4 Methods of Improving Private Equity Operating Models




Bain's Global Private Equity 2020 report highlighted that the last decade in private equity is the first that comes anywhere close to the equivalent public market index returns. This can, in part, be attributed to the strong recovery the domestic U.S. economy saw following the Great Recession, however, this also points to the increase in prices and valuation multiples across the board for private equity. Over the past 10 years through 2019, the S&P 500 index has produced an IRR of ~15%, with private equity average returns through the same time period marginally topping that figure.

Half of the returns in private equity were derived through multiple expansion, which highlights the need for new sources of alpha in the future. This need becomes even more obvious with a close look at recent multiple trends, with record highs and deteriorating macroeconomic conditions following COVID-19, perhaps into the next decade. The spread between entry and exit multiples has likely plateaued and could start to diminish. Further, most GPs can no longer include multiple expansion as a given in their LBO models.

In order to continue growth and the expansion of the private equity industry, GPs must find new sources of value creation if multiples can no longer provide the same degree of return contribution. These new avenues of value can include rollup strategies, M&A, reducing costs, gaining market share, or expansion into new products or locations. However, this change in operations is new is easier said than done.

In Bain's report, researchers highlight that 65 fully realized buyout deals invested in 2009 through 2015, the average margin fell significantly short of the LBO model forecast, and the bulk of deals failed to meet projected margin expansion targets. To put a finer point on the issue, for the deals where margin improvement was critical as part of creating value, more than ¾ of the studied deals did not meet the margin target. In other words, the operating skills of private equity are currently inadequate to continue relative outperformance of public benchmarks.

4 Operating Models for Private Equity, Skill and Software:

  • Operations-as-a-Service (OPaaS) – firms that have reliable operating partners, whether that be consulting firms that outsource operators or talent networks such as industry recruiters, will likely outperform those that do not have scalable solutions. Further, operators with a track record in private equity will be highly coveted, and should be compensated accordingly, given a reliability in generating returns that not only outstrip the S&P 500, but also outperform rival funds.
  • Operating Software (OpTech) – firms that utilize "fund in a box" software models, such as software-based fund administrators and finance management software, exemplified by models such as those offered by the JTC Group, Resolvr and eFront by BlackRock. Returns on investment into these models include time savings through automation, dollar savings through billing improvements and compliance monitoring through proper LP commitment tracking, for example.
  • Dedicated M&A Teams (M&A Ops) – the rollup strategy has become an art form in the world of private equity, led in 2019 deal count by firms such as the Audax Group (96), Kohlberg Kravis Roberts (92), HarbourVest Partners (91) and The Carlyle Group (82). This avenue of expanding revenues has been the main contributor towards the ~1/3 of PE returns due to "revenue growth," which essentially reflects the incorporation of new businesses under a single legal entity. This can also include new contracts for portfolio companies, but novel technology, to date at least, has rarely featured as a significant differentiating factor for portfolio companies. Integrating new companies is no small feat, however, requiring sizable documentation and planning across virtually all business units. Accordingly, a specialty M&A team, either as part of the GP or within each portfolio company, is a must in order to achieve outsized returns relative to public indices and peers.
  • Reducing Costs (Expense Management) – expense management and allocation is a key part of driving margin expansion, which contributes ~20% of the average private equity deal return on investment (MOIC). This model can follow playbooks that include cost synergies, such as standardizing software across acquired businesses and leveraging scale for pricing negotiations, through to dedicated expense management and allocation software platforms. You can read more on expense allocation best practices here, and all of these practices are designed to maximize visibility over a private equity fund and portfolio companies, allowing managers to decide which business units are driving value and which are not.

Whatever strategy or strategies GPs decide to use; fund managers will continue to face a broad challenge: how to put record amounts of dry powder to work amid stiff competition and difficult macro conditions. The most effective responses will include more thoughtful approaches to talent, technology-driven insights and creating a scalable operating model that can contribute investment multiples without a need to rely on expansion.

Contact Information

If expense allocation software (or spend management software) could help your hedge fund or private equity firm, get in touch with us to learn more about what we offer. We can set up demonstrations, trials and complimentary consultations to see if Resolvr fits your fund's requirements, with no strings attached.

[email protected]


Authored by:

Matthew Markham

Matt is an ex-Morgan Stanley investment banker, bringing an innovative, go-getter mentality and facilitating new opportunities for the business.

Go back