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Lessons Learned From Private Equity – Enhancing Performance
As private equity firms become more successful, many public firms are learning how to implement these companies’ winning strategies. According to McKinsey research, about 75% of private equity firms do not experience better success than the stock market. However, the remaining 25% of these firms consistently achieve results that outperform the stock market.
This high performing group has mastered several components to enhancing performance. For example, deals in the private sector that are worth over $100 million, did not evolve because private firms paid less then market value. Instead, these private equity firms are using calculated strategies to determine which companies to purchase.
Researching Deals
Public firms can enhance success during acquisitions by investing in a strategic assessment of potential deals. This assessment is typically taken during the first few months of a deal, and accomplishes several goals:
- Determining which costs to cut
- If there are new markets to pursue
- Potential portfolio changes
Once these components have been evaluated, a value creation plan can be implemented. In this plan, managers will determine the possible risks and value from acquisition activities.
Compensation Strategies
Private equity firms are highly committed to overseeing investments once the deal is closed. A method used to enhance performance is using compensation strategies to align high level managers with strategic objectives. This entices managers to invest more of their time in collaborating with the board and completing research to help set the direction of the company. According to McKinsey research, private equity partners using this strategy invested about 50% of their time three months after the deal closed. While, less successful private equity firms devoted only 15% of their time.
Successful partners also spent more time working with management to determine if staffing changes needed to be made after the deal closed. Active partners also used operation indicators to measure performance instead of standard financial measures.
Realigning Governing Structures
Although many companies use financial engineering or price arbitrage to measure performance, private equity firms are finding these tools to be less effective in current market conditions. The highest performing equity firms are adapting governance arbitrage, which involves realigning governing structures that are not aligned well.
Public Firm Challenges
Many public companies are focused on compliance instead of enhancing the effectiveness of governance. This is partially because of the growing number of regulations and codes that are evolving.
In addition, those who are not at the executive level do not always experience financial gains when the company is performing well. However, if the company experiences hardship, these individuals are affected. Since these individuals are often recruited from professional management positions, they are usually more emphatic with managers than shareholders.
Spending more time on strategy and developing talented managers can help board members have a better understanding of the company’s initiatives and objectives. Currently, most executives feel that the board has limited understanding of goals and corporate strategy.
Sharing Information
Public companies can implement strategies used by private equity firms such as creating a free flow of information between managers and non-executives. This includes sharing information that is not financial in nature – like strategies and initiatives. Although public companies do not have incentives, implementing these strategies can help boost performance.
External Benchmarking
There are also external benchmarks that can be used to determine performances initiatives. For example, these benchmarks may include overhead costs, cost per unit production, manufacturing processes and purchasing. Benchmarking these areas can give a company a competitive edge.
The benchmarking process should also provide independent verification that the benchmarks are being achieved. Companies also need to evaluate how often benchmarks are created. Since this process can be time consuming and expensive, companies can reevaluate these areas every few years.
Performance Challenges
Unlike pubic firms, private equity firms can offer managers equity stakes, investment opportunities, and bonuses for meeting objectives. In fact, top managers in equity firms own up to 19% of the equity. This creates personal motives for outperforming the competition.
When a private equity firm is having difficult times, management is quick to act swiftly – spending more time with management, minimizing underperforming areas, and hiring consultants to improve performance.
Because incentives are structured differently with public firms, the strategies and actions are often less aggressive. This is an area of opportunity for public companies. Taking aggressive steps to improve performance will ensure that actions are better linked to value creation objectives.
Searching for Talent
Finding a management group that is ready for extreme change can be challenging. If executives are not completely behind the changes, they will not be effective. These leaders must also have a high level of understanding of each team’s strengths and identify weak players.
Although public companies may face challenges, learning a few lessons from private equity firms can enhance performance. Revamping the governance structure will allow public firms to compete more effectively with leading private equity firms.
