De-risking CEO succession in private equity
Read this before you call Spencer Stuart
This article looks at PE firms’ heavy reliance on CEO recruiters and offers a playbook for internal CEO development instead.
If you want support implementing this approach for a fraction of what you’d pay a headhunter, our CEO Operating System (CEO-S) can help. It’s like EOS for grown-up companies.
Schedule a call with me to discuss your portfolio’s CEO succession strategy, or grab a copy of our book to see how the system works.
If you work in private equity, you know that almost all portfolio companies need a new CEO during the hold period.
Research puts that number at 73%, with half that turnover being completely unexpected.
This puts PE folks in a position where they do a LOT of CEO recruiting.
When it’s time for a new portfolio CEO, the default next step is to get a headhunter on the phone. With an experienced recruiting firm on board, the PE firm feels like the task is handled. Phew. You can sit back and trust that you’ll be given a slate of shiny can’t-miss CEO candidates who’ve “done it before.”
The pedigrees, resumes, and charisma will be there.
But is that shiny new external-hire CEO the best one to drive value creation in the portfolio company?
Based on many years of observation and direct work with CEOs, I’ve come to believe that many PE firms reach way too quickly for the magic bullet of the CEO headhunter.
The External CEO Reflex
About 75% of new PE-backed CEOs are external hires. That’s a total flip on how public companies do CEO hiring; they opt for an internal candidate 77% of the time, up from 67% just five years ago.
The Cooks, Nadellas, and Barras of the world were usually working in the ranks of their famous companies for many years before taking the CEO mantle.
I don’t think these public company boards are making those internal appointments out of sentimentality. Many have learned that internal candidates come with advantages - and those advantages often do translate to private equity.
Part of what drives PE firms toward external searches is the deal structure itself. Most private equity deals are competitive and thus start with an ambitious investment thesis.
This translates to a natural pressure to believe you need someone new to pull off that performance. The thinking is that new blood is needed for the new approach. But is that gamble worth it?
The Overlooked Risks of External CEO Hires
Although executive search for an external CEO has become private equity’s reflexive path, there are downside risks:
1. You pay a big premium.
External CEO hires command 18-20% higher compensation than internal promotions.
That premium flows through to higher equity grants and incentive opportunities, affecting your returns throughout the hold period. Add the often-lavish search firm fees and the opportunity cost of a six-month search plus another six months of ramp-up time, and you’ve consumed a year of your hold period before meaningful value creation begins.
2. Character is harder to assess from the outside.
It’s very hard to predict the character and behavior of an outside person who you bring in as CEO.
You can do your due diligence on a candidate, but it’s not the same as having worked with them. If you have an existing executive that you’ve worked with for five or 10 years and they’ve knocked it out of the park consistently and never had any big issues, you know something about their character. There’s probably not going to be a situation where they freak out as CEO.
In my rather unscientific estimate, there’s about a 30% chance the external hire ends up being a nutcase who does something stupid - maybe going to a Coldplay concert with the head of HR - and screws the whole thing up. That number goes down significantly if your new CEO is someone you’ve worked with for a while and trust.
3. Institutional knowledge gaps are wider than you expect.
There’s a lot your external CEO hire won’t know on day 1:
How decisions actually get made in the organization.
Which customer relationships are fragile.
Why the last three change initiatives failed.
Maybe even how the core business works.
They may struggle to decode the nuances of your portfolio company’s culture, customer base, or operational quirks. Those missing pieces can be a huge drag on execution speed.
4. Trust takes time.
For a CEO to lead, they have to earn their team’s trust. That takes a while when you’ve got someone new parachuting in. I’ve seen deals drag on by a full year simply because a new external CEO couldn’t build trust with the team fast enough.
5. External hires create retention risk across your executive team.
If you bring in a new CEO who’s not a great fit while ignoring the talented executives who could have been promoted, they will usually start updating their LinkedIn profiles. Once more people start jumping ship, you’re forced to fill multiple positions rather than build momentum toward an exit.
6. Prior CEO experience often doesn’t transfer the way you think.
Someone who successfully ran a division at a Fortune 500 company frequently struggles when they need to be hands-on with operations at a middle-market business. The skills that made them successful in one context can be counterproductive in another. You end up forcing them to unlearn habits that don’t fit. This is often harder than developing a high-potential internal candidate who doesn’t have conflicting muscle memory.
Do you need a genius CEO?
Here’s what I think many PE firms misunderstand about the CEO role itself: they dramatically overestimate the level of talent needed and underestimate the importance of knowledge and process.
