One-two punch of superior due diligence and activist ownership key to private equity outperformance; according to new Bain & Company market report


Contact: Dan Pinkney
Bain & Company
Telephone: +1 646 562 8102


New York, NY-March 4, 2010-According to a comprehensive private equity (PE) market report ("Global Private Equity Market Report, 2010") to be issued today by Bain & Company, the market leader in private equity consulting worldwide, a superior due diligence process followed by a quick transition to active owner involvement will be key to generating exceptional returns-in a future devoid of free-flowing credit, multiple arbitrage and mega-deal opportunities. The outlook finds that new buyout funds formed and new investments made over the next three-to-five years will likely generate gross returns in the low to mid-teens on average, several percentage points below their historic levels.

Bain's analysis of PE fund performance finds that the 'quality of the buy' drives top returns. The best-performing buyout funds have fewer deals that end up as 'zeroes'-just 8 percent versus 14 percent for the average fund. They also hit a lot more 'home runs' (defined in the analysis as five times the return on equity investment)-23 percent of deals versus 7 percent for average performers. The head start they give themselves with enhanced due diligence enables leading PE firms to deliver on what has become their most important differentiating capability-their talent for creating value in their portfolio companies post-acquisition. In an analysis of its clients' performance on deals closed and exited between 1993 and 2009, Bain finds that deal returns were 3.6 times the original investment, on average, in situations where early post-acquisition work was undertaken-well above the industry average of 1.4 times.

"As important as it is for a PE firm to be masters at adding value post-acquisition, that counts for little if it does not close the right deals, at the right price, in the first place," said Hugh MacArthur, global head of Bain's Private Equity Practice and author of the market study. "Then, even before the ink is dry on a deal, top PE firms pivot from deal-making to active engagement, accelerating performance in their new portfolio company to quickly achieve aggressive goals for post-deal value creation."

The report finds that enhanced due diligence is becoming increasingly important as PE firms focus their sights on smaller companies-often private ones or carve-outs of larger companies-where information is often less transparent. The analysis further goes on to explain that with less accommodating debt terms, it is becoming harder for PE firms to compete against the abilities of trade buyers to generate synergies. With valuations remaining at lofty levels, it takes strong due diligence to avoid losers and develop the proprietary insights required to stretch for winners.

While most, if not all, of PE firms have established due diligence processes, this capability is emerging as essential coming out of the downturn for firms to outperform their competitors in the days of modest returns ahead. Bain finds that PE firms which are best-in-class elevate their due-diligence model several notches, by:

  • Launching their due diligence before the auction process gets underway. They conduct an external assessment pre-auction to winnow deals and get a head start
  • Tailoring the length of their due diligence to the complexity of the asset being evaluated and remaining flexible based on their findings along the way. Instead of following a rigid three-to-four week process, they tend to engage in extended due diligence to deepen and refine insights beyond what their competitors develop
  • Expanding the scope of their due diligence far beyond testing the management plan and establishing the base case, as most PE firms do. Best-in-class PE firms augment their base case by testing for factors that can potentially boost the upside or increase risks. They also focus their resources on exploring potential "answer-changing" issues (those details that can make or break a deal) to develop a strong investment thesis
  • Following an institutionalized data-driven approach that is geared towards building proprietary insights on the target and its industry from the bottom up and outside in. They do not rely on management plans or third-party research reports

According to MacArthur, "the best PE firms not only have more horsepower in the due diligence engine room, but they also bring better processes to bear in the investment committee board room." As the report states, they formulate clear investment strategies and criteria that govern their decisions and are consistent with their investment focus. They follow a structured evaluation process, whereby each successive round focuses on different decision criteria that give them an effective 360-degree look at a potential deal. Finally, they zero in on key analytics that facilitate discussions that add value. Specifically, the investment committee examines a "must-have" set of analyses that tie to the firm's investment strategy-for example, evaluation of cyclicality, pricing trends, and customer concentration. The committee also abides to specific, non-negotiable 'deal breakers.'

Activist owners begin with a systematic on-boarding process to engage senior management at their new holding to focus on a handful of high-value initiatives that can yield outsize gains within the three-to-five year PE ownership period. Applying five key tools to help management deliver on the targeted goals, they:

  • Tap their network of external advisors and seasoned industry insiders to put the right people in the right jobs;
  • Work with the management team to develop a blueprint for choreographing the steps that need to convert the core initiatives into results;
  • Mobilize common functions and resources-such as purchasing, payroll management, and the like-across their portfolio companies to help hold down costs and bring scale efficiencies to bear;
  • Monitor and track a few key metrics to provide an early-warning system to alert management to take fast corrective action if the program begins to drift off-course;
  • Cultivate a results-oriented mindset in portfolio companies by putting in place an incentive system that holds management accountable and amply rewards them for hitting ambitious targets.

"Leading PE firms create repeatable processes that enable them to spur performance improvements again and again," concluded MacArthur. "Flawless execution of differentiating capabilities is the new price of admission for PE firms in the post-recession world."

Editor's note: To learn more about Bain's "Global Private Equity Market Report, 2010", or to schedule an interview with Hugh MacArthur, please contact Dan Pinkney at or +1 646 562 8102.

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