As published by Madeleine Farman in the December/January issue of Private Equity International.

Value creation and operating resources for private equity firms is going to be a “table stakes” requirement, writes Madeleine Farman.

That’s according to John Beil, Head of Private Equity and Real Estate at Partners Capital. Many private equity firms have achieved a return of at least 2x and 15-plus percent gross returns over the past decade by acquiring high-margin, high-growth businesses with “abundant cashflow generation, riding their growth wave, and selling them to a larger PE sponsor”, according to a recent whitepaper published by the firm.

However, backing these same pockets won’t be enough to generate outperformance in the future. More than a quarter of firms do not have a value creation team, while many others “either rely on relatively disengaged and non-exclusive operating partners, or distribute value creation work for one deal across multiple PE firms”, the paper says.

And while some firms have invested heavily in their value creation resources, others are more focused on differentiating themselves via the way they approach a process, or by their unique sourcing angles, Beil says. Those firms may have fewer dedicated operating resources. “There are some old-school firms that have done well and plan to continue doing well by using more of a third-party model with operating resources,” Beil says. “We think that will be a challenged strategy going forward.”

Multiple expansion

Beil notes: “If a manager is just now thinking about investing in their operating resources, they’re already at least half a decade behind their peers that have really embraced that model.” He adds that those firms have built out teams, defined their strategy and have hired “the best talents in the market” who are incentivised by funds that have already been raised. For example, of all the PE exits to take place between 2016 and 2021, more than half of the value returned came from multiple expansion, the whitepaper shows. By 2025, Partners Capital expects more than half of the value returned will come from revenue growth, with multiple expansion representing 25 percent.

“Given the paradigm shift that we’ve had in the interest rate environment, it’s not to say that multiple expansion is going away forever,” Beil says. “But it’s going to be much harder to come by, and you can’t take it for granted any longer.”

There is no one-size-fits-all approach to assessing value creation resources and strength on the LP side. A small firm, for example, will not have the heft of a large alternatives asset manager with sizeable resources.