Is PE value creation instrinsic?
First of all a disclaimer, I could be completely wrong as I dont have any PE experience.
However, I get the idea that a substantial portion of the value created by Private Equity (PE) firms may be attributed to "paper value" rather than sustainable, intrinsic value. Because of the techniques used to generate this value e.g. financial engineering, agressive cost-cutting measures, revenue growth manipulation.
I was wondering if some experienced PE professionals could shed some light on this. Have you ever sold or bought a company that wasn't as it seemed?
if they are successful in some sort of buy n build strategy or get lucky with the companies growth progression relative to industry naturally that can create actual value
but artificial value is usually created from cost cutting, which long term is probably not super sustainable but generates interim margin uplift // and if sold at near similar multiples equates to immediate cash on cash returns. usually loads the company with shit tonne of issues, bad morale from job losses and increasingly unrealistic goals.
coming from a company that got acquired by a PE, i ran for the hills and sure enough the company went to shit and went from being a market leader to a sad case. they swapped out the CEO for a cleaner (someone who just went aggressive on their cost cutting) and all the top talent just walked over to the next best competitor. quite ironic
maybe that’s just my experience, but whilst i’m IB i worked with a lot of sponsors, aswell as receiving an offer with a sponsor and i kid you not the business case i had to present was just that.. fire a bunch of peripheral departments, replace with cheap outsourced labour, long term present some sort of acquisition universe to consolidate / increase capacity utilization (which was the BS spin to get financing) but the cash on cash was mostly generated from trying to produce the same output with less resources. or burn the existing employees. sure some companies might not be fully efficient but that’s just the way the world works, not everyone is a human machine and runs optimally.. morale and a good work environment / cohesive team is pretty important - go figure
Thank you! I've heard similar stories about what happens when a PE enter a business. I wonder if the majority of cases follow this pattern. How do PE firms consistently generate such strong returns, especially as more funds continue to emerge? It would make me cautious about buying a company from a PE firm, as I would definitely consider the possibility of unsustainable value creation and aim to purchase at a discount to mitigate this risk. Additionally, why is there such a large market for secondary PE buyouts? You would think that PE professionals would be more cautious?
because other pe firm buys the company - it's a merry go round of bs until the music stops and the companies goes into administration
Lol this feels so spot on. Great experience if you're in PE Portco leadership and get to work with the Sponsor to achieve the goals (these leaders tend to get some equity percentages). But if you're just a regular employee, you can get screwed really bad.
Used to work at a PE Portco and a lot of those 'leaders' made out like bandits with great financial exits while a lot of the employees ended up suffering as the company eventually went to shit / plateaued.
What I don’t understand is wouldn’t you think in whatever exit they aim for, whether to another sponsor or strategic, the diligence process would uncover all the signs pointing to unsustainable cost cutting?
Like its certainly a good short term play for margin uplift etc as stated, but wouldn’t whoever they’re tryna hot potato the asset to not be dumb enough to be the last one holding it? Or is it genuinely difficult to get a sense of things like employee morale / retention dynamics?
No value is created whatsoever. You just become the owner and ride an increase in value that would have happened anyway if the company had been under another owner due to normal GDP growth, market expansion, etc. so your implication is nil. The only thing that may plausible to say about PE-owned businesses is the sort of financial incentive that it creates for some managers who then gladly push themselves to the limits to achieve the milestones you set (if previous manager was pushing himself at 80% capacity, you bring someone who does it at 95%, which in some cases may contribute to a small increase in the financials).
In general, as a whole, PE is value destruction for society and the economy. The concentration of so many talented and smart individuals, including the billions of capital handed to them, to pursue acquisitions where you deem the company could do 0.5% better is just absurdism. Some of the costs also go to other non-value production fields: Auditors, lawyers, consultants, etc.
Whoever tells you otherwise is just coping. People just do this because they are good at it, find it fun and interesting, and it pays well. No one really cares about value or impact or similar purposes.
I feel like you're discrediting the private equity (PE) sector a bit. It almost seems like you didn’t get the offer you wanted! 😉 That said, I genuinely believe there are many inefficient companies that could benefit immensely from improvement, and PE can create substantial long-term value for these businesses. Many companies aren't necessarily run by the most capable managers, and the added expertise and financial support from PE firms can help drive significant growth.
However, I do think the drive to maximize value can sometimes push PE firms to operate in ways that aren't sustainable in the long run, which was the point that i was trying to make in my post.
On the other hand, I agree with your point about the potential waste in finance, especially when talented individuals, like engineers, move into this field. I also believe that most people in the industry are motivated more by financial rewards and the occasional intellectual challenge rather than by moral values or a desire to make a positive societal impact.
So you're saying a PE firm taking a +50% stake in a company to "help" with capital structure and financial management, including reducing the cost of capital, qualifies as value creation? Sure, for the PE firm—but not for the company. Here's the same concept from another angle: the "cost" of this service, or however you'd like to call it, is effectively equity handed over to the PE firm.
Now, let me give you a business idea: start a financial advisory firm specializing in liability management (equity is also a liability) for businesses and throw them some additional financial services (working capital, 13 week CF, etc.). You'd essentially be providing the same service. The difference? You won't capture what PE firms do—namely, the recapitalizations that inflate the "financial value" they showcase to their LPs and, to some extent, the unique market insights gained from their portfolio companies which then helps them to prepare other PortCos if they anticipate something good or bad for X sector. But again, this benefit of "protecting the company" comes at a cost: it's a wealth transfer from the company to the PE firm. No real value creation occurs, the company keeps nothing from this,—it's just reallocation: The excess profit or loss avoidance just gets trespassed to the PE firm. Don't mix the two, value for the firm =/= wealth for equityholders, because value for the firm means the firm expands/grows, meanwhile wealth for equityholders means depriving the firm from the capital, capital which is needed to contribute to "value creation".
anyway wait 'till you get in and you'll see how the idealization fades away quickly
.
Inventore ea nisi aut aut. Est animi sint numquam sed praesentium amet asperiores. Sed omnis rerum suscipit dolorem asperiores similique tempore eius. Sed earum cumque repellendus odio sint molestias ab.
Ullam eligendi in quibusdam minus occaecati magnam. Sint qui repellendus quia quasi facilis. Et saepe autem enim. Eius suscipit magni maxime beatae.
Ipsam libero delectus architecto ullam hic quas ut. Dolorem aut occaecati magnam eum est. Qui saepe vero harum. Alias harum ratione aperiam.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...