Every one of the 4,500 employees of Harley-Davidson will soon be a shareholder in the business. The iconic American motorcycle brand announced the initiative in February; it’s a public company, but it drew inspiration (and expertise) from a private markets firm.
KKR’s US industrials team, under the leadership of partner and co-head of Americas private equity Pete Stavros, has been honing an approach to employee engagement that could reshape private equity.
The team has now completed eight deals in which equity has been granted to all employees in the form of options. It is a simple idea that draws on a long-standing PE principle: that ownership is a powerful aligning force. This, however, goes beyond the conventional approach of “cutting in” only a select group of managers.
The most recent example involved manufacturing business Ingersoll Rand, formerly known as Gardner Denver. In September 2020, 16,000 employees (excluding management) were granted stock options worth a combined $150 million. This was the second grant during KKR’s ownership of the 150-year-old manufacturing business; at the time of the 2017 Gardner Denver initial public offering, all employees participated in a $100 million grant.
“If you look at the market value of all the equity awarded, it would be about $400 million,” Stavros tells New Private Markets in December, referencing the share price rise since IPO of around 120 percent. “We believe it is the largest such all employee grant ever done by a public company.”
“First of all, we think this is just the right thing to do”
When Stavros and I discuss the tactic over a Zoom call, I ask him: why do they do this? What do they hope for from their $400 million of value transferred to employees?
“First of all, we think this is just the right thing to do,” he responds. “But if you’re strictly talking about performance, we definitely see in the data higher retention, lower absenteeism and higher levels of employee engagement, which we measure pretty religiously in our companies.”
“At the same time, at the company level, we are seeing higher levels of productivity, higher quality, lower scrap rates, et cetera,” he continues. “So the company performance has improved, the employee experience has improved. And the logical leap you’ve got to make is that those two are connected… which is something we’re very comfortable betting on.”
How does this translate into returns? Stavros declines to discuss the performance of the deals, besides saying it has been a “win” for investors as well as employees. The market cap of NYSE-listed Ingersoll Rand was $18.6 billion at the time of writing. KKR originally delisted the business (then known as Gardner Denver) for $3.9 billion in 2013.
Stavros studied the history of employee engagement as an MBA student. He was inspired by conversations with his father: an hourly worker who riled at the perverse incentives that meant he would be better off maximising his time spent “on the job”, rather than focusing on getting the job done well and efficiently.
“My Dad’s not got much of a formal education, but he is a very smart guy,” says Stavros. “I think he was keen to have me understand as a kid that there was something wrong with the set up as it relates to hourly workers.”
When he reached a leadership position at KKR, he met with little resistance when he wanted to introduce the idea, because (in his words) it fit with KKR’s culture of partnership. When the private equity giant went public in 2010, every employee got stock.
“The conventional wisdom is that hourly employees won’t value ownership […] my dad was an hourly worker, so I find the concept of that offensive. I also just think it’s wrong”
KKR is not the only firm to cut employees into the economic upside of a buyout. French firm Ardian puts in place employee profit-sharing schemes for some of its private equity and infrastructure assets, but declines to discuss the details of these arrangements with New Private Markets.
Partners Group, another large private markets firm, has indicated that it will go in a similar direction. In early 2020 it announced that it was exploring options to channel some of the proceeds from portfolio company growth into a stakeholder benefits programme aimed at “creating positive impact for employees and other stakeholders”, and therefore “building better, more sustainable businesses”.
Other firms will probably follow; Stavros reports that buyout firm peers have been in touch to discuss his approach. At the time of our discussion he mentions he has been discussing the concept with an unnamed iconic US brand, which later turns out to be Harley-Davidson.
Before the world’s attention was diverted to the global pandemic, private capital had found itself on the receiving end of increasing public criticism. Examples of investments gone bad and sponsors not seeming to share sufficiently in the downside led to questions about private capital’s “licence to operate”. An investment approach that shares the upside more widely, therefore, could be a strong antidote to public disaffection.
The success of KKR’s programme – and its enthusiastic reception – leads me to ask Stavros: why don’t all deals look like this? It is not yet even standard practice across all KKR’s private equity deals.
There are barriers to this sort of grant, he says. For one thing it requires chief executives to adopt a whole new management style. “If you are going to do this the right way,” says Stavros, “the way [CEO] Vicente Reynal does it at Ingersoll-Rand, you have almost to turn towards open-book management, where you open up the business plan to your entire workforce; ‘Here’s the plan. Here’s where we’re headed. Here’s how we’re going to create value and you’re going to participate in it. And I’m going to share data with you every week on how we’re doing.’
“That’s a huge undertaking, and you’ve got to have a whole management team that wants to do it,” he adds. Nevertheless Stavros states with confidence that all the CEOs he has worked with consider this to be the “most fun” and “most meaningful” thing they’ve done in their careers. He highlights also that equity ownership is only one facet of an effective employee programme.
Another more obvious barrier is a reluctance to “give up” a slice of the financial upside.
“The conventional wisdom is that hourly employees won’t value ownership; they won’t understand it and ownership is really best suited in the hands of a small number of people at the top of an organisation who will understand it, value it, and are best positioned to drive performance,” says Stavros.
“My dad was an hourly worker, so I find the concept of that offensive. I also just think it’s wrong. We see it in the data. We see it anecdotally. We see change behaviours in employees at our companies that prove to us that that’s wrong.”
There are also sector-related barriers, notes Stavros; the sector in which he operates – industrials – is especially suited to equity grants because it involves large numbers of hourly workers, often long-tenured and lower income. There is normally plenty of scope to improve employee engagement. Other sectors may be less suited; retail, for example, builds in so much employee churn that “if you show up and start talking about a five-year plan, you would have lost people in the first 10 minutes because they don’t anticipate being there in a year’s time,” says Stavros. A software business, meanwhile, with smaller headcount and higher compensation levels might already have pretty high employee engagement rates.
That said, KKR is considering its application to other verticals and geographies, says Stavros, declining to elaborate.
The Ingersoll-Rand deal was team Stavros’s largest equity grant yet. This combined with his connection to the Harley-Davidson deal has started to garner more attention from the wider business community. The question is: how many other GPs will follow suit?