Thinking creatively about diligencing management teams
There is a striking takeaway from the latest Catalysis research on mid-market investor approaches to handling people issues is that when asked for their gut feel on the relative importance of management quality compared to other factors (including market, technology etc) in determining investment outcomes. The average across 94 responses across 52 PE houses is almost 68%. Such a high figure merits a fuller discussion of what that really means. But - for starters - it does suggest that understanding the nature of teams being backed should be a major preoccupation for investors.
In an ideal world, there would be plenty of time, access and budget to give the topic the fullest consideration. The problem, however, is that all sorts of circumstances affect how and how much insight into teams can be obtained:
Fee budgets may be limited
Accelerated deal timetables may make access tricky
Internal confidentiality issues may mean certain people cannot be involved
External confidentiality may mean that referencing cannot be safely carried out
Worries about goodwill may make investors reluctant to pursue diligence in this area.
Such concerns might lead a deal team to rely solely on their own observations of a management team together with impressions from whichever diligence streams are running. That could be supplemented by open-source background checks by people like our friends at Neotas (https://www.neotas.com/). There are limits, though, to the levels of insights on team/organisation risks such a restricted process is likely to offer – although forward-looking team and organisation strategy can be carried out post-deal.
Happily, there are multiple ways of approaching this conundrum with a little creativity. The starting point is to note that diligencing a team and organisation requires some degree of triangulation between sources. Unlike, say, financial DD which can (hopefully!) rely on a single set of accounts produced in accordance with proper accounting standards, work on teams requires make sense of team and organisational by considering several imperfect perspectives.
In principle, such perspectives can be accessed through a sufficiently wide range of referees. But, generally speaking, discussions with managers is a core prerequisite of any serious process. Those minimal considerations leave plenty of room to cope with a range of different transaction contexts through different DD and post-deal solutions.
The options below have been given labels but those are less important than the illustrative clusters of activities and the possibilities they create.
Full team and organisation review
Deploying a wider range of tools to gain input from not only top team but often also from second tier managers, on team and organisational issues.
Full discussions with members of the top team and shorter ones with other managers and stakeholders.
Initial verbal feedback to investors, followed by a full report and further feedback. Write ups on each individual as well as addressing key questions and an executive summary looking at the balance of challenge and horsepower. A full set of recommendations.
A management version of the report followed by a feedback session with the CEO and the Chair designate.
Question driven review
A tighter scope for typically smaller ticket transactions involving smaller organisations.
Use of a top team questionnaire, leadership profiles and background checks, then full interviews with key managers.
A focus in the report on key questions, executive summary, and recommendations. Two rounds of feedback with the deal team.
A management version of the report followed by a feedback session with the CEO.
Team referencing
Typically, a range of reference calls with qualified referees who are able to comment on specific individuals but also at team level. CEOs usually have a greater focus than others.
Reference positivity benchmarked against similar individuals and teams, to provide a sense of relative strength.
Summaries of each conversation as well as a synthesis of themes across the team.
‘Assessment plus’
Designed for situations where a team is small, or access very limited, and budget is constrained.
A focus on 1-2 key individuals, albeit usually with some input from other key stakeholders.
A shorter report with limited comments on wider team and organisation issues – but plenty of insight on the ‘backability’ of key individuals.
Post-deal pre-strategy review
Initial discussions with key board stakeholders to establish context, objectives, timelines and any constraints.
After a briefing to participants, ‘homework’ is issued to senior and second tier managers. That would involve a questionnaire to the top team or wider management team but could also involve our mapping roles or leadership profiles.
A range of discussions with senior managers and other internal and possibly external stakeholders, looking at individual, team, organisation, strategy and governance themes.
A data pack based on the homework is created with high-level commentary.
An initial feedback session with the project sponsors (usually 2-3 executives) to identify key issues and agree the approach to next steps.
A wider management workshop, probably with the whole senior team, to debate issues and options, and then form conclusions for management to work up into fuller proposals for the board.
In a subsequent board session, management is supported in presenting conclusions and talking through action items.
Those various elements can, of course, also be mixed and matched to get the right balance between time, insight and cost. Work can be split into two stages with key risks covered early on (e.g. assessing an MBI candidate) followed by team and organisation strategy work later in DD or post-deal.
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