Article

It's time for PE firms to "up their alpha game"

Market indicators clearly point to stronger PE activity across the board in 2011, but PE firms must reassess how they can continue to deliver superior returns.

著者：Hugh MacArthur

First published on 3月 24, 2011
min read


Our view of the 2011 global PE markets must take into account not only the conflicting forces at work in 2010, but also the continued fragility of the global economic recovery and credit markets. Market indicators clearly point to stronger PE activity across the board in 2011: More deals will be consummated, more deals exited, returns will be higher, LPs will commit more funds for future transactions. However, stronger PE markets remain just one major geopolitical problem or sovereign debt crisis away from being derailed. When assessing the world of PE over the coming year, our watchwords of the day are "cautious optimism." Confidence that the still-fragile economic recovery will gain momentum in 2011 is fueling optimism that conditions are in place for the revival in PE deal volume to continue. PE firms wielding vast sums of dry powder are eager to put capital to work, the supply and range of deals will increase and more stable debt markets are better able to provide financing than they have been since 2007. Slow economic growth in the developed economies of North America and the EU continue to push GPs and LPs to look to new geographies and sectors for promising growth opportunities. Attractive emerging markets like Brazil and Central and Eastern Europe will continue to draw interest and will see outsize activity. PE firms have seen exit opportunities improve over the past year; and public-equity markets, sponsor-to-sponsor transactions and corporate M&A all continue to show signs of strength pointing to a continued pickup in exit activity in 2011. The pace of exits will be a major factor influencing new PE fund-raising in the year ahead, as GPs distribute realized returns to LPs and provide the lubricant to get the fundraising cogs turning. GPs and LPs will continue their dance around terms and conditions in search of a new alignment of interests. Although most LPs report seeing greater willingness on the part of GPs to modify nonfinancial terms, changes over hurdle rates and carry structures will not come easily. Without market beta in the form of strong GDP growth, expanding multiples and abundant leverage to drive returns, both GPs and LPs recognize that only the alpha that PE firms can provide through proprietary investment theses, enhanced due diligence and post-acquisition value-creation skills will lead their portfolio to outperform. The trading conditions for private equity have improved and may strengthen further in 2011. But if they did not recognize it before, investors should now be fully aware that the forces unleashed since the 2008 slump will continue to make generating attractive returns very challenging. PE firms must adapt and evolve. They need to reassess how they can continue to deliver superior returns when the traditional drivers they looked to in past years—GDP growth, multiple expansion and friendly debt markets—no longer provide the lift they once did. Going forward, PE firms will need to demonstrate to discriminating LPs that they have a well-defined investment strategy, a fully professionalized organization, rigorous due diligence processes and especially the distinctive value-creation capabilities needed to excel in the changed environment. Develop an adaptive investment strategy built on core strengths. To keep in step with LPs' changing tastes, many PE firms have expanded their geographic footprint across borders, and many have moved into new fund types. But PE firms cannot simply pursue diversification for diversification's sake and expect either to remain credible with LPs or have serious prospects for success in new areas. Bain analysis has found little correlation between the number of fund types or geographies in which a firm invests and its overall performance. Moreover, our interviews with LPs reveal that many do not place a premium on firms that bridge several fund types or geographies. Rather, these LPs evaluate each fund opportunity on its own merits. Before venturing outside their core, the best PE firms start by looking objectively in the mirror and asking themselves: "What do we do best?" PE firms that have enjoyed the greatest success typically follow five steps: First, they weigh not just the attractiveness of the opportunity but carefully vet it against their own strengths to assess their firm's ability to compete. Second, they ensure that the opportunity will be big enough to support an investment team and related infrastructure needed to succeed. Third, they carefully define their investment "sweet spot," that is, the deals they prefer to do based on such factors as industry sector, size, degree of control and investment thesis. Fourth, and often in parallel with the previous steps, they gauge interest of LPs and get their support before committing to the opportunity. Finally, after they proceed, they communicate their diversification plans clearly to LPs, leaving no opportunity that their well-thought-out investment strategy can be confused for style drift. Strengthen and professionalize the organization. PE firms need to attend to their organizational health and continually seek ways to professionalize, with a focus on four key areas. The first is talent management, with programs to attract, retain and motivate the best people. Of particular concern are the morale and incentives of PE firms' junior partners and analysts, many of whom joined at the height of the PE boom and have yet to earn any carry. PE firms will want to address these motivation issues, possibly rebase profit-sharing policies to improve incentives and strengthen the firm's overall culture. The second organizational area needing attention is investor relations. Most PE firms can no longer afford to cling to the old part-time model of fund-raising, having their best deal makers hit the road for a period of intensive interaction with LPs. They need to raise funds and manage investor relationships every day, year-round. That requires them to devote more full-time and senior talent to the task. They also need to create a strategic plan for mapping and segmenting the LP universe—staying connected to old LP relationships and developing new ones. Knowing more PE investors and getting better acquainted