Despite the private equity arena becoming increasingly challenging due to rising interest rates and greater government scrutiny, private equity firms have maintained their meteoric rise with acquisition targets only growing larger.
According to McKinsey, private markets added $4 trillion in assets in the past decade.
Australian entrepreneur and AFL aficionado, Darren Herft says that this growth has largely been due the reputation private equity firms have built in the world of finance.
“Private equity firms are known for dramatically increasing the value of their investments.”
While he attributes their ability to achieve such high returns to many factors, Herft thinks that the main reason behind private equity’s stupendous growth rate is often overlooked.
“Private equity firms, unlike their public counterparts, are there to steer a business through performance improvement to sell them. Most firms are not looking to hold onto their acquisitions for a long period of time,” he adds.
The rapid turnover of businesses means that private equity firms gain knowledge and experience faster. A successful example of this is Permira. A European private equity firm. It made more than 30 considerable acquisitions and over 20 disposals of businesses within a five-year period. Public companies able to boast of such a depth of experience in buying, transforming, and selling businesses are few and far in between.
The strategy, which exemplifies a powerful synergy between business and investment-portfolio management, is at the heart of private equity’s success.
Herft opines that the lucrative incentives private equity provides for both the operating managers of businesses in the portfolio as well as private equity portfolio managers allows them to hold on to a highly experienced class of leaders determined to make profits.
Additionally, PE firms aren’t saddled with the burden of company regulations and public. This allows them to make aggressive use of debt, providing a financial edge as well as tax advantages.
Herft believes that public businesses could do well to learn or borrow from the buy-to-sell approach deployed by PE firms.
He clarifies, “Buying to sell is by no means a universal strategy for public companies to adopt. This strategy is best as a short to medium-term value-creation opportunity.”
Darren Herft believes that in cases of underperforming, undervalued businesses that haven’t been optimally managed – buyers must take outright ownership and control.
“In such cases, once the necessary changes to achieve growth targets have been made, it makes sense for the proprietors to sell the business and move on to new opportunities,” says Herft.
Private equity firms following a buy-to-sell strategy, sell their acquisitions soon after their increase in value which usually produces marginal gains in the long run, typically within three years of implementing growth strategies.
Herft explains, “The buy-to-sell approach isn’t for companies whose acquisition was spurred by their prospects for long-term organic growth within the buyer’s existing portfolio.”
While public companies may achieve identical operational performance with their acquired businesses, Herft thinks that their long-term strategy of holding on even after value-creating changes have yielded their best results dilutes their final return on investment.