Playbooks for the Current Economy: Impact of a Downturn on the Human Capital Function

This session at the PEI OP Human Capital Forum, which brings together an elite crowd of human capital value creators and operating partner talent specialists, was organized to discuss if and how private equity firms are adjusting to current economic conditions, both in the portfolio and within the human capital function. Our attendees were predominantly talent partners with middle market funds, with a few venture and family office attendees. The majority of the attendees expected that:

1) The recession is close, but not here yet

2) The recession is likely to start around Q3 2023 to Q1 2024

3) It to be a "Soft" recession, lasting a few quarters; however, at least two firms expect it to be a "Hard" recession with significant, longer-term impact

Are there things you are doing or seeing in your portfolio as a result of the current economic situation?

Recruitment

The human capital leaders started off by commenting on recruitment. Overall, they said undesired churn is well down off its peak a year or so ago. While there is still a talent shortage, hiring demands are down. Consequently, talent partners are taking a few actions around recruiting to support their portfolio, such as:

• A few have pushed hiring to Q2 and Q3 instead of Q1.
• If positions remain unfilled, they are being cut.
• Another firm has consolidated their recruiting partners from three firms to one.

Talent optimization

Most firms are placing renewed emphasis on performance management, reflecting a shift from "how do I find talent" to "how do I optimize talent." Some are forcing HR managers to segment the population - clearly identifying the bottom 20% or 10%. Several discussed initiatives to upgrade those bottom-tier players. For the first time in a while, the talent pools are allowing leaders to "not settle" for lower levels of performance. Managers in businesses are being asked to focus on who they might replace and upgrade on their teams.

Because larger technology companies tend to have performance cultures, they already systematically go through this exercise, so it is easier for them to impose it on their companies. The messaging around performance management is also oriented towards retention, e.g., the strong team members who have recognized the mediocre teammates are "being heard."

Several members are also implementing guidelines for managing the top 20%. This includes new "playbooks" for High-Po identification and development as part of a retention strategy. The members are addressing ways to satisfy High-Pos in the case that compensation levels need to fall this year. Talent Leads are often being asked to outline development plans for these High Pos.

Workforce planning

Workforce planning and resource analysis is under greater scrutiny. Several attendees are developing their first Reduction in Force/Downsizing playbooks to get ahead of an expected downturn at the backend of the year.

Find out if your portfolio HR leads have done a RIF before. Most haven't. Portfolio companies tend to be high growth and had never been through a downsizing previously. Many firms are already working with HR managers to put a plan in place.

How to identify target employees? What are the legal ramifications? How can we train managers to deliver a message with empathy? How to manage/communicate with those who remain? A formal comms plan for the CEO was cited as urgent.

Cost reduction

There were other options being explored to reduce costs or shift from fixed to variable employee cost structures. Some firms have brought someone in to negotiate contracts for procurement across the portfolio as many companies did not have a sophisticated purchasing group or did not have the volume for great discounts. Outsourcing or offshoring are increasingly being looked at as a solution. Some are getting more traction with automating the back office; implementing RPA or find bots where you can replace a head, such as invoice automation.

Compensation

There were significant concerns around compensation of portfolio employees, particularly executives:

• It is important for human capital operating partners to look at how bonuses are being accrued - now. Find out about potential shortfalls and estimate appropriate targets (which are unlikely to be full payout). Determine whether there is enough clarity around merit and performance-based incentives and have your HR directors get in front of it.
• In a recessionary environment, messaging about bonus payouts is critical. Many employees have never gotten anything below full payout and will be shocked.
• Create or leverage the Compensation Committee, which should begin the discussion ASAP on expectations for full or partial payouts. Begin the discussion with EO/Top Team on equity well before Q4.
• Several are considering an equity bridge if bonuses are down or exits delayed.
• The discussion on exit delay and lower valuations have already been thought through by most boards in preparation for these discussions.
  

Bank failures

Finally, there were a surprising number of firms affected by the recent bank failures - approximately half the audience. Biggest lessons for the rest?

• Floating payroll was the biggest concern. Know which banks your portfolio companies use for payroll.
• Make sure there are at least two bank accounts available to your portfolio company - a primary and a backup, both pre-wired for payroll as this can take time to set up (often two weeks) and is difficult to do if there is a swift run on the bank.
• Consider scenario planning or a simulation with your HR directors.