The Bleak Future of Private Equity

There’s no avoiding the reality: we are in a seller’s market right now, and that’s wreaking havoc on private equity firms.

As a result of the current climate, there is currently a greater supply of PEs than ever before.  Yet, with this increased number of PEs comes the stark reality that there’s very little (if any) differentiation as to what they do.

In short, they’re all focused on the same purpose: to buy companies. Yet while PEGs are growing in number, the amount of good companies worth buying remains limited.

What you’re left here with is a simple case of business economics: you have a lot more capital chasing after a limited amount of opportunities, meaning the deal valuations balloon in price.

In the end, PE firms and other buyers are forced to overpay. Good news for sellers. Not so good news for PEs.

Early successes has led to this shift

The pains that PEs are feeling today are a result of the period of economic growth in the early 21st century (through 2007). The attractiveness of the 2/20 compensation model brought on a flurry of new entrants to this space, including boutique investment banks, consultants and more.

And now, it appears, the industry is experiencing growing pains, similar to what’s occurred with the housing crisis (where an oversupply of assets of questionable value slows down the market’s ability to grow healthily).

Taking on an industry expert

While it’s never been more of a challenge to be a PE as it is today, that doesn’t mean that these firms are treading water without hopes of moving forward.

Realizing that many top-level executives are underemployed and in transition, a growing number of PE firms are snatching up these execs and offering them an unpaid role as industry expert-board advisor executive.

These executives provide PE firms with industry-specific knowledge, and offer the type of leadership and support necessary to help firms make business-savvy decisions. But they also serve a different purpose: that of a bargaining chip.

If and when a deal comes down to auctioning, having a top-level exec in your corner could be the difference between a done deal and one left on the table.

The use of Operating Partners

Another necessity for PE firms looking to adapt to their new business climate is the use of an Operating Partner, or executive mentor. The main purpose of this Operating Partner is to play an active role in post-closing implementation of strategy for the first 100 days following an acquisition.

The use of a fully integrated Operating Partner is a vital component of a successful PE firm, particularly for firms with an industry focus. That’s because this Operating Partner can and will be used consistently, jumping from one project to the next.

RC Victorino
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