May 6, 2021
Samuel Robberts, Director at drx discusses the challenges around assessing leadership teams and how the firm approaches these.
Sometimes it just works. We’ve all experienced circumstances where for some unexplained reason, everything clicks, and it just works seamlessly. It’s even possible for this to happen among leadership teams. Indeed, it’s not uncommon in my work to engage with leadership teams where the why and the how of the team can’t be explained, even by those inside it. What these people know for certain, however, is that ‘at this moment in time’, it is working.
The more remarkable observation comes when, on paper, it looks like it really shouldn’t work, but somehow it does. This poses a challenge for people like me who are attempting to develop a more effective way in which to evaluate private equity-backed leadership teams and help optimise their potential for success.
In my experience, the discussion surrounding leadership evaluation and development can often reduce down to how much or how little the decision maker is willing to incorporate data into the process. I am aware that for some readers ‘data’ is a four-letter expletive, while for others it is like a red rag to a bull, maximally engaging their curiosity. This is why we bring a healthy and evolving scepticism to our work.
In fact, as we continue to build a dynamic criteria for evaluating leadership, results that deviate from our model are, on the contrary, very helpful. They provide us with an opportunity to learn, to adapt and to ultimately keep the model relevant and effective.
Companies that succeed ‘in the moment’ have often developed significant idiosyncrasies, forged through frequent challenges in the market. We might call these companies ‘functionally dysfunctional’. This is an idea analogous with false positives in the medical sector because while, yes, the test result may be positive, the issue at hand is ultimately benign.
Functionally dysfunctional organisations are ones that have clearly managed to succeed in creating value, but people are just struggling to explain why or how. They may be playing all the notes out of order, but they are still making music. We have recently completed work on a number of projects that sit inside this phenomenon. These projects usually correspond to the moment the music stops. In other words, the way in which things used to work have now changed.
Once again, the reasons for this are inexplicable. This does, though, tell us something about leadership teams, which our research has already demonstrated. It’s all about having the right people in the right place at the right time. As the time and place changes – as it should when companies go through value creation – the need for a leadership team to evolve should be considered. Seldom does this happen, however.
Indeed, our work is focussed on making sure that a leadership team as a whole is fit for the future and will be resilient to headwinds and shocks – such as Covid-19 – that may occur along the way. To that end, among these functionally dysfunctional teams, we seek to understand what could change in the business that will prevent the leadership team from achieving their results.
The maturity measure
One of the most interesting aspects that we’ve identified in this regard is the maturity of the organisation. This has traditionally been very hard to objectively measure and evaluate. Our quantitative approach to leadership, however, now enables us to do so, and it is worth considering in more detail. If we step back and think about the typical lifecycle of a company, the average profile for a founder is aged 40-50. This founder-led organisation becomes reasonably successful and along the way, they organically create a leadership team that reflects their own values. Because much of the leadership dependency is on the founder, the team functions in a hierarchical manner.
These companies are, therefore, anchored in the charisma of the founder. But there is a natural limit in the ability of the charismatic founder to fuel continued growth. Why is this? Often, it is because advanced age and/ or a successful period of wealth creation leads to a change in motivation. Additionally, a leadership structure that reflects the founder is less likely to be a forum for creative tension and, therefore, less likely to challenge certain orthodoxies. This is when organisations move into the functionally dysfunctional environment.
The leadership team has developed organically and is now a reflection of where it has come from more than where it needs to go. In other words, while it might be a highly effective team today, it is unlikely to be robust and effectively set-up to achieve what the value creation plan requires, and as that change starts to occur, the music can stop.
Too concentrated in experience
drx was recently engaged in an accelerated, off-market acquisition process to analyse a successful European testing and inspection company. The CEO-founder was looking to crystalise value from the company after 25 years of leading and building the business up from scratch. The founder was the traditional charismatic figure at the head of the company who had gradually stepped back into a Chair-like position.
The question the private equity investor had for us was: can we back this leadership team without the charismatic founder?
Within 48 hours, we were able to report back using an arm’s length evaluation. The departure of his valuable experience would be a key factor, but in addition, he was set to leave behind a functionally dysfunctional team with half a dozen ‘founder-clones’. This would create both a dependency issue and a leadership team too concentrated in one experience type and profile.
What’s more, the type of leadership deployed by the founder was now unsuited to the value creation plan. A robust leadership structure – one you could have confidence in throughout the investment plan – was missing.
It is apparent that these types of concentrated teams have limited longevity and will struggle to adapt. The functional dysfunctionality of the team would be fundamentally altered with the founder’s departure, and it was difficult to have confidence in the remaining team without considering a significant change to the leadership group.
In other circumstances, though, when working post-deal, we’ve been able to support companies beyond the functional dysfunctionality phase. Currently, drx are working with a £30m EBITDA digital homeware distributor. Through the pandemic, the business has fared remarkably well, which is a testament to their digital distribution model. But there is still a question to answer that concerns the team’s ability to effectively capitalise on the market’s opportunities over the next three years.
This solution is not focussed on wholesale change, however. It is about maximising the impact each part of the team is able to achieve. Our insights supported the client’s decision to move towards a clear function-led team, while also transforming the responsibilities of key members to better reflect their experience and capabilities. Only once the functional dysfunctionality was unpicked, was the team in a position to consider active changes and introduce new leaders.
Ultimately, this business is being guided through the same functional dysfunctionality that many businesses experience. It is moving towards a more mature state of leadership where a formal structure is in place to manage the requirements of the company moving forward. It will have delineated authority and responsibility within it.
Leadership as a fault line
The need for this constant evolution of a leadership team throughout the value creation cycle means that ‘leadership lag’ as the business evolves is a constant challenge. And this ‘lagging’ concept where the right leader maps to the right company at the right time is an important consideration, but one to expand on later perhaps.
We have carried out a lot of research into these maturity cycles and we know that successful companies are the ones that shift from functionally dysfunctional into a ‘functionally formal’ stage, while avoiding the pitfalls of becoming bureaucratic.
Founder-led businesses are hugely value accretive and are a force for good in the private equity ecosystem. However, founders are not going to be around forever, so ensuring that the leadership of the business is sustainable into the future can naturally be a tension point. This tension is normal. The question is how the transition can be made as painless and seamless as possible, so as not to disrupt value creation, and in fact, enable it.
Ultimately, our analysis tells us that leadership is the fault line in successful value creation. Yet it may surprise some, as it does us, that the leadership team is not always seen as the primary driver of an investment’s success. Even so, we believe strongly in this idea and our research continues, with a conviction, to deliver critical insights alongside our clients’ decision-making process.
Data can indeed be divisive, be it a four-letter expletive or an opportunity to discover. But regardless of where you sit, we all want to evaluate and develop leadership teams that can achieve consistent long-term success. In this endeavour there is no divide.
Director, Head of drxDATA