with the ones they already know is a much surer path to continued success. Building resources to support repeatable value-creation processes is the third organizational area PE firms need to address. With portfolio companies potentially needing more time to find their way to profitable exits, PE firms are left managing larger—and in many respects, more challenging-legacy portfolios. Nurturing these companies consumes precious partner energy, time and resources. Portfolio management can also be a distraction from the equally urgent business of scouting out and closing on new deals. Both activities need to be appropriately resourced and cordoned off to ensure they are done well. Because the business of running a PE firm has never been more complex, the firm's general management needs to be professionalized—the fourth organizational issue needing attention. Investment teams that operate across asset classes, regions and sectors need support that imposes new dimensions of responsibility for strategic planning and for managing the firm's brand, knowledge and talent. New regulatory requirements and compliance issues are making administrative roles more demanding. The most forward-looking PE firms have developed an integrative senior-executive-level set of functions that set the firm's direction, facilitate the sharing of insights across investment teams, develop the programs to recruit and motivate top talent, and take the lead in fund-raising and managing investor relations. Many PE firms are exploring whether their business would benefit by establishing an office of the CEO rather than continuing to be managed by committees, as many are today. Have truly proprietary investment theses and beef up due diligence: Given the higher-than-ever competitive intensity GPs face and the elevated prices they are required to pay for assets they acquire, PE firms need to dig deeper to ferret out how they can make money on deals. As important as it is for PE firms to be masters at adding value post-acquisition, that counts for little if a firm does not close the right deals, at the right price, in the first place. Firms that are best in class recognize that strengthening their due diligence and investment-committee processes helps them avoid losers and develop the proprietary insights required to stretch for winners. Build repeatable value-creation processes: Even in the heady days when PE returns were propelled by leverage, strong economic growth and buoyant equity markets, the top GPs set themselves apart by their ability to add alpha to their portfolio returns through their distinctive portfolio-management strengths. Today, however, with those traditional external sources of returns not expected to provide as much uplift, value-creation skills need to be in the tool kit of every PE firm. Many PE firms have already taken the first crucial step: They know they must become portfolio activists. In recent surveys, respondents from nearly four out of five firms agreed that helping their portfolio companies achieve operational improvements will be the key source of value creation over the next five years. More than 75 percent said they have begun to increase their involvement in portfolio company management, typically by beefing up standard financial and operating performance reporting. Some PE firms have gone further, assembling dedicated internal portfolio teams to unearth new operating efficiencies or growth potential in their portfolio companies and helping their managers to achieve them. But bringing talent and resources together to unlock value in their portfolio companies has led many PE firms into one or more of these common pitfalls: Throw people at the challenge without resolving how best to deploy them. Having a disciplined process is far more important than the volume of resources it consumes. With a focus on people over process, the squeaking wheel always gets the grease. It is easier, and certainly more valuable, to help a good company on a path to three times cash-on-cash return boost its performance to five times than it is to help a struggling company get from 0.5 times back to par or above. Achieving this calls for a process that reaches out to every portfolio company. One size fits all. The complexities of dealing with different businesses and management-team personalities are immense. A process that is both disciplined and flexible enough to partner with management teams to create value is crucial. Paralysis by analysis. Not knowing how to get started and struggling to change deeply entrenched operating norms, some PE firms wind up doing nothing. That is the worst pitfall of all. Our experience working with a wide range of PE firms around the world has shown that there is no single "killer app" that is right for all circumstances. Rather than try to do everything at once, PE firms that set out to become portfolio company value creators can begin by adopting a prevalent process that best suits their unique combination of firm and portfolio company characteristics. A prevalent process is a starting point and a guide for action, not the ultimate destination. Because it captures the most common situations a firm and its portfolio will likely face, the model a PE firm chooses becomes the foundation for developing the disciplines of a repeatable model. As their competence grows, PE firms can shift to a second phase—customizing their process and resources to the unique needs of each portfolio company. Ultimately, PE firms evolve into a third phase when they are able to flex their model dynamically to suit portfolio company needs at any stage in the ownership life cycle—from creating a post-acquisition blueprint to paving the path to an exit three to five years later. PE firms that reach this stage are able to combine fact-based insights about the business with the emotional intelligence required to read the needs of their portfolio company management teams in order to achieve a great plan within a performance culture that delivers over the entire life of the deal. More a précis than a full argument, the hot topics for 2011 we discuss above are certainly not exhaustive. Rather, they are a tip sheet of critical issues that we believe every PE firm needs to work on to be positioned successfully to earn outsized returns for its stakeholders in the years ahead. Hugh H. MacArthur is the head of Global Private Equity, Bain & Company. Excerpts from Bain & Company's Global Private Equity Report 2011.

