In Bain & Co.’s 2016 Global Private Equity Report, the consultancy rang the alarm bells for the asset class, highlighting just how important it is for buyout firms today to “mine” their sweet spot in both sourcing and executing upon investments that play into their areas of specialization. This focus on developing and then leveraging the value proposition of the partnership is even more critical in an era marked by high valuations where outsized returns are harder to find. And while most private equity firms have at least begun embarking on their journey toward a defined niche, it’s still a rather novel concept among most private debt providers. This will soon change, however, as specialization provides distinct competitive advantages that are as apparent in the lending universe as they are among private equity sponsors.
Specialization, of course, can take on many different forms. In the middle market – a specialty in and of itself – most equity sponsors will define themselves as either sector specialists or regional firms active in a particular geography. But these so-called “sweet spots” can also take shape around the investment lens employed, whether it’s sourcing turnaround opportunities or candidates for growth, or even the type of assets acquired, be it founder-led or closely held businesses, corporate carve-outs, or public companies’ taking-private situations. The key, though, is that to drive consistent and repeatable returns over time, private equity investors today must operate from a playbook in order understand the intrinsic value of acquired assets, drive top- and bottom-line growth, and then secure an attractive exit. As evidence, Bain offered an analysis showing that in one sample portfolio, “sweet spot” investments yielded a return of 2.2x invested capital compared to a lackluster 1.3x for deals considered out of scope. Moreover, nearly a third of those deals Bain labeled as “opportunistic” in nature, generated negative returns.