Editor’s Note: Fred Hassan will keynote our second annual PE-Backed CEO Summit, focused on the particular needs of portfolio-company CEOs, on Dec. 6, 2021 at the Nasdaq Marketsite in New York City (virtual options also available). Join us >
When it comes to leading companies there are few people we know who have more experience—and more varied experience—than Fred Hassan. From running industry-reshaping deals like his $41 billion sale of Schering Plough to Merck to founding his own biotech startups and scaleups to serving on the boards of numerous public and PE-backed company boards over decades, Fred has literally seen it all when it comes to leading businesses.
Now, as a director at Warburg Pincus, he’s helping the private-equity giant make bets and build wins. He routinely serves on boards of their portfolio companies, coaching their CEOs to transformational changes in some of the most complex, innovative industries on earth—amid one of the most overheated markets in memory.
I reached out to Hassan ahead of his keynote at our upcoming PE-Backed CEO Summit for thoughts and advice for leaders operating in this unprecedented moment for private equity, where pressures—and investor expectations—can be gargantuan. Here’s some of what he had to say, edited for length and clarity:
What goes wrong in the first year that you find most commonly? What are some of the trapdoors you’ve seen PE CEOs fall through when they’re trying to get up to speed on that tightened timeline?
The biggest trapdoor is to create false expectations with the investors. There is more pressure for performance from the investors. They are looking for EBITDA and revenue increases and then other things, and CEOs have a tendency to want to please the new people on the board. They might be tempted to overpromise that, yes, we will produce $50 million EBITDA this year, even though their gut tells them that that’s not going to be easy.
So there are ways CEOs can educate the board on what’s possible, what’s not possible and what might be a bit of a variable in the system.
If I can deliver $50 million and I’m very confident, I would then say that. But if it’s a stretch to deliver $50 million EBITDA, I would say, “Look, it’s a bit of a stretch, but I will go for it and my management team will go for it, but we will let you know if it’s becoming too much of a stretch as we go down the road”. For example, it might look like $50 million is doable in January, but it might be very much of a stretch by June. If you’re falling off the track that you’re on, in the back half of the year, you really need to jump a lot more to get to $50 million.
Sometimes, CEOs don’t communicate that clearly enough and explain that to the board, that “look, this thing is gonna be below the number and for this reason, and here is why you still need to have hope in this company and me because next year and the following year, things are gonna be better.” Well, we just need to be able to communicate that a little bit more because investors are more interested in results than in a typical public company board situation where you’re really having the analysts do your interpretation for you.
Do you find that given the heat of the current deal market that the expectation level on CEOs has gone up? People are clearly overpaying for things and they know they are. But there’s a lot of fear of missing out and money is free and there’s a lot of leverage going on. So do you find that there’s more pressure now on CEOs in that environment than there was say five, six years ago?
Much more because multiples overall have gone up about 100 percent. So what might’ve been a nine times or 10 times EBITDA, that multiple has now become 17, 18 times EBITDA. It’s the same asset and it’s the same environment. It’s just that because of the low cost of money and the abundance of money coming to private equity and the intensity of competition for assets, the going-in value has gone up a lot, which means that there is a bigger expectation from the management team to produce. That’s where I think there is a tendency for some disconnect.
Investors are assuming more EBITDA increases during the holding period as a way to justify the high valuations. That’s just human nature. I don’t think it’s a deliberate thing. It’s just human nature. There’s a lot of pressure to show that what normally would have been an increase of 7 percent or 8 percent CAGR becomes a 10 percent CAGR.
That’s a very large difference over five years, on the EBITDA. That kind of thinking has gone into place because when you’re paying multiples like 17 or 18 times EBITDA, your expectations to grow that EBITDA, go up dramatically. In other categories like tech, EBITDA is not the driver as much as revenue because people are still paying based on revenue multiples if it’s a SaaS asset, in which case, there is an expectation that revenue will grow 10 percent, 15 percent, 20 percent a year. Typically, 20 percent a year, because that’s the kind of expectation there is to justify a multiple of 30 times EBITDA or 40 times EBITDA.
