The GFC brought many lessons for PE: the one that stuck was about operational excellence

One of the most profound impacts that the global financial crisis had on private equity was to teach it to fundamentally improve its portfolio companies.

Ten years on from the collapse of Lehman Brothers: there is no better time to reflect on how the private equity industry was shaped by the global financial crisis. How effective was it as a steward of investors’ capital? Have the pain points of the past informed its current behaviour?

A recurring theme in this discussion is one of nervousness around leverage at this late stage of the cycle. Steve Rattner, former private equity boss, presidential advisor and now CEO of Bloomberg’s private family office, captures this in a short video filmed at the Private Debt Investor New York Forum this week. “The state of the credit markets is a bit scary: how tight the spreads are, how high the leverage ratios are, particularly in private equity deals. And that could all unwind,” he says.

Or as an unnamed GP put it to our reporters in Hong Kong last week: “People are returning to the bad behaviour of 2007-08, but worse.”

Do not assume, however, that nothing was learned from the events of the last decade. One lesson seems to have been knitted into the very fabric of the industry: the need for genuine operational engagement with portfolio companies.

As Béla Szigethy, co-CEO of global mid-market investor Riverside, notes, the recession instigated by the financial crisis pushed his firm, like many others, to adopt a greater operational role in its portfolio companies.

“That was not the case before 2008,” says Szigethy. “There is nothing like a good recession to shake you up and make you realise what you weren’t doing and what you could be doing to maximise the portfolio’s performance. In a way it was a blessing – a difficult blessing and one that caused our returns to go down, but it’s made us a better firm today and the private equity industry is better today as a result too.”

The need to effect or facilitate genuine operational value creation within portfolio companies is now widely accepted. Indeed some of our most attended events are those that bring operating partners, PE firms and investors together, such the forthcoming Operating Partners Forum: New York in October.

Yet the concept is a mercurial one. As Joncarlo Mark, an LP-turned-consultant, notes in our upcoming Operational Excellence Special (stay tuned for that next week) there is no “correct” formula for firms to be good at this. Repeatable excellence in this field could be achieved by an operationally focused firm with a deep bench of in-house operators. It could equally be achieved, however, by a financial buyer with the connections to bring in and align the right CEO for the job.

With no standard playbook, it is a true challenge for LPs to probe their managers effectively to establish just how good at this they are. (Worth noting that Mark runs a course on exactly this at the Institutional Limited Partners Association Institute.)

Next week we will reveal the winners of our annual Operational Excellence Awards: 12 case studies of private equity ownership that have been selected as outstanding examples of operational value creation. Judges from the worlds of consulting, investing and operations pored over applications to assess which stood out as stellar examples of operational improvement (as well as generators of stellar financial returns).

It is getting harder and harder to “pick winners” when selecting funds (at least according to this data set). We hope the OpEx roll of honour, when unveiled next week, gives LPs some insight into how a winner invests.

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