Private Equity is often seen as the area for best practices in strategy execution, general management and shareholder value creation. The consulting firm L.E.K. continues this in their recent issue of “Executive Insights” (Volume XV, Issue 25).
“Private equity holds several notable advantages over public ownership, not least its ability to boost equity returns through creative leverage structures. […] It is managerial discipline and strong operational performance, not financial engineering, that explain private equity’s impressive results.”
L.E.K. backs this statement by comparing the performance of major indexes with the Cambridge Associates LLC U.S. Private Equity Index. While the mentioned index outperforms all of the usual benchmarks (e.g. Dow Jones, Nasdaq, S&P 500), I noted that the Dow Jones U.S. Small Cap Index is doing a pretty good job keeping up with private equity, maintaining a close parity and even outperforming during the 5-year period. This leaves the question whether private equity companies really are delivering outstanding performance, or whether it is mainly the size of the companies which is the main differentiator.
L.E.K.’s thesis is that public companies can learn from the PE-managed companies in the following areas:
- Focused Investment Theses
- Relationships, Relationships, Relationships
- Objective and Systematic Analysis and Diligence
- Strategy Activation
- Top-Flight Management Team
- Develop a Culture and Incentives Oriented Toward Performance
The elements that I want to point out are the following:
L.E.K. sees a clear difference between the strategy itself (here focused investment theses) and the implementation (i.e. strategy activation). The latter contains the usual identification of clear-cut goals and outcomes, while the strategy should give the basis of where and how one plans to compete. (See also: M. Porter on Strategy)
The most interesting take-away for me was the discussion of incentive schemes within private and public companies. L.E.K. points out that the personal investment of management into the company is a “skin in the game” scenario that is rarely seen in public companies. While public companies do use options, these are largely influence by the overall performance of the stock market, not the company. This is why a mix of “indexed options” and other incentives oriented towards long-term cash flow are recommended.
For the full article please go here: Full article by L.E.K.
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