It seems like right now it’s a mad scramble for the exits and understandably so. There’s so much money out there. The SPAC market has opened up new windows, the IPO market is on fire. What’s a tip for CEOs operating in this current environment where that 40-month, 50-month exit timeframe may suddenly get collapsed down on them?
There is no clear evidence in my mind that the hold periods are shrinking. There is a lot of evidence that the intensity at the time of pursuit has gone up dramatically, which is why the going in multiples have gone up a lot.
Typical hold periods are five to seven years. I haven’t seen evidence that that is changing a lot, but the expectation over these five to seven years has definitely gone up in EBITDA increases because people know that what might have been a very large multiple coming in, like 20 times or 18 times may not be the case five years out because the cost of money would have normalized by that time, and that’ll bring the multiples closer back to where they usually are, which is probably low double digit or high single digit. So that’s when people try to make up for the multiple compression by expecting more EBITDA increases and more pressure comes on management as a result of that.
Now, in certain markets like China, where exits are very hot right now, the hold periods have shrunk quite a bit because the IPO markets have opened up in Shanghai and there, it’s becoming much easier to buy at a pretty good multiple, not necessarily drive the EBITDA up that much, but then exit still with a very good exit value on the public markets in China.
So it really depends on the local situation. I’m talking a lot more about the US context here, as opposed to other places. Europe is also very, very heated up, very heated up right now. The whole private category is extra hot compared to public. And the pressure on CEOs is very high.
You coach a lot of CEOs. What do they ask you and what’s your best piece of advice these days for PE CEOs who might feel like a piece of metal between the anvil and the hammer at their companies?
Just be totally, brutally honest with yourself. Don’t fool yourself about anything. Just look at yourself in the mirror every day and ask yourself, “What am I doing? Where am I going? Am I good at what I’m doing? What am I not very good at? How should I go about doing what I need to do?” Just don’t fool yourself. Too many times, people just don’t have the self-compass, which is so important whether you’re in a private or a public thing.
The second thing is talent, talent, talent right now. There really is a war for talent, and it’s not all about money and incentives. It’s also about people feeling valued. So CEOs creating that high-touch environment with not only the level twos, but level threes and level fours can make a huge difference.
If you can prevent some of your hate-to-lose people from living in this environment, that can be very valuable. And talent then creates very good strategies and action plans. All the good stuff will occur if you have to have the talent. And at that point, the CEO has to be the culture shaper and the culture carrier, and both are very important. One is to shape it the way you want it to be and the second is you have to live it so people can see you doing it.
Many times people focus on performance, but good CEOs focus on: what do you do so that you get the performance? That means excellence and knowing your customers—intimacy with customers. Excellence in internal team spirit and teamwork.
These basics are absolutely critical. Some CEOs preach it regularly and live it themselves and that company is a much stronger company than those that just give it lip service, but really don’t come across as authentic on these three matters.
That’s where it finally catches up with you sooner or later, because if you are in a five-to-seven-year journey and if you haven’t built that internal resonance with your people and your customers, then you cannot outperform your competition. You’re probably going to be at—or below—your competitive situation.
The point I make to everybody is try to build that extraordinary resonance so you can get extraordinary results. If you have that resonance, you’ll have the extraordinary innovation. You’ll have extraordinary customer touch. You’ll have great team spirit on the inside, good communication. Everything will go well for you.
The other item I say to companies that scale up: if you’re growing 15 percent, 20 percent a year over three or four years, you’re soon going to be double the size and you’ll have more complexity, more layers, more silos. Fight the silos. You can’t avoid silos, but make this matrix not a problem to be managed, make it a competitive tool where you will do a better job than your competition. The reality is, as you get larger, you are going to have to work with a matrix. You are gonna have to work with layers. But make the culture your competitive weapon.
It’s surprising how people can be very successful with this. Others, they are just bound down, they’ll get very bureaucratic and eventually things don’t go well because people don’t know what the other group is doing or they start to have internal competition, which is not productive. The company starts to slow down, slow down and it becomes a helpless supertanker. It’s a real problem. So keeping the company alive, agile, and well-connected is really very important.