Yes, there are rare cases where individual CEO talent drives the lion’s share of value. A Steve Jobs or an Elon Musk obviously makes a huge difference on performance. If it had been me running Tesla from day one, there’s no way Tesla is in the same position that it got to under Musk, because I wouldn’t have taken the same risks or been as out-there as he was.
But most CEO jobs just aren’t that way. Most CEO jobs hinge on the knowledge and the process of it. Up to 75% of the job comes down to understanding how the company creates value and getting good systems in place. If you’ve got a good market and are making widgets for the industrial mining industry or whatever - in that case there’s not the huge value of the Steve Jobs or Elon Musk.
And here’s the part that’s very under-appreciated: A lot of the CEO job is not about the upside. It’s about minimizing the downside. The CEO has as much downside or more downside potential to influence the organization than they do have upside potential. It’s more about NOT doing things wrong than anything brilliant you’re going to do.
That’s why those known quantities - internal candidates - make a lot of sense when you’re looking to de-risk the CEO search process in a portfolio company.
A lot of the CEO job is not about the upside. It’s about minimizing the downside.
The Overlooked Alternative
What I think many PE firms miss is the raw leadership and operational talent already in their portfolio companies.
That high-performing COO, VP of Sales, or CFO in the portfolio company right now has already demonstrated they can drive results. They know the business deeply. They have relationships throughout the organization. What they typically lack is exposure to the full scope of CEO responsibilities: owning the vision, providing resources, building culture systematically, making decisions that balance the whole organization, and delivering predictable performance.
But these skills can be taught. The CEO role is learnable for talented leaders with genuine motivation.
In a lot of businesses, it’s very hard to hire anybody who actually knows what they’re doing on day one. It’s often much more efficient to train them. You can’t hire people who are already good CEOs into your mid-size private equity portfolio company. And there just aren’t that many good CEOs anyway.
There certainly are times where external talent is required, but sometimes investing in great portfolio company executives who you and the team know and trust is a much better bet. They need to learn the specific aspects of the CEO job that are not obvious to somebody who hasn’t been in it. Then in all likelihood they can be pretty successful.
But these skills can be taught. The CEO role is learnable for talented leaders with genuine motivation.
The key is evaluating your options appropriately and having the wisdom to see when to turn to the leaders currently on your team. You’ll then make the decision from strength rather than defaulting to external search because it seems like your only option.
A PE Playbook for CEO Succession
Here’s how to make internal CEO development a part of your value-creation approach:
1. Map executive talent right after the deal
Within 90 days of closing each deal, identify the high-potential executives at the portfolio company. Within six months, assess who could potentially grow into CEO-level capability. Don’t wait for a CEO opening to start this evaluation.
Then, when CEO transitions happen (planned or unplanned) you have real options.
2. Give your CEOs a common operating system
A good operating system like CEO-S (think EOS for companies that have scaled up) creates a network of leaders across your portfolio who speak the same language of performance. The system compounds value across your entire portfolio rather than having a chaotic collection of fiefdoms using cobbled-together approaches.
This dramatically de-risks the CEO role because you’re not just taking random shots at people. You’re providing training and systems so they know what they’re doing.
3. Invest in executive development
Invest in expanding executive capabilities through formal training, board exposure, and strategic projects. Give high-performers visibility into CEO-level decision-making before you need them to step into the role.
What it requires is the right person combined with proper training and support. It’s a matter of teaching them the specifics of the CEO role, training them on the tools and mental models specific to that function.
4. Know the framework for internal vs. external CEOs
Internal candidates work best when:
The business is performing solidly
Operations are complex and institutional knowledge matters
You have strong talent ready to step up
Speed of execution is critical
The job is primarily about solid execution rather than dramatic transformation
External searches make sense when:
The business is genuinely struggling and needs a complete strategic reset
There is truly no internal leader with the capability or interest in stepping up
You need specific, rare expertise that doesn’t exist anywhere in the current team
The portfolio company has grown well beyond the current team’s scope and complexity level
You genuinely need that rare “Steve Jobs” level of individual talent
Apply these criteria consistently rather than defaulting to external search by habit.
CEO succession should be part of your value creation thesis from day one, not crisis management when someone quits.
Your next CEO might already be in your next board meeting. The question is: Will you develop them before you need them and give them a chance to shine once you do?
That’s often a much better bet than the shiny external hire who could blow up your deal.
If you found this post helpful, let’s talk about your own succession plan. I’m happy to talk with you about developing your promising internal execs into CEO material.