Private equity (PE) firms face several challenges in their quest for high-potential investments, including rising capital costs, extended holding periods, and economic unpredictability. However, an often-overlooked factor in their evaluations of their portfolio companies is the importance of effective human capital management.

The success of most companies is intricately tied to the presence of skilled and talented employees. In 2024, this is becoming more crucial than ever, especially as the best employees look towards companies that value employee well-being.

A study by FTSE Russell found that companies focusing on effectively managing their human capital have significantly higher productivity, revenue, and profitability, with revenue-per-employee growth nearly double the average rate. These can be untapped gains for a new acquisition, especially given the higher attrition rates during transitions and the challenges of retaining employees when leadership changes.

Studies consistently show that businesses prioritizing their people and fostering a positive culture achieve significantly higher levels of productivity, revenue, and profitability. In a business environment where every investment can impact the bottom line, nurturing a strong workforce within portfolio companies is especially important.

For most HR organizations, contributing to a company’s overall growth means fulfilling basic HR obligations like benefits and compensation. Consistent success and reliable growth patterns require skilled and talented employees who want to stick around. This aspect of HR goes beyond the due diligence necessary to provide benefits and compensation—technological advancements, changing work patterns, and a growing skills gap challenge firms to improve portfolio performance. Therefore, PE firms must prioritize strategic human capital management to improve portfolio performance.

In my recent 3Sixty Insights Research Note, I highlight the value of strategic human capital management for emerging PE firms. It demonstrates the increasingly effective approach of leveraging a professional employer organization (PEO) HR outsourcing model to fill potential gaps in HR. Especially for emerging organizations or those undergoing mergers and acquisitions, PEOs can provide scalable HR expertise and a scalable infrastructure and help drive profitability.

This is where a skilled PEO like Insperity comes in. Often referred to as handling “concrete HR,” PEOs can help manage the day-to-day nuts and bolts of running an HR organization, such as payroll, benefits, taxes, and compliance, that often bog organizations down. Insperity, for example, steps in to relieve the burden of these operational tasks, allowing in-house HR teams to focus on “abstract HR” – higher-level initiatives like enhancing employee experience, HR roadmap items, and aligning with the internal goals. Meanwhile, in the background, a PEO provides stability and operation excellence, which is crucial for businesses expanding into new states or growing rapidly.

For PE firms looking to streamline and grow their portfolio companies, PEOs can act as strategic partners since they enhance overall efficiency. Insperity, for instance, offers dedicated HR teams to each client, optimizing functions, helping reduce costs, and supporting strategic growth through expertise in mergers and acquisitions. PEOs also enhance employee engagement and stability during transitions, ensuring top talent retention and aligning HR strategies with business goals for sustainable growth. A boon for employees is also the access to enterprise-level benefits that would otherwise be unattainable outside the umbrella of a PEO.

One key aspect of PEOs is their ability to minimize disruptions during transitions, ensuring business continuity. In the event of compliance work caused by the frictions of change, PEOs can ensure businesses are prepared for lawsuits, fines, or other issues, allowing internal teams to focus on growth.

While there are some misconceptions about PEOs – such as fears that they take control away from business owners – these are unfounded. PEOs assume specific employer obligations, but ultimate control remains with the business owners. Rather than replacing internal staff, PEOs complement them, minimizing disruptions and offering value to small and large companies. However, knowledge gaps about the PEO model persist, prompting PEO providers to provide educational resources to help PE firms understand the strategic value of PEOs in improving HR functions and overall business performance.

Private equity firms can’t afford to ignore the strategic value of HCM and successful HR organizations. By partnering with a skilled PEO, PE firms can enhance operations and retention while driving optimization across their portfolio companies. The landscape of work is constantly changing, but having a PEO partner can keep your business on a path to success.