Mckinsey Why Some Private Equity Firms Do Better Than Others

Published on May 2017 | Categories: Documents | Downloads: 62 | Comments: 0 | Views: 506
of 3
Download PDF   Embed   Report

Comments

Content


The McKinsey Quarterly 2005 Number 1 24
Private equity firms have long promoted
the virtue of active ownership—the hands-
on style that distinguishes them from
traditional portfolio investors. But what does
active ownership mean, and does it really
lead to superior performance?
Recent McKinsey research reveals a strong
correlation between five steps that private
equity firms can take to direct a company
in which they invest and outperformance
by that company—in other words, perfor-
mance better than that of its industry peers.
Many private equity firms have embraced
these steps and execute them well, yet
surprisingly few do so in the consistent and
systematic way that would increase the
returns from an active-ownership approach.
Eleven leading private equity firms, all
boasting better-than-average track records,
made up our sample. Each of them
submitted five or six deals from which they
had exited. The deals represented a range
of returns from average to very good. To
calculate the value generated by active
ownership, we built a model to isolate the
source of each deal’s value: overall stock
market appreciation, sector appreciation,
the effect of extra financial leverage on
those market or sector gains, arbitrage (a
below-market purchase price), or company
outperformance.
The main source of value in nearly two-
thirds of the deals in our sample was
company outperformance. Market or
sector increases accounted for the rest
(Exhibit 1).
1
Outperformance, which
generated a risk-adjusted return twice that
of market or sector growth, was the least
variable source of value.
These results show that outperformance by
companies is clearly the heart of the way
private equity firms create value. How do
top investors make this happen? Interviews
with deal partners and with the CEOs of
Why some private
equity firms do better
than others
Joachim Heel
and Conor Kehoe
� � � � � � � �
������� ��� ����
������� ������ �� ����� ��������� �
�� ����
��� ������� ������
������� � �� �
������� ������� �� ����� �� ������� ������ �����
�������
��������������
�������������
������������� ����
�������� ��������
���������
��
��

���� � �� ����� ���� �� ������� ������� ������ ����
Investments don’t govern themselves; active ownership is the answer.
Kevin Curry
Research in Brief 25
target companies—and the correlation
of the results with cash-in/cash-out
multiples
2
—identified five common features
that could constitute a code of leading-edge
practice. The first two concern traditional
private equity competencies, the other
three a more engaged form of corporate
governance that we describe as true active
ownership.
First, successful deal partners seek out
expertise before committing themselves.
In 83 percent of the best deals, the initial
step for investors was to secure privileged
knowledge: insights from the board,
management, or a trusted external source.
In the worst third of deals, expertise
was sought less than half of the time.
Second, successful deal partners institute
substantial and focused performance
incentives—usually a system of rewards
equaling 15 to 20 percent of the total
equity. Such incentives heavily target a
company’s leading officers as well as
a handful of others who report directly
to the chief executive. In addition, best-
practice deal partners require CEOs
to invest personally in these ventures.
There is no standard formula, but the
most successful arrangements call for a
significant commitment by CEOs while
ensuring that the potential rewards don’t
make them too risk averse. Formulas
that failed to account for the individual
circumstances of a company’s officers or
that spread incentives too widely proved
less effective.
Next, successful deal partners craft better
value creation plans and execute them
more effectively. Naturally, management’s
plan is a part of the process, but the best
new owners view it skeptically and develop
their own well-researched viewpoint that
they use to challenge it. Once developed,
the plan is subject to nearly continual
review and revision, and an appropriate
set of key performance indicators is
developed to ensure that it remains on track.
Firms implemented such a performance-
management system in 92 percent of
the best-performing deals and only half as
often in the worst.
Fourth, the most effective deal partners
simply devote more hours to the initial
stages of deals. In the best-performing
ones, the partners spent more than
half of their time on the company during
the first 100 days and met almost daily
with top executives. These meetings
are critical in helping key players reach a
consensus on the company’s strategic
priorities: relationships are built and per-
sonal responsibilities detailed. A deal
partner may use the meetings to challenge
� � � � � � � �
���� ���� �����
����� �� ����� ������� �������������� ��� ���� ������ �� ����� �� � �� ������
�� ����
��� ������� ������
������� � �� �
������� ������ �� ���� ��������� ����������� �� ������ �������
��� ���
����
�����������
������ ���
����� ���
�����
�����
�����
� �� ���� ��������� ���� �������
�� �������

� � �
��
��
��
� �� ���� �������� ��� ������� ��
���� ���� � ����������� ��� ����
������ ��� ��� ����
���
��
��
� �� ����� �� ����� ����
������� ���������� ���������
���� ���� ��� ��� ���
� � � ������ ���
��� ����
����
����
����
� � � ����� ���
��� ����

������ ���� �� ���� �������� �� �������
������� ���������� ���� ���� �������� ��� ���� �� ������ ������������ �������� ��������
The McKinsey Quarterly 2005 Number 1 26
management’s assumptions and to
unearth the company’s real sources of
value. By contrast, lower-performing deals
typically took up only 20 percent of the
investors’ time during this crucial period
(Exhibit 2).
Last, if leading deal partners want to
change a company’s management, they do
so early in the investment. In 83 percent
of the best deals—but only 33 percent of
the worst—firms strengthened the manage-
ment team before the closing. Later in
the deal’s life, the more successful deal
partners are likelier to use external support
to complement management than are the
less successful deal partners.
These research findings pinpoint the
practices that distinguish great deals from
good ones. The five steps are, in the
main, uncontroversial. They are applied
inconsistently, however, and their
implementation seems to depend on the
individual partner’s beliefs and skills. A
standard active-ownership process that
applies and develops best practices is the
next step for the private equity industry.
Joe Heel is a principal in McKinsey’s Miami
office, and Conor Kehoe is a director in the
London office. Copyright © 2005 McKinsey &
Company. All rights reserved.
1
In 3 of the 60 deals, value was created primarily
through arbitrage. Since these deals are relatively rare,
and interviews indicated that they are difficult to
find, we excluded them from our analysis.
2
Calculated by dividing the cash realized from a deal
by the cash invested.

Sponsor Documents

Or use your account on DocShare.tips

Hide

Forgot your password?

Or register your new account on DocShare.tips

Hide

Lost your password? Please enter your email address. You will receive a link to create a new password.

Back to log-in

Close