How Private Equity Firms Create Value?

Private Equity Create Value © Zai Aragon, Fotolia

How Private Equity Firms Create Value?


Despite the challenges, the PE industry is thriving and will likely continue to do so, delivering impressive results in the short term while dramatically outperforming public markets in the long term. But how?

How can private equity (PE) firms continue to prosper in today’s high-multiple, hyper-competitive deal landscape? That’s the challenge of creating value through transactions. Successful PE firms are leveraging advantaged deal flow to succeed in a world where old-school proprietary deal flow no longer exists.

• Global growth remains sluggish

• PE firms are sitting on a record-high amount of cash, estimated at roughly $700 billion. That’s a lot of dry powder, resulting in intense competition for attractive assets and high multiples

• Stock markets are soaring, providing public companies with cheap currency for acquisitions and adding to the already crowded pool of potential buyers

• Increasingly, the assets that come to market have already undergone the transformation from family ownership to professional management, leaving less hidden value for buyers

• Historically low interest rates suggest that future refinancing on more favorable terms is highly unlikely

• Finally, we live in an increasingly unstable world defined by political unrest and frequent economic shocks, further compounding systemic risk

And yet, despite these challenges, the PE industry is thriving and will likely continue to do so, delivering impressive results in the short term while dramatically outperforming public markets in the long term.

So what are the best PE firms doing to deliver stellar returns? From our study of a number of successful PE transactions, we observe that one key ingredient is advantaged deal flow, executed in one or several of the following ways:

• Choosing a winning sector early in its development

• Buying and building from a smaller platform

• Leveraging knowledge developed from owned and divested assets

• Deploying superior management

• Targeting underperforming companies

• Performing equity carve-outs of orphan divisions of large corporations

Let’s examine these six strategies one by one:

1. Choosing a winning sector early in its development. Self-evident, perhaps, but winning PE firms make understanding the future their focus. They develop an investment thesis based on an emerging trend or a looming regulatory shift. Next, they identify a strategic segment within the larger market that stands to benefit disproportionately in the new environment. Invest in the right platform and the upside potential is twofold: market growth and company development.

2. Buying and building from a smaller platform. Look for a quality target that may be missing key ingredients and also presenting opportunities to grow, organically or by acquisition. That could be a company with a solid domestic market presence, for instance, but without international markets. Or one that’s small but offers entry into a market that’s ripe for consolidation.

3. Leveraging knowledge developed from owned and divested assets. Hard-won knowledge and experience gained from previous investments can be indispensable tools for unlocking value in later investments in the same industry. Consider Blackstone, which has been buying and selling hotel chains since 1990. Recent deals include Extended Stay (purchased in 2005, sold in 2007, purchased again in 2010); Motel 6 (purchased in 2012); Hilton Worldwide (purchased in 2007); and Hersha Hospitality Trust (purchased in 2014). Along the way, they’ve come to know their customers well; they’ve developed close relationships with a broad network of industry executives; and they’ve gained a sophisticated understanding of market vulnerabilities and hot spots. All that adds up to a tremendous advantage over less experienced players on the next hotel acquisition opportunity.

4. Deploying superior management. Top quality management is a scarce and important resource, and increasingly valuable. In a competitive environment where so many other variables are subject to commoditization, identifying, recruiting and retaining top managers are all critical. Skillful leaders can’t be streamlined, they can’t be outsourced and they can’t be replaced by new technology. Nor are they interchangeable. The best PE firms skillfully match specific management talent with the needs of specific assets.

5. Targeting underperforming companies. Assets with potential for value creation through operational or strategic improvements are often ignored by PE firms who don’t have the capabilities or interest in making fundamental changes to the business. Many successful PE firms look for companies with significant operational or strategic issues that require wholesale changes to uncover hidden value.

6. Performing equity carve-outs of orphan divisions of large corporations. These transactions typically require significant amounts of operational oversight as the carving out process can be challenging and involved. However, there may be legacy divisions suffering from lack of attention or investment, or perfectly viable operations that for one reason or another are no longer part of the parent company’s core business. Similar to #5 above, these companies typically require a healthy dose of operational or strategic improvements to reach their full potential.


Fierce competition, an abundance of capital and high multiples demand more from PE firms to identify the best investment opportunities and to close deals quickly. Notwithstanding these challenges and well-conceived strategies for advantaged deal flow, the need to bring uncompromising discipline and rigor to vetting each investment opportunity cannot be underestimated.

There is no substitute for independent, fact-based analysis that maximizes value and reduces buyers’ risks that can be delivered to high-performing PE firms at an accelerated pace.