When it comes to operational excellence, there are a lot of firms out there that talk a good game, but how many of them are walking the walk with their portfolio companies?
It goes without saying that in a challenging investment climate, operational expertise isn’t a nice-to-have; it’s a prerequisite for success. The median US private equity deal multiple hit a staggering 12.9x in 2017, up from 9.6x in 2016, according to a report by valuation advisory firm Murray Devine.
In such an environment, either general partners are paying full prices for portfolio companies that they will need to radically transform to make money on, or they’re paying lower multiples for less-well performing companies that they will have to revitalise to make a profit. Either way, buying, holding and relying on multiple expansion is no longer an option, and hasn’t been for quite some time.
Limited partners are raising their standards for GPs. Investors’ growing desire to bypass funds either partly or altogether is putting pressure on fund managers. For one thing it means LPs and GPs are competing over the same talent pool, but more importantly, if a GP wants to maintain a coveted spot in an LP’s shrinking private equity portfolio, it will need to demonstrate it’s worth the fees.
But while assessing a firm’s operational capabilities is becoming increasingly important, it’s also becoming harder. GPs’ performance has been muddied by the use of subscription lines of credit, which can be used to lift returns by 300 basis points or more, according to research from Cambridge Associates. This makes it crucial for LPs to be able to determine the actual investment capabilities of the fund managers they invest with.
Actively demonstrating those skills is more important than ever.
That’s where PEI’s Operational Excellence Awards come in. Every year, we shine a light on those that are doing the best job at generating outsize returns in a volatile investment environment – and leaving their portfolio companies stronger and more resilient than when they started.
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