How Do Private Equity Firms Thrive? What You Need to Know About PE

By Generational Equity


The premise is simple: Private Equity (PE) firms need to generate ample returns for the limited partners (trust funds, endowments, charities, pension funds, and millions of Americans who have investments in funds that invest in PE). The steps to make this a reality, however, are challenging to say the least because the only real way to do this in a sustainable manner is to consistently improve the operations of the companies that these firms invest in.

A recent study by Grant Thornton entitled “Value Creation: Beyond Financial Engineering” puts it this way:

At their very core, private equity firms have one job — to generate strong returns for their limited partners (LPs). To do this they must increase the value of their investments. While the premise may sound simple, the task at hand is not…

Kelly DePonte, a senior professional with placement agent Probitas Partners, [states]: “The only thing that consistently generates value is increasing the earnings of a portfolio company. The best strategy to increase earnings is to make positive changes within the portfolio company. To make it a reality, you must have experienced people on board, a well-thought-out plan and be able to execute on it.”

The difficulty in actually accomplishing this goal is clear. However, the good news is that firms specializing in the lower-middle market (typically defined as companies valued below $100 million) have a proven track record in accomplishing two things: Creating great returns for their LPs AND growing businesses substantially (and not solely via financial engineering). According to our research and the Grant Thornton study, there are several key reasons that they are able to achieve this.

Value Added

First and perhaps most critically, PE firms that tend to be most successful in growing holdings are usually using an industry specific strategy per fund:

To create true value at the portfolio level, some of the most successful private equity firms have become specialized, focusing on one sector or a few sectors where they have deep industry knowledge. The data suggests this strategy drives returns…

Industry experience usually comes from operating professionals that are sometimes in-house and other times third-party consultants. There’s no difference if the operators are brought in on a case-by-case basis or full-time employees of the private equity firm. What makes the difference is having that industry talent available when it’s needed.

This is critically important for founding owners who want to see their business legacy grow post-sale: If you are talking to an equity firm as a buyer for your business, be sure to discuss their track record and, most importantly, drill into their future plans for your company.

Do they have expertise in your industry? Can they provide you not only with capital to grow but also professional management guidance, accounting expertise, sales and marketing know-how, and HR/IT advice?

This is especially critical if you are going to retain an equity position in the new company with the goal of participating in a second liquidity event later. Make sure you are comfortable with the skills and talent they will bring to your business. And then ensure that you can work with their team to achieve great results. Sometimes entrepreneurs make awful employees post-acquisition.

Execution is Key

Secondly, successful PE firms not only bring talent to the table but they also are skilled in developing strategies and implementing business models that achieve great returns. This is critical because it is easy to parachute key people into a new holding; it is far harder to come up with plans for success. Again, according to the Grant Thornton study:

Grant Thornton conducted a survey of more than 215 C-suite executives working for middle-market private equity portfolio companies at the end of 2015. More than one-half of survey respondents felt private equity firms added significant value when they were able to devise a thoughtful strategy for the portfolio company on a go-forward basis. This is where private equity firms do feel they add the most value.

When we work with PE buyers on behalf of our clients, we strive to make sure that the PE firm has solid plans and strategies in place for both its platform company as well as its add-ons going forward.

What never ceases to amaze us is just how brilliant the folks working for these lower middle-market equity firms are. They are under tremendous pressure to deliver returns to their LPs but they never lose sight that the way to do that is to effectively find, acquire, integrate and grow their holdings. So if you are interviewing PE firms without the aid of an experienced M&A advisor like Generational Equity, ensure that the firm has plans in place to help your legacy grow (and ensure you a great return).

The Importance of Assimilation

I used a key term above that we also feel is vital to any private equity firm’s success (as well as the longer term success of our clients) and that is the word “integration.” History has proven, and our research confirms this, that post-transaction success is closely tied to how effective the equity firm (or any buyer type for that matter) integrates the new holding into its existing operations/platform. Grant Thornton found that PE firms that are consistently successful with their holdings use what is commonly called a “100-day plan”:

“Having a 100-day plan can be enormously helpful. The first 100 days is essential — employees are expecting change. Later — down the road — change can be a disruption. It’s best to start things off right,” [says Ben Siebach, a managing director who specializes in performance improvement in Grant Thornton’s Transaction Advisory Services practice].

To have an effective 100-day plan, the process should ideally start before the asset is acquired.

As we have learned from the many, many deals we have closed, the first 100 days can make or break an investment. A successful PE firm will work with current management during due diligence to create a 100-day plan that will focus on change in 2-3 key areas – not simply change for the sake of change but a focus on areas of the business that need initial improvement.

Beware here: We often have to calm a client down who gets his/her ego ruffled because a transition team with an equity firm suggests a change that the founder would not have thought of/disagrees with/gets feelings hurt by. Remind yourself that the only way to improve is to be open to change, some of which may be threatening to your ego. If you can put that aside, you will be far more successful post-acquisition with any buyer.

It All Comes Down to One Thing

This brings us to perhaps the most important reason PE firms that focus on the lower middle-market are successful: They know it is all about the people, especially during the first 100 days. This is what Grant Thornton found:

At the end of the day, it’s the people who make a business thrive

Private equity professionals understand how important the human element is to the success of a business. “We collaborate with entrepreneurs and management to ensure that the skill set and talent is in place that we believe will drive growth and scale the business,” says Kevin Masse, chief portfolio officer at TA Associates.

Nearly all of our clients, when we do our post-close quality assurance interviews, tell us the same thing: “At the end of the day the deal I accepted was not the highest value, it was the one where I knew my key people would be treated well and would have ample opportunity to grow professionally.”

Naturally part of your legacy is based on the team that you have developed. If they can expand, learn new things, be challenged to change and ultimately help the company reach new levels, you will have post-transaction peace.

The great news is that successful lower middle-market PE firms know this as well and take tremendous steps to ensure that key folks are taken care of both professionally and financially (in fact, most PE transactions allow key management to participate as owners in the new company).

So now you know why most lower middle-market equity firms are successful. They simply know what they are doing! The reality is that not all privately held companies are logical targets for an equity firm. Most, as you can see from the info above, have specific criteria regarding what they are looking for in an add-on to a portfolio. They also take great care to ensure that the management team is compatible with their goals and that they can work well with a retained business owner.

If you would like to learn more about how equity firms operate, attend a Generational Equity exit planning conference in your area. These are educational, complimentary, and introduce business owners to a wide variety of buyer types, not just PE.

To learn more, call me at 972-232-1125 or email me at I will be glad to chat with you about your business, its future, and put you in contact with one of our senior business advisors for further information about our conferences.

And special thanks to Grant Thornton for producing such a comprehensive and thoughtful report on why PE firms are successful. If you would like to read their entire study, you can do so here: Value Creation: Beyond Financial Engineering.

Carl Doerksen is the Director of Corporate Development at Generational Equity, part of the Generational Group.