IESE & BCG – Private Equity Shakeout

 

“Private equity firms will survive only if they create business value through their companies’ operational
performance, as investors demonstrate that they will not invest in firms focused on value creation through
financial leverage.

This is one of the conclusions of a recently published white paper developed jointly by IESE Business School and
The Boston Consulting Group (BCG). The authors of the paper are Prof. Heinrich Liechtenstein of IESE and Heino Meerkatt, a Munich-based senior partner and private-equity expert at BCG.

Titled “Time to Engage – or Fade Away: What All Owners Should Learn from the Shakeout in Private Equity”, the
study points out that there has already been an important increase in the number of investors in private equity and concludes that private equity will remain one of the key assets for capital allocation. However, there was a consensus among the investors interviewed for the study that financial leverage is over and that those companies that fail in operational value creation will disappear.

Based on interviews with limited partners who recently committed capital to private equity investments, the study describes the main nine levers that, according to both experts, are vital for operational value creation. Divided into two categories (table stakes and differentiators), these levers address and challenge widely spread common practices in business management.

For example, Prof. Liechtenstein points out that frequent evaluation of top management is one of the key stakes that allow companies to be on the radar screen of investors. “Through our study, we learned that those companies that evaluate their CEO and other top managers on a yearly basis produce a higher ROI.” But evaluation is only useful if
it has consequences. “Companies have to act, and this might mean supporting and developing managers, but it could also mean replacing them,” he said.

The white paper identifies incentives as another important lever in operational value creation. According to the authors, research shows that there is a significant positive impact on a company’s performance when the equity
stake held by managers increases. Research also shows that this equity stake is more effective than stock option programs at creating a share in downside risk.

Other important levers mentioned in the paper include a good business strategy, which the authors say requires a disruptive impulse to be developed. Because companies do not tend to create such an impulse themselves, private equity firms can benefit from a change in control or from the fact that they invest in companies with the clear intention of selling them after a time. The paper describes other levers, such as having a board with firepower and benefitting from the fact that private equity firms are insiders in the companies in their portfolio.

The category of levers that the authors call differentiators are those that make a real difference to investors. These levers, which are related to experience and capabilities and require much more time to implement, include
ownership experience, industry expertise and regional experience”.

Source: IESE Business School 

Download the full study