McKinsey: To maintain growth, private equity firms will need a more entrepreneurial approach
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If recent trends are anything to go by, it’s still a pretty good time to be running a private equity firm.
Leveraged buyout activity in the first half of this year hit the second-highest level ever, and as of July, global PE companies had more than $US2 trillion of capital to deploy – a record high.
For many private equity firms, business has largely been based around the art of the deal: sourcing deals and buying companies (often with leverage), then finding buyers at the right price and moving onto the next one.
But a report this month from consulting firm McKinsey & Company said that in order to match historical rates of growth, private equity will have to take a more hands-on approach.
In the post-financial crisis macro environment with steady growth and increasingly higher valuation multiples, active management “hasn’t always been required for PE firms to make healthy returns”, the analysts said.
However, “there is a palpable sense in the market that deal prices have likely reached their peak”.
And as competition increases, creating value from private equity investments is now “less straight forward than it once was”.
The McKinsey team said that while many PE firms have paid lip service over the years to active involvement, few companies have actually deployed the necessary resources to make core changes to business strategy post-acquisition.
But to create value at current price points, high-performing firms will need to “essentially become more entrepreneurial”.
That will mean taking a long-term view towards value creation, engaging in strategic planning, and hiring additional staff where necessary to ensure the right skillsets are in place.
The analysts cited the example of a mid-sized PE firm which purchased an Italian-based IT systems integration company.
The PE firm’s plan was to drive growth via an aggressive acquisition strategy, but in order to do it effectively it hired a full team of staff dedicated to post-merger integration.
From 2017 to 2019, the firm acquired and integrated 12 companies and doubled revenues to €500m.
While the good times continue, McKinsey said some firms will maintain the existing way of doing business with a stronger transactional focus.
However, the analysts assessed that “PE professionals sense a change is in the air”.
“In the coming months, those firms will indeed find it increasingly difficult to extract value from their investments,” they said.
“Investors who take an early lead on the path toward entrepreneurial ownership can boost their returns, as well as their firm’s reputation.”