Our view of the 2011 global PE markets must take into account not only the conflicting forces at work in 2010, but also the continued fragility of the global economic recovery and credit markets. Market indicators clearly point to stronger PE activity across the board in 2011: More deals will be consummated, more deals exited, returns will be higher, LPs will commit more funds for future transactions. However, stronger PE markets remain just one major geopolitical problem or sovereign debt crisis away from being derailed. When assessing the world of PE over the coming year, our watchwords of the day are "cautious optimism."

Confidence that the still-fragile economic recovery will gain momentum in 2011 is fueling optimism that conditions are in place for the revival in PE deal volume to continue. PE firms wielding vast sums of dry powder are eager to put capital to work, the supply and range of deals will increase and more stable debt markets are better able to provide financing than they have been since 2007.
Slow economic growth in the developed economies of North America and the EU continue to push GPs and LPs to look to new geographies and sectors for promising growth opportunities. Attractive emerging markets like Brazil and Central and Eastern Europe will continue to draw interest and will see outsize activity.
PE firms have seen exit opportunities improve over the past year; and public-equity markets, sponsor-to-sponsor transactions and corporate M&A all continue to show signs of strength pointing to a continued pickup in exit activity in 2011. The pace of exits will be a major factor influencing new PE fund-raising in the year ahead, as GPs distribute realized returns to LPs and provide the lubricant to get the fundraising cogs turning.
GPs and LPs will continue their dance around terms and conditions in search of a new alignment of interests. Although most LPs report seeing greater willingness on the part of GPs to modify nonfinancial terms, changes over hurdle rates and carry structures will not come easily.
Without market beta in the form of strong GDP growth, expanding multiples and abundant leverage to drive returns, both GPs and LPs recognize that only the alpha that PE firms can provide through proprietary investment theses, enhanced due diligence and post-acquisition value-creation skills will lead their portfolio to outperform. The trading conditions for private equity have improved and may strengthen further in 2011. But if they did not recognize it before, investors should now be fully aware that the forces unleashed since the 2008 slump will continue to make generating attractive returns very challenging.

PE firms must adapt and evolve. They need to reassess how they can continue to deliver superior returns when the traditional drivers they looked to in past years—GDP growth, multiple expansion and friendly debt markets—no longer provide the lift they once did. Going forward, PE firms will need to demonstrate to discriminating LPs that they have a well-defined investment strategy, a fully professionalized organization, rigorous due diligence processes and especially the distinctive value-creation capabilities needed to excel in the changed environment.

Develop an adaptive investment strategy built on core strengths. To keep in step with LPs' changing tastes, many PE firms have expanded their geographic footprint across borders, and many have moved into new fund types. But PE firms cannot simply pursue diversification for diversification's sake and expect either to remain credible with LPs or have serious prospects for success in new areas. Bain analysis has found little correlation between the number of fund types or geographies in which a firm invests and its overall performance.

Moreover, our interviews with LPs reveal that many do not place a premium on firms that bridge several fund types or geographies. Rather, these LPs evaluate each fund opportunity on its own merits. Before venturing outside their core, the best PE firms start by looking objectively in the mirror and asking themselves: "What do we do best?" PE firms that have enjoyed the greatest success typically follow five steps:

First, they weigh not just the attractiveness of the opportunity but carefully vet it against their own strengths to assess their firm's ability to compete.

Second, they ensure that the opportunity will be big enough to support an investment team and related infrastructure needed to succeed.

Third, they carefully define their investment "sweet spot," that is, the deals they prefer to do based on such factors as industry sector, size, degree of control and investment thesis. Fourth, and often in parallel with the previous steps, they gauge interest of LPs and get their support before committing to the opportunity.

Finally, after they proceed, they communicate their diversification plans clearly to LPs, leaving no opportunity that their well-thought-out investment strategy can be confused for style drift. Strengthen and professionalize the organization.

PE firms need to attend to their organizational health and continually seek ways to professionalize, with a focus on four key areas. The first is talent management, with programs to attract, retain and motivate the best people. Of particular concern are the morale and incentives of PE firms' junior partners and analysts, many of whom joined at the height of the PE boom and have yet to earn any carry. PE firms will want to address these motivation issues, possibly rebase profit-sharing policies to improve incentives and strengthen the firm's overall culture.

The second organizational area needing attention is investor relations. Most PE firms can no longer afford to cling to the old part-time model of fund-raising, having their best deal makers hit the road for a period of intensive interaction with LPs. They need to raise funds and manage investor relationships every day, year-round.

That requires them to devote more full-time and senior talent to the task. They also need to create a strategic plan for mapping and segmenting the LP universe—staying connected to old LP relationships and developing new ones. Knowing more PE investors and getting better acquainted with the ones they already know is a much surer path to continued success.