Resource:
Andreas Beroutsos, Andrew Freeman and Conor F. Kehoe. “What Public Companies Can Learn from Private Equity.” McKinsey on Finance, Winter 2007.Mark Jordan is the Managing Principal of VERCOR, an investment bank that creates liquidity for middle market business owners. He is the author of “Driving Business Value in an Uncertain Economy,” “Selling Your Business the Easy Way,” “Enhancing Your Business Value…The Climb to the Top,” and co-author of “The Business Sale…A Business Owner’s Most Perilous Expedition.” Mark also has a monthly column in btobmagazine.com. For more information, visit http://www.vercoradvisor.com
Private Equity FAQ:
Question: Can you give me definitions of hedge funds, private equity funds and equity market?
Answer: Hedge Fund = mutual fund for rich people with very few limits set by the government.
private equity funds = a pool of money used to invest in non-public corporations or securities…often with the intention of running or reorganizing the companies after purchase.
equity market = the public exchange of ownership rights for legally recognized and structured businesses.
Question: What are the management fees for in Private Equity?
Answer: Management Fees are fees charged by a fund, partnership or other entity and will vary in percentage amounts and for different things, and thus are not equal or standardized as each entity is different and have various cost structures. All fees are required to be disclosed in the Private Placement Memorandum (PPM).
Question: To start a business, which is better private loans or investors?
To have an investors has a lot of benefits. They provide capital for the business to start in return for equity. But the problem is that shareholders can ruin the company or change the direction of the company and make it commercial. Shareholders can cause problems for the owner and loans are harder to get but you have full control of the company. To start a company, which better private loans with an interest rate or investors who takes shares of the company?Answer: I would have to go with investors on this one because if the company does not succeed then you will not have a debt to the government, if it does on the other hand all is well your investors get a cut if it weren’t for them the business would of never gotten off the ground. Take this and build a solid partnership over the long term and you are golden its all about who you know in this world. Karma is a real thing.
Question: How does private equity work, and how do you become a private equity investor?
I am 18 years old and I have an interest in the idea of becoming a private equity investor if I manage to accumulate enough starting capital. How does one go about becoming a private equity investor and becoming a multibillionaire like roman abramovich of millhouse capital, or prince alwaleed bin talal of the kingdom holding company? Please could somebody help explain.Answer: Private equity consists of investors and funds that make investments DIRECTLY into private companies, instead of trading through the stock market. Usually they include institutional investors (banks, hedge funds…) and rich individual investors. I think you might be interested in becoming a venture capitalist, which means you find starting businesses and invest money for a share of the business (a type of private equity investment). But before all this, you need the money, and this takes a lot of time and effort.
Otherwise, you could get an education (degree to start with) and get employed by a large financial institution (maybe even AlWaleed’s), become a senior analyst and make decisions in investing the institution’s private equity…maybe even a takeover!
Question: Will the private equity industry still be here in America in 20 years?
Will it still be as large as it was? I just wanted to know because I plan on getting into this industry after college.Answer: PE is one of the hardest areas of finance to get into. PE is surely here to stay for 20 years, and may be even longer! The reason being that PE firms rely primarily on the markets, both capital and debt markets, to source business. As both the aforementioned entities are in no hurry to disappear, it is a hard to imagine the non-existence of PE.
Question: What is the difference between Venture Capital and Private Equity?
Answer: Venture Capital is actually a type of Private Equity.
Private Equity means shares that are not traded openly in the public. Venture Capital is given to start-ups or entrepreneurs as an exchange for some % of share in the new company.
Question: Who can I hire to sell my private equity placement with out violating reg D laws?
I’d like to know how hard money lenders use the private placement offering. I understand you can raise money but I am unsure if they are hiring brokerage firms and if they are, who are they?Answer: Generally they hire an investment banking firm and a law firm. It is very expensive. If you have to ask, you can’t afford it. You would have to be talking about a placement of millions of dollars in equity to make it worthwhile to properly prepare the paperwork for a private placement.
Question: What is Private Equity?
And is it hard to get a career in it because I heard people who work in it make boatloads of money?Answer: You could become either a broker, trader, analyst, etc. If you are fiercely competitive and sharp you could make plenty.
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