Private Equity & Business Psychology

‘The issue for private equity is whether the intuitive and instinctive approach to selection it seems to prefer will guarantee success as deals get bigger and the stakes higher. We are finding more and more private equity investors are concluding it is not.’

 Dr. Robert Irving, RHR International London office

‘Nearly every mistake I’ve made has been in picking the wrong people, not the wrong idea’

 Arthur Rock, venture capitalist pioneer– early investor in Intel, Apple Computer, Scientific Data Systems and Teledyn

Whilst the application of business psychology to Private Equity is novel in South Africa, internationally it has been widely applied and practised with great success, with established, global companies such as RHR International, Human Equity Ltd and Fisher Rock Organisational Consulting offering an array of Business Psychology services to a kaleidoscope of Private Equity companies (such as Altus Capital Partners ; ARCH Venture Partners; Chicago Growth Partners ; CHS Capital ;Colville Capital ; FdG Associates GE Equity ;Glencoe Capital and Great Hill Partners).

Thus, while many South African Private Equity firms continue to make money and grow and cultivate successful portfolios of investments, the question one needs to ask is “why are so many international companies willing to spend capital and invest in Business Psychology services?”

The answer to this question can be found in international research, which has revealed that applying a rigorous, systematic HR due diligence improves Investment IRR[1]. Additionally, international case studies highlight the benefits to Portfolio Companies’ bottom-line performance, translating into a faster return on investment through utilising business psychology services during the ownership period[2].

So, what exactly is Business Psychology, and how can it be applied to your business?

Business (or Industrial psychology) is a relatively new branch of psychology that was created for corporations and organisations that needed greater guidance around effective human capital management. It is a discipline that aims to provide this guidance by evaluating employee behaviour for the good of the company. It is often referred to as organisational psychology because of its emphasis on analyzing individuals who work for various organisations.

In essence, then, Business Psychology is the application of the behavioural science of Psychology to the world of work. This application can take many different forms, the most pertinent of which, at least to the Private Equity context includes replacing a subjective, “gut feel” approach to selecting and working with an acquisition or portfolio management team, with a more rigorous, scientific methodology. Thus, Business Psychologists are trained in the “scientist-practitioner” model, which helps them to employ scientific principles and research-based designs to generate knowledge. They use what they have learned in applied settings to help clients address workplace needs.

Although Business Psychology did not begin until the 1920’s, the discipline has evolved rapidly and revolutionized the workplace within the last century. Because the workplace is a social system, the application of Business Psychology is useful in understanding its complexity. This is because Business Psychology evaluates the interaction between people and their jobs. Crucially, Business psychology also helps CEOs and executives adjust their way of thinking and their management style, in order to make the company more productive and sustainable.

So, how can one apply Business Psychology to the Private Equity Environment in South Africa?

Whilst different sections of the South African PE industry operate at different levels, target deals of different sizes, and thus face different types of challenges, the principles of Business Psychology can be applied to assist Private Equity businesses in two broad areas, and in several different ways. These are represented as a pyramid, below:

The remainder of this article will briefly touch on some of the generic ways in which Business Psychology can be applied to these two critical Private Equity areas.

Due Diligence

During the due diligence period, every Private Equity company is faced with several critical questions, such as those displayed below.

• How will this management team be able to execute our strategy?
• Will the organisation’s culture support the objectives or get in the way?
• How can we accelerate management’s ability to execute the investment thesis?
• Which players do we keep and who needs to go?
• How will this management team partner with us?

These questions are answered through the following Business Psychology interventions:

• CEO and Management Team Evaluation

 A rigorous scientific methodology combining both psychometric and competency-based assessments can be applied to determine CEO culture fit, strengths and development areas, as well as strategic and leadership capability. From a management team perspective, the focus is on understanding the team’s culture, potential, synergy, as well as strengths and developmental areas.

• Change Readiness Evaluation

Through the application of a Change Management Methodology the portfolio company’s change readiness, capacity to change and internal competence to manage change can be evaluated.

• Organisational Architecture and Remuneration gap analysis

In this process, an initial evaluation of the organisational architecture, organograms, performance management systems and remuneration levels can be undertaken, in order to highlight any potential misalignments with the culture of the Private Equity company, potential capability and resource gaps, and potential remuneration issues.

Ownership Period

During the ownership period, Private Equity firms are faced with a different set of questions to those faced in the Due Diligence phase. These may include the following:

• How do know that management have the skills to drive value into the future?
• How can we quickly get a new CEO integrated into our portfolio company and rapidly align the top team and organisation?
• What can we do to accelerate management’s alignment with a private equity business model
• We need to place a Senior Manager and choose from a shortlist of candidates – Who is the best person to select?
• What can be done to get an existing management team up to speed if they are not delivering?

Business psychology can help to maximize value creation with existing portfolio management teams with solutions to these questions, which can be achieved through the following services and strategies:

• Strategy Facilitation, Company-Wide Balanced Scorecard & Performance Management

The development or refinement of the portfolio company’s business strategy can be facilitated through the application of different Business Psychology methodologies and tools. The business strategy can then be translated into specific organisational performance objectives, as part of the Portfolio Company’s Balanced Score Card. The overall Balanced Scorecard can then be cascaded into departmental and individual balanced scorecards to ensure that a robust top-down performance management system is in place.

• Team Development

Psychometric assessments and other psychological tools can be used to unleash a team’s potential and enhance its synergy. Additionally, Business Psychologists can help teams uncover their strengths and developmental areas leading to greater value generation.

• Talent Assessment, Development and Coaching

Through the use of psychometric assessments, assessment centres and technical testing, Business Psychologists can tap into critical psychological constructs that impact occupational performance, such as cognitive ability, personality, and emotional intelligence. The developmental areas that emerge can be improved upon through coaching sessions leading to an overall enhancement of bottom line performance.

• Talent Mapping

The strength of the portfolio company’s talent pipeline can be assessed focussing on both employee potential and performance criteria. This ultimately produces a talent grid that can inform succession planning and broader business decisions.

• Change Management

International, scientific Change methodologies (such as the Anchor Chain Change Methodology) can be applied to firstly develop a change management strategy, secondly plan the change and lastly reinforce the change and deal with inevitable resistance. This approach helps companies to embrace the change and the new organisational reality.

• Organisational Design

Business Psychologists can ensure the organisational structure is properly refined, organograms are developed, job profiles created, reporting lines are clear and areas of responsibility are delineated.

• Evaluation of Reward and Incentive Schemes

Business Psychologists can review existing remuneration and reward systems through focussing on job evaluation, salary benchmarking and salary surveys. This process will ensure that a cost-effective reward system is in place.

[1] Human-Equity’s 2008 Survey of VCs and PE funds

[2] Human Equity, 2011