As PE firms have become more specialized, they have focused more on operations, and operational expertise has become more important.
It’s no secret that it’s gotten harder to achieve outsized returns from private equity investments as the industry has matured. When the industry was new, private equity firms’ returns were typically driven by financial engineering.
Over the last 20 years, fund managers and limited partners have increasingly focused on making money not solely through the use of leverage, or relying heavily on multiple expansion, but by increasing earnings. Today, most private equity firms tout relationships with professionals that offer operational expertise who are expected to increase earnings. For more, see The Rise of the Operating Partner.
Private equity firms far and wide began hiring people with operational expertise, or forming partnerships with them, after the recession that began in 2008. These relationships are very important to LPs. According to Probitas Partners’ annual U.S. Private Equity market survey released in June 2015, 68 percent of LP respondents say they want to invest in funds focused on operational improvements heavily staffed with professionals with operating backgrounds.
"The ability to drive returns from using leverage is a thing of the past. You need to grow a company with revenue and Ebitda. When we are evaluating fund commitments, we are always looking at what type of operational expertise a fund has and how those professionals are compensated,” says Sheryl Schwartz, a managing director and lead investment professional for primary and secondary funds with New York-based Caspian Private Equity. For more, see 5 Ways to Win Over LPs.
In Mergers & Acquisitions’ November cover story, we highlighted a handful of operational experts, including Graham Partners’ Dan Soroka. With two decades of strong operational experience in the building products industry under his belt, the senior operating partner helps Graham’s portfolio companies shave millions of dollars off the costs of raw materials, leading to profitable exits.