Building resources to support repeatable value-creation processes is the third organizational area PE firms need to address. With portfolio companies potentially needing more time to find their way to profitable exits, PE firms are left managing larger—and in many respects, more challenging-legacy portfolios. Nurturing these companies consumes precious partner energy, time and resources. Portfolio management can also be a distraction from the equally urgent business of scouting out and closing on new deals. Both activities need to be appropriately resourced and cordoned off to ensure they are done well. Because the business of running a PE firm has never been more complex, the firm's general management needs to be professionalized—the fourth organizational issue needing attention.

Investment teams that operate across asset classes, regions and sectors need support that imposes new dimensions of responsibility for strategic planning and for managing the firm's brand, knowledge and talent. New regulatory requirements and compliance issues are making administrative roles more demanding. The most forward-looking PE firms have developed an integrative senior-executive-level set of functions that set the firm's direction, facilitate the sharing of insights across investment teams, develop the programs to recruit and motivate top talent, and take the lead in fund-raising and managing investor relations. Many PE firms are exploring whether their business would benefit by establishing an office of the CEO rather than continuing to be managed by committees, as many are today.

Have truly proprietary investment theses and beef up due diligence: Given the higher-than-ever competitive intensity GPs face and the elevated prices they are required to pay for assets they acquire, PE firms need to dig deeper to ferret out how they can make money on deals. As important as it is for PE firms to be masters at adding value post-acquisition, that counts for little if a firm does not close the right deals, at the right price, in the first place. Firms that are best in class recognize that strengthening their due diligence and investment-committee processes helps them avoid losers and develop the proprietary insights required to stretch for winners.

Build repeatable value-creation processes: Even in the heady days when PE returns were propelled by leverage, strong economic growth and buoyant equity markets, the top GPs set themselves apart by their ability to add alpha to their portfolio returns through their distinctive portfolio-management strengths. Today, however, with those traditional external sources of returns not expected to provide as much uplift, value-creation skills need to be in the tool kit of every PE firm. Many PE firms have already taken the first crucial step: They know they must become portfolio activists. In recent surveys, respondents from nearly four out of five firms agreed that helping their portfolio companies achieve operational improvements will be the key source of value creation over the next five years. More than 75 percent said they have begun to increase their involvement in portfolio company management, typically by beefing up standard financial and operating performance reporting.

Some PE firms have gone further, assembling dedicated internal portfolio teams to unearth new operating efficiencies or growth potential in their portfolio companies and helping their managers to achieve them. But bringing talent and resources together to unlock value in their portfolio companies has led many PE firms into one or more of these common pitfalls:

Throw people at the challenge without resolving how best to deploy them. Having a disciplined process is far more important than the volume of resources it consumes.
With a focus on people over process, the squeaking wheel always gets the grease. It is easier, and certainly more valuable, to help a good company on a path to three times cash-on-cash return boost its performance to five times than it is to help a struggling company get from 0.5 times back to par or above. Achieving this calls for a process that reaches out to every portfolio company.
One size fits all. The complexities of dealing with different businesses and management-team personalities are immense. A process that is both disciplined and flexible enough to partner with management teams to create value is crucial.
Paralysis by analysis. Not knowing how to get started and struggling to change deeply entrenched operating norms, some PE firms wind up doing nothing. That is the worst pitfall of all. Our experience working with a wide range of PE firms around the world has shown that there is no single "killer app" that is right for all circumstances. Rather than try to do everything at once, PE firms that set out to become portfolio company value creators can begin by adopting a prevalent process that best suits their unique combination of firm and portfolio company characteristics. A prevalent process is a starting point and a guide for action, not the ultimate destination. Because it captures the most common situations a firm and its portfolio will likely face, the model a PE firm chooses becomes the foundation for developing the disciplines of a repeatable model.

As their competence grows, PE firms can shift to a second phase—customizing their process and resources to the unique needs of each portfolio company. Ultimately, PE firms evolve into a third phase when they are able to flex their model dynamically to suit portfolio company needs at any stage in the ownership life cycle—from creating a post-acquisition blueprint to paving the path to an exit three to five years later. PE firms that reach this stage are able to combine fact-based insights about the business with the emotional intelligence required to read the needs of their portfolio company management teams in order to achieve a great plan within a performance culture that delivers over the entire life of the deal.

More a précis than a full argument, the hot topics for 2011 we discuss above are certainly not exhaustive. Rather, they are a tip sheet of critical issues that we believe every PE firm needs to work on to be positioned successfully to earn outsized returns for its stakeholders in the years ahead.

Hugh H. MacArthur is the head of Global Private Equity, Bain & Company. Excerpts from Bain & Company's Global Private Equity Report 2011.