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The new rules of private equity success

Three years after the global economic downturn, the contours of a new future for private equity are finally coming into sharp focus.

By Graham Elton, Hugh MacArthur and Suvir Varma

First published on agosto 21, 2012
min read


Three years after the global economic downturn, the contours of a new future for private equity are finally coming into sharp focus. Having guided their portfolio companies through the cyclical upheaval, the PE industry has begun to recognize the need to adapt to the new normal. As we explained in our Global Private Equity Report 2012, the skills of managing a balance sheet and keeping costs under control are now basic industry table stakes. Succeeding in these times requires new skills across every dimension of how private equity firms source deals, vet their growth potential, partner with portfolio management teams to achieve supercharged results, and, perhaps most challenging of all, reorganize themselves to develop a repeatable model for success. Here's what it takes to win: Identify growth opportunities others don't see At a time of premium-priced assets, general partners (GPs) need to dig deep to win auctions or seal proprietary deals—without overpaying. Leading private equity firms parlay their industry and sector expertise to enrich the mix of prospective candidates for their deal pipelines, probing deeply into specific subsectors in their deal "sweet spots" where growth opportunities are likely to be more abundant. To help expand and refine the target list, they engage a network of senior industry advisors and operating partners to bring in more potential deals and conduct an early triage to determine which prospects are worth pursuing further. Vigorously test the investment thesis With a focus on uncovering the true growth potential of the survivors of the initial vetting, the due-diligence process takes on a new importance and intensity. An enhanced due-diligence process thoroughly examines each opportunity both for hidden traps and buried treasure by first developing an exhaustive list of questions for the diligence team to explore. The team then fleshes out the priority issues that demand attention and carefully scope the diligence process to focus on them. Next, the team eliminates the blind side by testing its value-creation hypotheses against a range of scenarios the target company could face. Even the best investors will lose money from time to time, but what separates them from their less successful peers is that they are never taken by surprise. Make sure management is on board from the start GPs ensure that they are truly aligned with company management about what really matters for creating value. They work with management to agree on a sequence of actions they need to achieve meaningful growth and the timetable for producing projected results. Finally, they make sure management and the organization they oversee have the right talents, capabilities and resources to reliably deliver on the value-creation plan. Build a repeatable model for success Markets and competitive dynamics may have fundamentally changed in recent years, yet many private equity firms retain the "cottage industry" practices from the industry's early years, when individual deal makers took complete responsibility for all decisions related to portfolio companies from deal close to exit. Leading PE firms are breaking with the past to develop capabilities that enable them to institutionalize success. They do this by recruiting top talent beyond the financial wizards that have traditionally populated their managing director ranks. They are adding seasoned operating executives and former management consultants who bring a trained eye to uncover and implement value-creation opportunities, and who have experience working with company management teams to achieve transformational change. Second, they are broadening the role of their investment committees, requiring them to sign-off on an overall value-creation plan and specific first-year initiatives for a newly acquired company at the time of investment. Finally, forward-looking firms are making their portfolio committees a formal part of their governance model, empowering them to monitor the progress of each investment on a quarterly basis, identify which ones may need hands-on intervention, and tee up those that may be near-term candidates for exit. This post was written by Graham Elton, Hugh MacArthur and Suvir Varma, leaders of Bain & Company's Private Equity Group.

Three years after the global economic downturn, the contours of a new future for private equity are finally coming into sharp focus. Having guided their portfolio companies through the cyclical upheaval, the PE industry has begun to recognize the need to adapt to the new normal. As we explained in our Global Private Equity Report 2012, the skills of managing a balance sheet and keeping costs under control are now basic industry table stakes.

Succeeding in these times requires new skills across every dimension of how private equity firms source deals, vet their growth potential, partner with portfolio management teams to achieve supercharged results, and, perhaps most challenging of all, reorganize themselves to develop a repeatable model for success. Here's what it takes to win:

Identify growth opportunities others don't see

At a time of premium-priced assets, general partners (GPs) need to dig deep to win auctions or seal proprietary deals—without overpaying. Leading private equity firms parlay their industry and sector expertise to enrich the mix of prospective candidates for their deal pipelines, probing deeply into specific subsectors in their deal "sweet spots" where growth opportunities are likely to be more abundant. To help expand and refine the target list, they engage a network of senior industry advisors and operating partners to bring in more potential deals and conduct an early triage to determine which prospects are worth pursuing further.

Vigorously test the investment thesis

With a focus on uncovering the true growth potential of the survivors of the initial vetting, the due-diligence process takes on a new importance and intensity. An enhanced due-diligence process thoroughly examines each opportunity both for hidden traps and buried treasure by first developing an exhaustive list of questions for the diligence team to explore. The team then fleshes out the priority issues that demand attention and carefully scope the diligence process to focus on them. Next, the team eliminates the blind side by testing its value-creation hypotheses against a range of scenarios the target company could face. Even the best investors will lose money from time to time, but what separates them from their less successful peers is that they are never taken by surprise.

Make sure management is on board from the start

GPs ensure that they are truly aligned with company management about what really matters for creating value. They work with management to agree on a sequence of actions they need to achieve meaningful growth and the timetable for producing projected results. Finally, they make sure management and the organization they oversee have the right talents, capabilities and resources to reliably deliver on the value-creation plan.

Build a repeatable model for success

Markets and competitive dynamics may have fundamentally changed in recent years, yet many private equity firms retain the "cottage industry" practices from the industry's early years, when individual deal makers took complete responsibility for all decisions related to portfolio companies from deal close to exit.

Leading PE firms are breaking with the past to develop capabilities that enable them to institutionalize success. They do this by recruiting top talent beyond the financial wizards that have traditionally populated their managing director ranks. They are adding seasoned operating executives and former management consultants who bring a trained eye to uncover and implement value-creation opportunities, and who have experience working with company management teams to achieve transformational change.

Second, they are broadening the role of their investment committees, requiring them to sign-off on an overall value-creation plan and specific first-year initiatives for a newly acquired company at the time of investment.

Finally, forward-looking firms are making their portfolio committees a formal part of their governance model, empowering them to monitor the progress of each investment on a quarterly basis, identify which ones may need hands-on intervention, and tee up those that may be near-term candidates for exit.

This post was written by Graham Elton, Hugh MacArthur and Suvir Varma, leaders of Bain & Company's Private Equity Group.