Private equity firms claim they create value through "operational excellence."
Better management. Strategic repositioning. Margin enhancement.
Academic research says: 80% of PE returns come from leverage and multiple arbitrage.
Only 20% from actual operations.
Thread🧵
Better management. Strategic repositioning. Margin enhancement.
Academic research says: 80% of PE returns come from leverage and multiple arbitrage.
Only 20% from actual operations.
Thread🧵
When you strip away the marketing, PE's value creation formula is simple:
40% = financial engineering (leverage)
30% = multiple expansion (buying at 10x, selling at 14x)
10% = riding sector/market beta
20% = genuine operational improvements
40% = financial engineering (leverage)
30% = multiple expansion (buying at 10x, selling at 14x)
10% = riding sector/market beta
20% = genuine operational improvements
That 20% "operational improvement"?
It's usually low-hanging fruit that competent public company management could have implemented anyway:
Cost cutting
Supplier consolidation
Basic ERP systems
Not exactly rocket science.
It's usually low-hanging fruit that competent public company management could have implemented anyway:
Cost cutting
Supplier consolidation
Basic ERP systems
Not exactly rocket science.
A 2023 study analyzed 8,000 buyouts over 36 years.
Conclusion: The vast majority of value creation is financial engineering, not operational genius.
When PE does outperform, it's because they bought small, unleveraged companies and added debt.
Conclusion: The vast majority of value creation is financial engineering, not operational genius.
When PE does outperform, it's because they bought small, unleveraged companies and added debt.
The uncomfortable truth about PE "operational improvements" + what happens after PE firms exit in my newsletter: []
The data will make you rethink every PE pitch deck you've ever seen.open.substack.com/pub/hacheimsch…
The data will make you rethink every PE pitch deck you've ever seen.open.substack.com/pub/hacheimsch…
Here's the dirty secret:
Many PE "operational improvements" come at the expense of long-term sustainability.
PE-owned companies systematically underinvest in:
R&D
Maintenance capex
Employee development
They optimize for EBITDA to maximize exit multiples.
Many PE "operational improvements" come at the expense of long-term sustainability.
PE-owned companies systematically underinvest in:
R&D
Maintenance capex
Employee development
They optimize for EBITDA to maximize exit multiples.
What happens after PE exits?
A 2022 study tracked companies 5 years post-exit:
60% underperformed industry benchmarks in revenue growth
45% had declining margins
The value extraction was front-loaded. The deterioration came after the PE firm sold out.
A 2022 study tracked companies 5 years post-exit:
60% underperformed industry benchmarks in revenue growth
45% had declining margins
The value extraction was front-loaded. The deterioration came after the PE firm sold out.
Think about the incentive structure:
PE firms hold companies 4-6 years on average.
Why invest in initiatives with 7-10 year payoffs?
Why maintain equipment that won't break down until after you've exited?
Short-term optimization ≠ long-term value creation.
PE firms hold companies 4-6 years on average.
Why invest in initiatives with 7-10 year payoffs?
Why maintain equipment that won't break down until after you've exited?
Short-term optimization ≠ long-term value creation.
The best evidence PE isn't creating operational value?
Look at what they pay portfolio company CEOs.
If PE firms were truly adding value through board expertise and strategic guidance, why do they need to pay CEOs 2-3x public company comp to hit targets?
Look at what they pay portfolio company CEOs.
If PE firms were truly adding value through board expertise and strategic guidance, why do they need to pay CEOs 2-3x public company comp to hit targets?
PE's operational value creation story is marketing genius.
It lets them charge 2-and-20 for what's essentially a levered small-cap value strategy.
Next time a GP pitches "operational excellence," ask them to quantify it vs. leverage and multiple expansion.
Watch them squirm.
It lets them charge 2-and-20 for what's essentially a levered small-cap value strategy.
Next time a GP pitches "operational excellence," ask them to quantify it vs. leverage and multiple expansion.
Watch them squirm.
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