Private equity firms are falling short of their operational targets

31 July 2018 4 min. read
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Firms in the private equity sector are falling short of their operational targets following an investment or acquisition, according to a new survey conducted among 50 mid-sized and large investors in Northern America and Europe.

The private equity sector is on a high. Globally there are now just under 8,000 investment firms – up from 4,000 in 2006 – that together hold around $2.8 trillion of assets under management.

These private equity parties are continuously on the lookout for the best deals in the market. These companies have substantial growth potential on the back of strategic changes, whether they stem from accelerated growth, cost synergies, or (portfolio) restructuring. Last year private equity firms spent, according to Bain & Company, a staggering $440 billion on buyouts worldwide. However, as per a new study by US-based operations consultancy Maine Pointe, much of this value is found to be lost in the execution phase.

The study, titled ‘2018 Private Equity Survey’, found that there is a gap between targets for cost reduction, cash flow, and/or growth and the actual value derived following roll-out of private equity-driven roadmaps and action plans. After investing in companies, private equity firms craft performance improvement plans. These plans typically average between 4-6 months, and yield, on average, between 1% to 20% EBITDA improvement with results taking around one year to impact financial statements. While the investors surveyed believe that, for good deals, the value potential should be between 30% to 50%, most (76%) are finding in practice that less than 30% of cost/cash reduction is directly driven by these initiatives.Private equity firms are falling short of operational targetsKey reasons behind the ‘value gap’ are, according to the respondents, a lack of appropriately skilled and qualified resources, time constraints, and difficulties getting CEO/management co-operation. “Finding the right individuals with the right experience on the ground is the main challenge,” said Dan Ginsberg, Executive at Maine Pointe. “This confirms what we are seeing in the market, that many private equity firms do not have the processes or the tools they need to evaluate the employees.” Across the board, only 44% of the respondents highlighted they had a formal resource evaluation process incorporated in their approach.

In light of rising valuations and growing anxiety to invest due to record-breaking levels of dry powder ($1.8 billion late 2017), the researchers believe it is becoming increasingly important for equity managers to know upfront how capable the acquired talent pool would be in realizing the master plan. The role of analysis is central, according to Ginsberg: “Operational due diligence already plays a significant part in the private equity partners’ decision to invest and will increase in importance in the next two years.”

In a bid to support operational plans, most private equity firms work with various third parties – operating partners – to achieve improved operating results. Operating partners typically bring in third party resources to support due diligence and improve data analytics and IT capabilities, as well as to support supply chain and operations improvements.

However, most investors are “struggling to get it quite right and measure performance,” commented Mark McTigue, Vice President at the consulting firm. “This is mainly due to operating groups heavily relying on their networks and word of mouth, as opposed to using data-driven results when selecting a third party resource.”

Ginsberg concluded, “Private equity is going through changes. A growing focus on value creation to achieve returns is forcing investors to advance their own operating models.”