Succession planning has always been a challenging and critical issue for all types of businesses to grapple with, and private equity firms are not exempt from dealing with these issues.Many private equity firms that neglect to prepare the next generation of leaders at their firm do not survive the lifetime of their founders.Like many other businesses, private equity firms can struggle with succession planning because the primary focus is on running the business--fundraising, doing deals and day-to-day activities.There are numerous factors that end up determining whether a private equity firm will have lasting success after their founders have left or retired, including:
·The founders must want the firm to outlast them and acknowledge that proper succession planning is vital to achieving that goal.
·The founders should cultivate a firm with strong leadership, structure and culture.
·The succession planning process should begin well in advance of the expected succession.
·The founders should be transparent with the next generation of leadership and take actions to prepare, motivate and retain them.
·The economics of the transition must be managed fairly to ensure all parties are satisfied.More specifically, the firm must consider how the economics (unvested/vested carried interest, unfunded capital commitment, capital contributions, profits earned on capital contributions, etc.) are affected upon the occurrence of various events (resignation, retirement, termination without cause, termination with cause, commitment default, transfer incident to divorce or bankruptcy, and breach of covenant).
·Current LPs should be made aware of the succession planning to both (i) solicit their input on their expectations regarding succession and (ii) show them (and potential LPs), which are increasingly doing diligence in the area of succession before committing capital, that the firm is focused on creating a stable, long-term future.
The failure of many private equity firms to survive their founders can be attributed to procrastinating on succession planning. Although succession planning is rarely the most pressing issue at any given time and founders often don’t want to acknowledge the reality of succession, it is crucial to all stakeholders in private equity firm that succession planning issues are addressed as early as possible to ensure the greatest likelihood of success for the next generation.