Barry Lyon recently made a career move that may have seemed odd. He was a rising executive as president of subsidiaries at Danaher, a Fortune 500 manufacturing conglomerate with 71,000 employees. Last summer, in his mid-forties, he left Danaher to become CEO of Industrial Physics, a 300-employee test and inspection company comprising 14 highly specialized brands.
The job’s appeal wouldn’t seem obvious except for one irresistible feature: Industrial Physics is owned by KKR, one of the world’s largest and most famous private equity firms, and it has big plans for the company. “I talked to other people who have made the jump from a public company over to a private equity CEO,” Lyon says. “The resounding theme is they just wish they did it earlier.”
It’s long been a running trend for CEOs and COOs to leave big companies in favor of helming private-equity-owned portfolio companies. But increasingly, lower-ranking executives are following a similar path. “There’s an increasing number of times where private equity firms are now taking division presidents,” says Jordan Brugg, global head of private equity at the Spencer Stuart executive search firm. These division chiefs are often potential CEOs at the publicly traded companies where they worked. As the trend advances, the C-suite repercussions could damage major corporations for years to come. “There’s a draining of succession talent from public companies,” Brugg says, “with their best people being plucked away.”
Private equity firms have grown into a rival corporate universe over the past 50 years, not nearly as visible as publicly traded companies and increasingly competing for the economy’s most valuable asset: human capital. These firms—Blackstone Group, KKR, CVC Capital, and Carlyle Group are the largest—have invested over $1 trillion in portfolio companies in each of the past two years, more than triple the amount of a decade ago.
To maintain such prodigious growth, private equity firms need more talent—and not just any talent. A recent McKinsey study finds that the most successful CEOs of private equity portfolio companies are “execution focused, decision-oriented, financially astute and motivated, and able to make consequential decisions quickly.” The U.S. has 22,956 PE-owned portfolio companies, according to the Private Equity Info research firm, and each one needs a CEO. After buying a company, the private equity firm installs a new CEO 70% of the time, and 75% of those CEOs come from outside the company, according to a 2022 study by researchers from the business schools of Harvard University, the University of Chicago, and Georgetown University. That playbook apparently works. The researchers found that companies that installed external CEOs in the first year performed best as measured by the increase in equity value, beating companies that didn’t by 27%.
Yet most big public companies follow a nearly opposite playbook, primarily selecting their CEOs from within. Among the S&P 500 companies that appointed a new CEO last year, 82% chose an insider, per Spencer Stuart research.
The private equity model holds many advantages in the intense competition for CEO talent. While public companies may consider an outsider, they’re strongly inclined to choose from a small number of internal candidates. By contrast, PE firms choose from the entire global market of managerial talent and somehow entice high-performing leaders to leave prestigious companies to run outfits most people have never heard of. How they do that is PE’s secret sauce—except it’s no secret.
Running a PE-owned portfolio company appeals strongly to public company executives because the experience is starkly different. The most important differences:
• Fewer distractions. High-level public company executives complain they don’t spend enough time running the business. They must also contend with quarterly earnings calls, Wall Street analysts, and sometimes take public stands on social or political issues. “I wanted to be more on the ground and able to direct my team’s focus to what matters most: designing products, making products, and selling products,” Lyon says.
• One shareholder. Public companies try to please thousands of shareholders. The CEO of a PE-owned company “doesn’t spend a big portion of their time aligning a variety of shareholders’ interests,” says Brugg.
• Clear strategy. A PE firm buys a company with a specific idea of how to make money, hiring executives and assembling a board of directors to execute that strategy. Little time is lost arguing over big-picture objectives and how to reach them. In Lyon’s case, KKR intends to consolidate many small firms in the fragmented test and inspection equipment industry.
• More resources. Big PE firms can raise money on better terms than most portfolio companies could on their own. They can also supply more and better advisors than most portfolio companies could engage.
• An endpoint. Portfolio companies, unlike public companies, are managed to be sold. From day one, the objective is to offload the company in three to six years at a price that doubles or triples the value of the equity. The company might be sold to a corporation, the public via an IPO, or even to another PE firm through a liquidity event. That clear, time-bound objective imposes a discipline that public companies don’t face.
• A huge payout (or not). Portfolio company CEOs may not always feel like CEOs. “There are no perks, no this, no that,” says Brugg. The base salary is lower than for public company CEOs, typically around $1 million vs. $1.2 million, and bonuses are tied to clear, aggressive goals. If a CEO doesn’t reach them, there is no bonus. But the CEO also gets a large grant of stock options, typically representing 2% to 3% of the company’s total equity. Consultants report rare cases in which the CEO gets 5% to 8%. If the company’s value increases, the options pay off at the liquidity event.
How much can private equity CEOs make? Consider a portfolio company bought for a modest $1 billion and sold for $3 billion five years later. That’s a $2 billion increase in equity. If the CEO’s options were tied to 3% of the equity, they would be worth $60 million. Add five years of salary plus bonuses equal to the salary, which is typical, and total pay is $70 million, or $14 million a year. It’s a huge sum for the CEO of such a small company.
The rewards can be far greater when all goes well at a larger portfolio company. That company’s CEO “can make hundreds of millions of dollars in a relatively short time,” reports Alan Johnson, a New York–based compensation consultant specializing in pay at financial firms. Another advantage? Less probing. “We’ve tried to demonize executives in the public sector,” Johnson says. “If you go private, you get no scrutiny at all.”
That’s the upside. The PE model also carries a potential downside. Consider one of the biggest-ever PE acquisitions, TXU Energy, Texas’s largest coal power plant operator. KKR, TPG Group, and Goldman Sachs Capital Partners jointly bought it in 2007 for $45 billion. It looked like a sure thing. Warren Buffett bet on its bonds, a blunder he later confessed was “an unforced error.” Seven years later, the company filed for one of the largest nonfinancial bankruptcies in U.S. history under the name Energy Futures Holdings. “People don’t pay much attention to the risk, and there’s a lot of risk,” says Brugg. “Some people come away with zero.”
In the battle for CEO talent, PE firms are taking the fight to public companies. They’re hiring highly credentialed full-time recruiters to constantly scan the landscape for potential CEOs and other executives, not necessarily with a specific portfolio company in mind. Courtney della Cava, Blackstone’s global talent expert, says she casts a wide net and especially likes to swipe public company No. 2 executives as portfolio company CEOs. “That’s where we have great success,” she says. “They’ve got the training, they’ve got the agility. They don’t have the calcified points of view. They bring the experience but not the playbook that they’re going to be rigid with.” Back at their public companies, those departing No. 2s may well have been future CEOs.
The intensifying contest for CEO talent is fiercely fought and could tip toward public or private employers. For now, PE firms are on the attack, and public companies are under siege. Public companies could play defense by partially mimicking PE pay, for example, offering new CEOs mega-grants of stock that vest in five to 10 years, with an understanding that no further grants will be awarded. Apple gave a similar grant to CEO Tim Cook several years ago, with spectacular results for him and Apple. Public companies could also be more open to outsider CEOs.
Withal, the allure of being a PE portfolio company CEO could wane. Interest rates have been near zero for most of the past 15 years, and delivering knockout results gets tougher with rates at 5% or more. “The easy days are over,” Johnson says.
Still, the grinding battle won’t end anytime soon. The only ones loving it will be high-potential CEO candidates.
