SOURCE: The Boston Consulting Group

The Boston Consulting Group

The Boston Consulting Group

February 04, 2010 00:01 ET

Investors Shift Away From Financial Leverage

Joint Study From The Boston Consulting Group and IESE Business School Concludes That Private Equity Firms Can Survive Only Through Operational Value Creation

BARCELONA, SPAIN--(Marketwire - February 4, 2010) -  Private-equity firms will survive only if they create business value through their companies' operational performance, as investors demonstrate that they will not invest in firms focused on value creation through financial leverage. This is one of the conclusions of a recently published white paper developed jointly by IESE Business School and The Boston Consulting Group (BCG). The authors of the paper are Prof. Heinrich Liechtenstein of IESE and Heino Meerkatt, a Munich-based senior partner and private-equity expert at BCG.

Titled "Time to Engage -- or Fade Away: What All Owners Should Learn from the Shakeout in Private Equity," the study points out that there has already been an important increase in the number of investors in private equity and concludes that private equity will remain one of the key assets for capital allocation. However, there was a consensus among the investors interviewed for the study that financial leverage is over and that those companies that fail in operational value creation will disappear.

Based on interviews with limited partners who recently committed capital to private-equity investments, the study describes the main nine levers that, according to both experts, are vital for operational value creation. Divided into two categories (table stakes and differentiators), these levers address and challenge widely spread common practices in business management. For example, Prof. Liechtenstein points out that frequent evaluation of top management is one of the key stakes that allow companies to be on the radar screen of investors. "Through our study, we learned that those companies that evaluate their CEO and other top managers on a yearly basis produce a higher ROI." But evaluation is only useful if it has consequences. "Companies have to act, and this might mean supporting and developing managers, but it could also mean replacing them," he explains.

The white paper identifies incentives as another important lever in operational value creation. According to the authors, research shows that there is a significant positive impact on a company's performance when the equity stake held by managers increases. Research also shows that this equity stake is more effective than stock option programs at creating a share in downside risk.

Other important levers mentioned in the paper include a good business strategy, which the authors say requires a disruptive impulse to be developed. Because companies do not tend to create such an impulse themselves, private-equity firms can benefit from a change in control or from the fact that they invest in companies with the clear intention of selling them after a time. The paper describes other levers, such as having a board with firepower and benefitting from the fact that private-equity firms are insiders in the companies in their portfolio.

The category of levers that the authors call differentiators are those that make real difference to investors. These levers, which are related to experience and capabilities and require much more time to implement, include ownership experience, industry expertise, and regional experience.

About IESE Business School

Prof. Heinrich Liechtenstein is Assistant Professor of Financial Management at IESE Business School. IESE is one of the world's top ten business schools and has pioneered business education in Europe since its founding in 1958 in Barcelona. IESE distinguishes itself in its general-management approach, extensive use of the case method, international outreach, and emphasis on placing people at the heart of managerial decision making. With a truly global outlook IESE, with campuses in Madrid and Barcelona, a center in New York and offices in Munich and Sao Paolo, currently runs programs on four continents.

About The Boston Consulting Group

Heino Meerkatt is a Senior Partner in the Munich office of The Boston Consulting Group (BCG). He is the Global Topic Leader on Private Equity for BCG. BCG is a global management consulting firm and the world's leading advisor on business strategy. We partner with clients in all sectors and regions to identify their highest-value opportunities, address their most critical challenges, and transform their businesses. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 68 offices in 39 countries. For more information, please visit www.bcg.com.