How PE can catalyze DE&I advancements
Over the past five years, McKinsey has studied the strengthening business case for gender and ethnic diversity: companies with greater diversity within their leadership team correlate to stronger financial results. Companies in the top quartile for gender diversity were 25 percent more likely to outperform industry-median EBIT growth than bottom-quartile companies. Similarly, executive teams in the top quartile of ethnic diversity were 36 percent more likely to financially outperform the industry median.
If this business case were to hold for PE-backed companies, beyond the increased likelihood of financial outperformance for the portfolio company itself, a PE fund focused on driving significant change across the portfolio would produce significant enterprise value for the fund. While it is still early days for PE on improving diversity, and the correlation remains to be validated for privately held companies, the scale of potential value creation is significant.
Firms are already moving ahead. Since May 2020, we have seen an uptick in the number of PE firms focused on DE&I. Much of that is because the energy gathering around gender and racial equity is raising expectations for employers. But institutional investors and other limited partners (LPs) are also beginning to bring DE&I criteria into their thinking as they allocate funds to general partners (GPs). Furthermore, as the data show, the push for increased DE&I could also make financial sense for PE firms.
While the standard tactics to improve DE&I—including early recruitment and interview prep for underrepresented minorities, unconscious bias training, and inclusivity surveys—are helpful to any company, some PE firms are beginning to assert that they can and should do more. A set of tailored and unique actions can help GPs and their portfolio companies improve DE&I in their organizations and lead across the business community. Here’s a small sample of those actions.
PE firms can do the following:
- Make a public commitment. Firms can, for example, establish an internal council on DE&I for themselves and their portfolio, with a C-level chair to signal that this matters. The council can develop metrics, set goals, and monitor progress on targets for both the firm and the portfolio.
- Conduct diversity assessments of targets. Firms can include DE&I throughout the deal life cycle. Building DE&I criteria into due diligence of targets and investment-committee reviews can help not only to assess risk but also to understand the value-creation opportunity inherent from improving DE&I. Once targets are acquired, owners should include DE&I in the 100-day value-creation plan. And they should revisit DE&I as one of the value-creation levers highlighted for buyers upon exit.
- Focus on diversity performance. Leadership can review firm and portfolio-company diversity metrics at all partner meetings and even link a portion of compensation to deal teams’ or portfolio companies’ performance on these DE&I metrics.
Within portfolio companies, advancing DE&I includes the following steps:
- Set diversity targets for boards. PE firms have seats on the boards of most of their investments. They can use those to position qualified, diverse candidates; they can also add seats to create a diverse board of directors with relevant skill sets for their companies.
- Establish diverse management teams. Firms can review the diversity of each portfolio company’s workforce and management and identify areas where increased DE&I could lead to improved culture and performance.
- Remove structural racism from all corporate policies portfolio-wide. Firms can examine current benefits and corporate policies and restructure them as needed to improve retention and promote equity in advancement of underrepresented minorities.
These levers are not exhaustive; instead, they are a few of the tangible ways that PE firms can lead in the creation of a more diverse, equitable, and inclusive workplace.
It is increasingly clear that PE’s push on DE&I in this moment can serve as a catalyst, with outsize impact across the business community, while also increasing the likelihood of outperformance for early adopters.
In the coming months, we will continue to share steps the industry can take to improve racial and gender diversity within its firms, portfolio companies, and as an industry.