Paving the Path for Succession
INTRODUCTION
Succession planning is essential for the legacy of any business. It requires more than determining which internal employee or employees will take on leadership roles as executives leave the firm. As more businesses refine their long-term plans, additional knowledge on the topic is required for successful transitions of leadership and equity. Succession planning is becoming more pertinent in the investment universe and Investors are asking for more clarity on best practices and future plans when it comes to evaluating Investment Management firms. Alliance Global Advisors is committed to providing Investment Managers with the informational materials necessary to implement a robust succession planning process.
The private equity real estate asset class began seeing greater institutional adoption in the 1980s as core funds were established. The asset class then expanded in the 1990s to include value-add and opportunistic strategies upon the formation of vehicles to target the distress driven by the Savings & Loan Crisis. With increased recognition in the sector, more firms emerged that were centered on offering Investors global choices in the asset class. Given the industry’s relative youth, the founders of many firms are now nearing retirement age. Additionally, many retirements were accelerated for many public plans in the post-COVID environment. Accordingly, these individuals are now focusing on maintaining a legacy and monetizing the enterprise value created.
As Blackstone executed its succession plan in 2018, current Executive Vice-Chair, Tony James, referred to succession planning as the “Achilles’ heel of any asset management firm.” It is a complex endeavor considering the emotional element of career discussions, involvement of strong personalities and the need to build consensus across a group.
Given these dynamics, no longer does an “emergency” succession plan meet the need of many investment firms or Institutional Investors’ expectations. This overview shares guidance for critical issues in succession planning, including leadership development, retention via economic alignment and compensation, transfer of equity and communication.
LEADERSHIP DEVELOPMENT
Investors value the articulation of a formalized leadership development process. It fosters comfort around organizational stability and business continuity, given leadership’s focus on building for the future by developing and providing a path to advancement for their team
A firm’s senior leadership must have a structured plan to identify and develop the next generation of leadership. Crucial to this is defining the firm’s culture, strategic direction and its implications for effective future leadership. Chris Miers, a Senior Research Consultant at NEPC, advised to “take stock of your entire team in conjunction with the firm’s long-term goals; this will identify gaps in competencies that will either need to be filled internally through further training and education or externally by introducing individuals with the required skills/knowledge”
With defined leadership roles, senior management should implement a systematic method to evaluate the strengths and weaknesses of the next generation. As the firm evolves, it is essential to assess the evaluation criteria and reassess candidates continuously. Miers commented, “It all starts with candid discussions amongst the executive team with respect to their strengths and weaknesses; once those have been identified, establish a team to develop a plan to retain, develop and attract talent as necessary. Many type-A personalities that sit at the top of an organization assume that others want to aspire to the senior ranks, when indeed many people are satisfied right where they are; this can lead to tensions about who should and wants to advance as the future leadership – and this can be avoided by an honest self-assessment by individuals and by the senior team”
RETENTION – ECONOMIC ALIGNMENT & COMPENSATION
Economic alignment with the success of the firm
General Partner (GP) Co-Investment
The purest form of alignment. Firms should consider avenues for broadening co-investment participation to include any professional who would like to invest and meets regulatory Investor eligibility requirements
Partnership
For the next generation, an equity interest in the management company ties their wealth creation to the future successes of the firm. In addition, becoming a partner is held in high regard as a milestone in career achievement
Carried Interest
Allocation of carry is vital for retention and alignment. During the succession process, senior leadership should reassign the carry of subsequent funds commensurate with their reduced involvement and the next generation’s increasing management and investment responsibilities
Competitive Compensation Structures (Salary & Bonus)
Salary and bonus are less complex components of retention. However, it is important for firms to conduct periodic surveys and benchmarking reviews to remain competitive
TRANSFER OF EQUITY
As the asset class has matured, sophisticated solutions have emerged to create capital events and monetize the enterprise value of a platform. A common solution is strategic Investors acquiring a majority or minority interest. A far less common but potential option to monetize value via the public markets is a rollup of the real estate assets and management company into a REIT vehicle
For Investors, the capital events raise questions around decreased alignment, impact on firm culture, pressure to have an asset-gathering rather than performance-driven mindset and potential for increased employee turnover
The valuations of these transactions have driven the prevalence of these strategic platform investment options. Accordingly, executing an internal transfer of equity is becoming more complex. The growth of GP seeding strategies may be a catalyst for increased turnover as the next generation considers spinning out to build their organizations in a more capital-efficient manner
Given these dynamics, the planning for an internal transfer of equity should be viewed as a long-term process to provide the most flexibility
On the topic of when it is acceptable to consider the sale of an entity in succession planning discussions, Chris Miers said that “A natural breakpoint would be when there is an impasse between the owners and/or between ownership and executive management. In the investment management industry, your company is worth the people it has and it is able to retain; if ownership issues create an issue around the firm’s ability to retain or attract talent, it might be time to introduce this topic”
COMMUNICATION
Employees
The need for transparent communication of succession planning is critical. It motivates employees by providing insight into career growth opportunities and clarity on the firm’s evaluation process for leadership roles
Investors
Investors have become increasingly focused on succession planning in diligence as Investors seek to ensure appropriate stewardship of invested capital. The lack of a clearly articulated succession process raises questions around organizational stability and team continuity. Once a firm has formalized a succession process, it should proactively communicate it to Investors
On the importance of communication in succession planning, Miers shared that "People like to generally minimize surprises in their work life; therefore, clearly articulate how each person can advance, explain what it expected of a person in that future role, and then provide each person the time and resources they need to advance/better themselves".
CONCLUSION
Research conducted by Deloitte indicates that 86% of business leaders believe succession planning is an “urgent” or “important” priority, although only 14% believe they do it well. Given the maturation of the private equity real estate asset class and recent retirements in the sector, a changing of the guard emphasizes the importance of thoughtful succession planning. The proverbial "hit by a bus" scenario is no longer the only question asked during due diligence. Adequate succession planning is a strategic initiative that considers building organizational longevity by developing the next generation. How are you protecting your legacy?
About Alliance Global Advisors
Alliance Global Advisors is a women-owned consulting firm focused on empowering the institutional investment community to elevate best practices. Advising clients with over $260 billion in assets under management, Alliance partners with organizations to provide an independent perspective and innovative approach to critical strategic initiatives. Our partnerships allow senior management teams to focus on what matters most: diligently managing client capital, creating value and delivering exceptional returns in a performance-driven market.
Disclaimer: This blog was originally published in October 2021 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance Global Advisors.