8/13/2019 Mckinsey Why Some Private Equity Firms Do Better Than
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The McKinsey Quarterly 2005 Number 124
Private equity firms have long promotedthe virtue of active
ownershipthe hands-on style that distinguishes them fromtraditional
portfolio investors. But what doesactive ownership mean, and does
it reallylead to superior performance?
Recent McKinsey research reveals a strongcorrelation between
five steps that privateequity firms can take to direct a companyin
which they invest and outperformanceby that companyin other words,
perfor-mance better than that of its industry peers.Many private
equity firms have embracedthese steps and execute them well,
yetsurprisingly few do so in the consistent and
systematic way that would increase thereturns from an
active-ownership approach.
Eleven leading private equity firms, allboasting
better-than-average track records,made up our sample. Each of
themsubmitted five or six deals from which theyhad exited. The
deals represented a rangeof returns from average to very good.
Tocalculate the value generated by activeownership, we built a
model to isolate thesource of each deals value: overall stockmarket
appreciation, sector appreciation,the effect of extra financial
leverage onthose market or sector gains, arbitrage (abelow-market
purchase price), or companyoutperformance.
The main source of value in nearly two-thirds of the deals in
our sample wascompany outperformance. Market orsector increases
accounted for the rest(Exhibit 1). 1 Outperformance, which
generated a risk-adjusted return twice thatof market or sector
growth, was the leastvariable source of value.
These results show that outperformance bycompanies is clearly
the heart of the wayprivate equity firms create value. How dotop
investors make this happen? Interviewswith deal partners and with
the CEOs of
Why some privateequity firms do better
than othersJoachim Heeland Conor Kehoe
Investments dont govern themselves; active ownership is the
answer.
Kevin Curry
8/13/2019 Mckinsey Why Some Private Equity Firms Do Better Than
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The McKinsey Quarterly 2005 Number 126
managements assumptions and tounearth the companys real sources
ofvalue. By contrast, lower-performing dealstypically took up only
20 percent of theinvestors time during this crucial period(Exhibit
2).
Last, if leading deal partners want tochange a companys
management, they doso early in the investment. In 83 percent
of the best dealsbut only 33 percent ofthe worstfirms
strengthened the manage-ment team before the closing. Later inthe
deals life, the more successful dealpartners are likelier to use
external supportto complement management than are theless
successful deal partners.
These research findings pinpoint thepractices that distinguish
great deals fromgood ones. The five steps are, in themain,
uncontroversial. They are appliedinconsistently, however, and
theirimplementation seems to depend on theindividual partners
beliefs and skills. Astandard active-ownership process thatapplies
and develops best practices is thenext step for the private equity
industry.
Joe Heel is a principal in McKinseys Miamiofce, and Conor Kehoe
is a director in theLondon ofce. Copyright 2005 McKinsey
&Company. All rights reserved.
1 In 3 of the 60 deals, value was created primarilythrough
arbitrage. Since these deals are relatively rare,and interviews
indicated that they are difcult tond, we excluded them from our
analysis.
2 Calculated by dividing the cash realized from a dealby the
cash invested.
