Top Private Equity Firms Mine Their Sweet Spots to Stay Ahead

Top Private Equity Firms Mine Their Sweet Spots to Stay Ahead

In private equity, as in most high-stakes business pursuits, sticking to what you’re good at is a surefire way to achieve real success.

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Top Private Equity Firms Mine Their Sweet Spots to Stay Ahead

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In private equity, as in most high-stakes business pursuits, sticking to what you’re good at is a surefire way to achieve real success. But in an industry in transition from its early buccaneering days, the thrill of pursuing attractive novelties can often result in a scattershot approach to finding new deals.

As we explain in Bain & Company’s Global Private Equity Report 2016, industry-leading PE firms know that the true sources of their repeatable success are encoded in their DNA—the combination of unique qualities deeply ingrained over time in the firms’ experience, ambition, talent and expertise. Many firms stray from their investment sweet spot because they fail to fully define what it is they know how to do best.

Finding, and sticking to, the firm’s investment sweet spot is critical because it provides a roadmap, showing deal teams the types of investments they should pursue, and gives limited partners (LPs) compelling reasons to back them. It sharpens the deal-vetting process by highlighting the critical issues to be tested during due diligence for every deal. It brings the firm’s expertise to bear in the bidding process by enabling the firm to make its best case with target-company management that, as owners, they would be the business’s best stewards. It increases the effectiveness of the firm’s investment committee by enabling the general partners (GPs) to recognize patterns that foretell success across deals. And it guides the firm’s multiyear investments to hire the right talent and build the right capabilities to ensure that success will continue to build upon success.


Bain’s analysis has found that deals that fall within the firm’s sweet spot consistently and significantly outperform those opportunistic deals that stray from it. On average, the multiple earned on all sweet-spot deals was a handsome 2.2 times invested capital vs. 1.3 times invested capital on the deals that deviated from the firm’s sweet spot.

The process of drawing a sweet spot’s boundaries is a painstaking one. When done right, the end result should circumscribe a precisely drawn investment space that encompasses the majority of the deals that a PE firm will undertake. That space should be at once broad enough so as not to limit the firm to just a narrow set of deal options but tight enough to focus the firm on areas in which it is most likely to result in success.

Begin with a deal postmortem. The first step is to undertake a deep dive into the firm’s own experience with deals, including those currently in its portfolio as well as those it has exited, by selecting a sample of investments that is broadly representative of its successes, so-so performers and failures across all the funds it has managed. The culling of winners from losers creates two pools of companies that a firm can probe for the sources of deal success and reasons for their failure.

Interview the experts. Step 2 of the sweet-spot investigation is to conduct structured interviews with the deal teams that managed a subset of the investments to explore the specific characteristics, value-creation initiatives, management team dynamics and external factors that influenced the deal outcomes. Understanding how deals succeed and why they succeed is essential for designing a repeatable model the firm can implement.

Weave the “red threads” together. By collating the data on deal performance with the insights derived from the deal team interviews, a PE firm’s sweet-spot steering committee is able to see the breakthrough features that its successful deals shared. The commonalities may span geographic markets, industry sectors, deal size and the types of companies in which the firm has invested.

Discover your “ahas!” The bull’s-eye of a well-defined investment sweet spot is the recognition of the winning factors that set a fund’s strong performers apart from its great ones. These are seldom the obvious criteria that investors usually look for such as a strong balance sheet or a patented process. Far more often, the unique competencies that a firm brings to bear are the ones that have a disproportionate impact on the deal’s success. PE firms that recognize the total impact that the presence of winning factors has on the returns of deals across their portfolio and that adhere to the disciplines of their sweet spot typically see a strong correlation—more winning factors typically bring higher returns.

Mind the warning signals. Often undermining the performance of deals that otherwise look so promising is the presence of common factors that nudge them off track. In some PE portfolio companies one of these warning signals might be a disruptive new technology, for example, or some other adverse shift in the competitive dynamics affecting the core business. Steering clear of these characteristics can spell the critical difference between a winning deal and a losing deal.

Of course, in today’s tough, competitive deal-making environment, it can be challenging for any PE firm to live within its sweet spot alone. But faced with today’s high prices and fast-paced competitive deal making, sticking to sweet-spot criteria can be the only way to maintain investment discipline. Knowing and adhering to its sweet spot gives a PE firm the confidence to be much more aggressive when sourcing and paying up for deals that it knows it can do well.

Hugh MacArthur, Graham Elton, Dan Haas and Suvir Varma are leaders of Bain & Company’s Private Equity Group.

Carl Evander is a principal in Bain’s Private Equity Group.


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