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Top private equity funds mine past wins for lessons

By investigating past successes and failures, private equity firms can lay a strong foundation for future funds, investments and performance.

By Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma

Published on April 23, 2013
min read


This article originally appeared on Forbes.com. Private equity firms that succeed in generating top-quartile returns deal after deal must do much more than ride favorable market currents. In today’s ferociously competitive deal environment and at a time of economic uncertainty, what can PE firms do to improve their hit rate? To get to the source of the mystery, Bain & Company teamed up with Oliver Gottschalg, a professor at the École des Hautes Études Commerciales in Paris, and PERACS, a provider of quantitative analytics for the PE industry, to investigate the performance of more than 8,000 realized buyout deals that have passed through PE funds dating back to before 1995. As we describe in Bain & Company’s Global Private Equity Report 2013, our findings confirmed that most buyout funds—including the top-quartile performers—produce a mix of deals that are big winners and money losers. Indeed, a close examination of 117 mature buyout funds globally found that, on average, 17% of the funds’ completed deals returned at least five times their original investment and 30% did not earn back their investors’ money. Among the top-quartile funds, the proportion of winners rose to 30% and the number of losers shrank to just 23%. Clearly, the top funds do a better job of steering clear of investments that result in write-downs or write-offs. To mobilize the right resources and processes to ensure that a higher proportion of their investments will become run-away winners, some leading firms are subjecting their past deals to a detailed forensic examination. A forensic investigation can serve a multitude of purposes. It can help lay a strong foundation for the launch of a new fund or set the right course for investing an immature fund. Such a probing dissection of nearly 100 of its past deals helped one major global private equity firm define its deal “sweet spot” and mobilize its resources and processes around factors that make a deal successful. Examining the scores of variables that influenced each deal, the firm evaluated hard measures that influenced returns, such as leverage, multiple expansion, revenue growth and margins. The forensic team also explored a range of softer factors, such as the target company’s market growth, its leadership position against competitors, trends in its EBITDA and the characteristics of its management team. The forensic team also looked at the private equity firm’s experience with similar deals and the degree of influence it had over those companies, post-acquisition. The exercise uncovered 10 specific investment themes that were common to the firm’s successful deals but were missing from the underperformers. Putting those findings to work, the firm formalized guidelines for the deals it would target and improved operations to ensure that it would adhere to those guidelines. For example, management fortified its due diligence procedures and required deal teams to quantify factors that would be deal breakers, as well as specify scenarios where they would likely occur. It also implemented new investment committee processes for deal sign-off. A detailed forensic self-assessment can also guide a private equity firm’s move into new sectors, regions or deal types by exploiting successful formulas that worked in the past. Last year, a leading US-based sector-focused firm used deal diagnostics to sharpen the definition of its investment core and assess opportunities to grow beyond it. The forensics team tested more than 35 deal characteristics that influenced its past track record, including how the deal was sourced, the investment size, and the sector and region in which the company operated. It also evaluated the influence of more subjective factors, including the firm’s own expertise in the sector, the competitive position of the company in its industry and the strengths of both the company’s management team and the private equity firm’s internal deal team. The investigation uncovered three combinations of factors that were present in deals that had realized outstanding returns—a road map to where the firm would find its deal “sweet spot” both in its core market and in attractive adjacencies where it could build on its strengths. Based on these discoveries, the team set about improving how it would source future deals. Plumbing the depths of a firm’s strengths and weaknesses takes resolve—and not a little courage. Self-assessments tend to be highly politicized undertakings that often involve individuals who have contributed to some of the firm’s best- and worst-performing deals. For deal forensics to work, there is no alternative to openly and objectively tackling the process and making realistic judgments based on prevailing market conditions, but with an eye to future industry and competitive dynamics. Written by Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma, leaders of Bain & Company’s Private Equity Group.

This article originally appeared on Forbes.com.

Private equity firms that succeed in generating top-quartile returns deal after deal must do much more than ride favorable market currents. In today’s ferociously competitive deal environment and at a time of economic uncertainty, what can PE firms do to improve their hit rate? To get to the source of the mystery, Bain & Company teamed up with Oliver Gottschalg, a professor at the École des Hautes Études Commerciales in Paris, and PERACS, a provider of quantitative analytics for the PE industry, to investigate the performance of more than 8,000 realized buyout deals that have passed through PE funds dating back to before 1995.

As we describe in Bain & Company’s Global Private Equity Report 2013, our findings confirmed that most buyout funds—including the top-quartile performers—produce a mix of deals that are big winners and money losers. Indeed, a close examination of 117 mature buyout funds globally found that, on average, 17% of the funds’ completed deals returned at least five times their original investment and 30% did not earn back their investors’ money. Among the top-quartile funds, the proportion of winners rose to 30% and the number of losers shrank to just 23%. Clearly, the top funds do a better job of steering clear of investments that result in write-downs or write-offs.

To mobilize the right resources and processes to ensure that a higher proportion of their investments will become run-away winners, some leading firms are subjecting their past deals to a detailed forensic examination. A forensic investigation can serve a multitude of purposes. It can help lay a strong foundation for the launch of a new fund or set the right course for investing an immature fund.

Such a probing dissection of nearly 100 of its past deals helped one major global private equity firm define its deal “sweet spot” and mobilize its resources and processes around factors that make a deal successful. Examining the scores of variables that influenced each deal, the firm evaluated hard measures that influenced returns, such as leverage, multiple expansion, revenue growth and margins. The forensic team also explored a range of softer factors, such as the target company’s market growth, its leadership position against competitors, trends in its EBITDA and the characteristics of its management team. The forensic team also looked at the private equity firm’s experience with similar deals and the degree of influence it had over those companies, post-acquisition.

The exercise uncovered 10 specific investment themes that were common to the firm’s successful deals but were missing from the underperformers. Putting those findings to work, the firm formalized guidelines for the deals it would target and improved operations to ensure that it would adhere to those guidelines. For example, management fortified its due diligence procedures and required deal teams to quantify factors that would be deal breakers, as well as specify scenarios where they would likely occur. It also implemented new investment committee processes for deal sign-off.

A detailed forensic self-assessment can also guide a private equity firm’s move into new sectors, regions or deal types by exploiting successful formulas that worked in the past. Last year, a leading US-based sector-focused firm used deal diagnostics to sharpen the definition of its investment core and assess opportunities to grow beyond it. The forensics team tested more than 35 deal characteristics that influenced its past track record, including how the deal was sourced, the investment size, and the sector and region in which the company operated. It also evaluated the influence of more subjective factors, including the firm’s own expertise in the sector, the competitive position of the company in its industry and the strengths of both the company’s management team and the private equity firm’s internal deal team.

The investigation uncovered three combinations of factors that were present in deals that had realized outstanding returns—a road map to where the firm would find its deal “sweet spot” both in its core market and in attractive adjacencies where it could build on its strengths. Based on these discoveries, the team set about improving how it would source future deals.

Plumbing the depths of a firm’s strengths and weaknesses takes resolve—and not a little courage. Self-assessments tend to be highly politicized undertakings that often involve individuals who have contributed to some of the firm’s best- and worst-performing deals. For deal forensics to work, there is no alternative to openly and objectively tackling the process and making realistic judgments based on prevailing market conditions, but with an eye to future industry and competitive dynamics.

Written by Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma, leaders of Bain & Company’s Private Equity Group.