PE firms that can emphasize value creation in the portfolio, execute on their defined investment strategy and create a professionalized back-office function will emerge as the winners of tomorrow.
The industry continues to evolve and react to challenging economic conditions. 2011 promises to be a dynamic year for PE. With banks and capital markets supporting a growing number of high quality deals, significant stores of committed capital to spend and increased exit opportunities, conditions are improving for a sustained period of normalized investment levels.
The next few years will be a decisive time for PE houses. Firms that can successfully tackle three over-arching issues — emphasizing value creation in the portfolio, executing on the defined investment strategy and creating a professionalized back-office function — will emerge as the winners of tomorrow.
Performance improvement to remain a key focus
At the heart of today's PE business is value creation. Long gone are the days of successful buyouts on the back of pure financial engineering. PE firms are business operators and spend significant time transforming the businesses they acquire.
As we continue through 2011, we expect to see continued and growing use of formal performance improvement initiatives as PEs adapt and refine measures implemented in the depths of the recession — used then to save portfolio companies, but used now to help those companies grow and thrive.
Many leading practices in performance improvement were already part of PE's normal practice; but were simply further reinforced by the downturn. Normal practices, such as the importance of a comprehensive and thorough due diligence process, having the right management team in place, making sure all parties are properly incentivized and aligned, and in particular, the increasing use of operating partners and portfolio operations teams are even more important given market conditions.
We expect future years' studies to show an even greater proportion of deal returns from PE involvement, the result of an increased focus on portfolio improvement initiatives throughout the industry. Our annual "How do private equity investors create value?" study shows a roughly even split in the returns attribution between debt, public market returns and outperformance.
PE firms are implementing performance improvement strategies to realize significant benefits and to respond to growing expectations from their LPs. Today's LPs want active ownership from PE investors. They want to see that value is being delivered and understand how — motivating PE firms to perform attribution analyses to reference contributions. Transparent communication between PEs and their investors has never been more imperative.
The importance of thorough due diligence
While the use of operating partners or teams and portfolio operations teams have been part of the PE model for some time, this growing practice is one of the key means through which PE firms are working to improve the performance of companies during their ownership period.
Operating partners can bring specialized expertise and deep industry experience to augment a PE firm, helping to identify new opportunities, quickly integrate acquisitions and rapidly implement a firm's strategic plan.
Many firms cite the expertise and experience they were able to access through their operating partners as one of the key differentiators that helped their portfolio companies survive the recession, and begin to thrive in its aftermath. They are now hoping that the intense focus on the portfolio companies will result in increased exit opportunities yielding positive returns.
Similarly, PE firms are increasingly relying on portfolio operations teams to realize revenue enhancement and cost-efficiency synergies across their portfolios. Operations teams are also credited with quickly professionalizing and optimizing existing policies, procedures and systems across the range of firms' portfolio holdings, including financial accounting and controls; reporting procedures and systems and IT infrastructure.
How far in advance firms evaluated
a potential target 2005-09