The Future of Private Equity

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The Future of Private Equity

Stung by the recession of 2008, private equity firms are struggling to recover. Consider these facts:1

  • Private equity fundraising actually worsened throughout 2010, with only $228 billion being raised. That was a drop of 23 percent from 2009, which itself was a depressed year.
  • New buyout capital raised was limited to $71 billion, which was only one-fourth of the pre-2008 figures.

This has left private equity firms searching for a course of action that will accelerate the recovery.

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But, downturns are nothing new for private equity, and each time firms have found new ways of creating value via new business innovations.

In the 1980s, these firms turned to harnessing the power of financial engineering. Successful firms bought companies using debt, took them private, and then sold them at a profitable rate of return.

In the 1990s, as private equity firms faced rising "bid prices" due to increased competition among themselves, they developed a second big innovation: operational engineering. This new approach included process improvements, outsourcing, and restructurings, all with the goal of cutting costs.

Today, as firms look to pull themselves out of the current down cycle, they face a new set of hurdles and challenges. For example:

  • Traditional elements, such as "rapid GDP growth," "multiple expansion," and friendly "debt markets" can no longer be counted on to drive business.
  • There is also widespread bad press about their fees and about the practice of "secondary buyouts."
  • Non-private equity investments held by limited partners, including real estate, have done poorly over the past few years.

These issues and many more raise the question of when and how private equity firms can revitalize "leveraged buyouts." Many firms are still relying on cost-cutting as the outcome driver, using strategies such as centralized sourcing and replacing people with technology.

For investments that are deeply underwater, this approach no longer provides the change that is needed. Private equity firms need to spur growth to increase the top line of these companies. This requires innovation in the creation of value leading to organic growth of the portfolio companies.

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According to an analysis by Booz & Company's Ken Favaro and J. Neely in Strategy+Business,2 a private equity firm must focus on three key areas to successfully engineer organic growth within its portfolio companies...

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