks to an investment thesis. While executives and teams can work cohesively and productively to drive value creation and accelerate growth, they can also hinder progress and create costly distractions. Knowing this, today’s GP’s are increasingly adding human capital assessment and risk mitigation to their standard diligence playbook.

Human capital due diligence can help private equity firms predict, evaluate and manage people issues inherent in all team environments, providing GPs the peace of mind that comes with knowing they have the right leaders in place; the right approach for keeping them on track and the right supports to address any existing gaps. Bottom line, it ensures an organization’s people are working in lockstep toward their big-picture goals, best positioning the investment for success.

Like other risk management strategies, human capital due diligence is most effective when applied during the early stages of an investment life cycle, including:

Pre-transaction

To avoid the costly delays and headaches that often accompany unanticipated and un-mitigated people issues, GPs should examine deals against six key drivers of human capital performance: strategic alignment, leadership quality, talent and engagement, culture and identity, change agility and execution. Adding such examinations of each deal’s human capital elements to standard pre-transaction diligence processes can help PE firms uncover the hidden gems and unearth the hidden landmines that can impact valuation.

Leader assessment

As part of their overall diligence process, GPs should implement an approach to assessing existing executives, and how they perform as a team. Beware, however, the assessments that give static performance indicators only: a letter grade or a percentage likelihood of success. Investors in 2021 have access to, and should capitalize on, smarter, more in-depth assessments that also provide them with a “user guide” and playbook for supporting the success of the executives and teams, especially during the first 100 days post-close.

Onboarding and strategic alignment

Investors can accelerate results by having a plan and process to help portfolio company executives clarify responsibilities, align on strategy, and build the relationships that enable teams to rapidly execute on the investment thesis. The best PE firms support such leaders, intentionally creating great working relationships with one another, the board, and the growth plan itself. They help engineer portfolio company management teams who deeply understand and believe in the growth strategy, and know exactly what they must do, both individually and collectively, to make it work.

The utilization of human capital due diligence across these three areas offers GPs one of the most effective means of mitigating risk, driving value creation, and accelerating growth. What’s more, it helps compensate for our overly virtual environment, adding more dimensions to evaluations, leadership development, team building and strategic alignment.

The return of the bullish market requires private equity investors to seek out every competitive advantage. Human capital due diligence offers the edge that is needed to capitalize on today’s opportunities and de-risk investment choices.

Dr. Matt Brubaker is CEO of FMG Leading and an expert in human capital dynamics in rapidly scaling companies. A frequent advisor to private equity firms, he serves as an operating partner at Windrose Health Investors.