Over the past 30 years, private equity funds have consistently generated better returns than listed markets. With the evolution and specialisation of private equity, value creation began to gain more weight than the achievement of returns than the arbitrage of entry and exit multiples or the use of financial leverage.
Various studies have been done to try to explain excess returns and I think the book “Lessons from Private Equity any company can use” best explains the best practices used by funds to achieve these superior returns.
This movement meant that private equity had to develop its own management style, defined through the use of the following 6 steps, ranging from a more general to a more specific one:
- Define the Total Potential: it is essential for companies to define their objectives and the potential that the company aspires to with the use of its resources. As with any action that we want to implement, it is essential that we first define the objectives. This exercise will result in the 4-5 strategic actions to be implemented.
- Define the strategic actions: after defining the objectives, it is essential to transfer them to a specific action plan where the actions necessary to achieve the objectives, their timetable and the necessary resources will be listed.
- Monitor the results: the next step after planning is to create the necessary tools to correctly monitor the execution of the action plan and to take corrective actions or improve the management of resources in order to achieve the goals set.
- Rewarding talent and streamlining decision-making: in order to fulfil the action plan, it is essential to create an incentive plan for employees, as well as to create agile and efficient decision-making bodies (management committees).
- Manage financial resources: Funds often use debt to maximise returns and to create a discipline of efficient management of financial resources. Management teams with less cash available tend to manage their working capital and investments more aggressively, resulting in a more liquid balance sheet.
- Build a results-oriented mindset: for this form of management to be assured in a daily and continuous perspective, it is necessary to create work processes as well as to develop a vision of continuous improvement where they are reviewed from time to time to make them more efficient.
The greater or lesser involvement of the funds in each of the steps described above depends on the professional career of the investment fund managers. Managers with a financial background tend to participate more in steps 4 and 5, with a more distant view of the management of the investee, while managers with more industrial experience tend to have a more active participation in the other steps.
“Long-term planning is not thinking about future decisions, but about the future of present decisions”