Our everyday culture has convinced us that we are the best judge of people’s character. While we wish that were true, consider the miserable divorce rate in the United States. If we can only get the most important decision of our life right less than 50% of the time, why do we continue to think we are the best judge of others? Entrusting a target investment to a leadership team based on little more than a semi-educated guess or an instinct is no different than Ben Affleck and Jennifer Lopez deciding to rekindle their relationship and hoping for a different result the second time around.
Leaders are hugely consequential for the organizations they serve. Their impact can determine the success or failure of organizations across industries, cultures, and geographies. Organizations live and die by the decisions that their leaders make regarding strategy, management, and execution. History is replete with stories of great companies that have failed because of poor leadership. Additionally, history provides us with examples of mediocre companies that made the right decisions and rose to the top of their industries through effective leadership. With all the research demonstrating that leaders are key to organizational success, why is “going on gut” such an accepted practice for private equity (PE) firms to assess the human capital of a target investment?
According to a Bain/Hunt Scanlon survey conducted in 2022, 122 PE principals reported that the quality of the target portfolio company management team was the most cited reason for deal success and the second most cited reason for deal failure. The same study found that 92% of respondents said that waiting too long to act on talent issues resulted in underperformance over the life of the investment. For an industry so focused on business-side diligence and data to secure success in all other aspects of dealmaking and value creation, the survey results paint a bleak picture of the “going on gut” strategy for performing human capital diligence. This current practice leaves the most significant determinant of success in plain sight, unquantified and unmeasured, except for occasional meetings, interviews, dinners, or happy hours. In short, industry experts are skipping one of the most consequential aspects of the business—the people.
Given the hyper-focus on the diligence of the economic side of a target transaction, the question remains, ‘What type of diligence are PE firms applying to the human capital side of the transaction?’ The answer is little to none. In fact, most PE firms are doing minimal or no diligence on the human capital side of their target transactions. In an industry consumed by analytical data from the business side of a transaction, “going on gut” appears to be the industry standard when performing human capital diligence. At its core, “going on gut” is no different than funding a top-notch F1 team and then entrusting the race car to my 16-year-old son. He has his license, has good manners, and his Mom trusts him—what could go wrong?
However, there is good news. Firms with the highest success rate have one thing in common: they are disciplined about linking talent decisions to the value creation plan from the beginning of diligence to closing and beyond. Starting during diligence, successful firms take a highly analytical approach when assessing the human capital side of the transaction. Using the firm’s plan for success, they work backward on the key talent evaluation by creating a fact-based, strategic set of talent requirements and identifying the critical capabilities and performance requirements needed to achieve the plan. After this step is complete, they can make more objective talent decisions and assess the current leadership team and key talent in the target portfolio company.
That’s where EnLite can help. Using predictive psychometrics and decades of validated research, EnLite employs a scientific approach to assess leadership talent against the backdrop of the firm’s objectives and critical capabilities. Our highly tailored, repeatable, and scalable process helps to de-risk the human capital side of the investment pre-deal and accelerate performance and time to value post-deal. This rigorous, analytical approach to human capital diligence makes talent decisions simpler by reducing ambiguity about what’s required to achieve success from the transaction.
To be truly successful in the long run, PE firms must replace “gut” decisions about who they liked during the meeting or dinner with a systematic and analytical approach to identifying the requirements for an investment and quantifying the likelihood of leadership to accomplish those objectives. Continuing to “go on gut” and disregarding rigorous, scientific human capital diligence is both risky and, in hindsight, could land you in a race car driven by my 16-year-old with Ben and J.Lo, asking yourself, “How did we get here again?”