From leverage to leadership: the evolving private equity playbook

The private equity industry has made strides in its ability to restructure companies and improve their value before selling them for a profit. The industry originated in the mid-20th century, gaining momentum in the 1980s with the rise of leveraged buyouts.

Today, private equity plays a major role in global finance, driving growth and operational improvements in companies across various industries.

Before 2000, most of the value creation in private equity stemmed from leveraging and deleveraging debt, otherwise known as “financial engineering.” This strategy involves using a significant portion of debt to finance an acquisition, with the expectation that firms can enhance the company’s value and generate substantial returns upon exit.

This approach allowed private equity firms to maximize financial engineering techniques without spending too many resources on making operational improvements or acquisitions for portfolio companies. In the last 20 years, this trend has reversed.

As financial engineering became more standardized and accessible, its ability to generate outsized returns diminished. Strategic growth (organic and inorganic) and operational improvements now account for most of the value creation in private equity portfolio companies.

In this article, we describe the “anatomy” of a modern private equity value-creation strategy and show why effective portfolio company leadership is playing a greater role in the process.

The anatomy of private equity value creation

In the last 10 years, the common private equity value-creation playbook has expanded beyond financial engineering to include a greater emphasis on strategic growth and operational improvement. By implementing this playbook, private equity firms aim to improve profitability, increase revenues and position the company for a higher valuation at exit.

“We have seen many private equity firms move from a model of extracting value to one that is focused on enhancing value by focusing on accelerating growth, optimizing efficiency and being a thoughtful strategy partner,” said Sean Curley, managing director at Charles Aris Transaction Services.

Within these main categories, private equity firms and portfolio leaders must also prioritize which processes are most effective for their specific business. This often depends on the kind of business they’re growing and the state it was in when purchased. Strategic growth and operational improvement still represent the bulk of the playbook, but the specific tactics that fall under these core processes vary significantly.

Depending on the size, state and needs of the business, we often see private equity firms focusing their growth and operational-improvement tactics on bolt-on acquisitions, roll ups, transformation and sales force effectiveness.

Differing investment philosophies also play a big role in how a private equity firm drives growth and operational value in a portfolio company. Hands-on firms, for example, will often work side by side with the business founder and provide access to a network of successful executives who can consult on the value-creation process.

Additionally, optimizing a portfolio company’s C-suite by identifying and closing talent gaps is an increasingly successful strategy for ensuring the right leaders are in place to oversee all the additional growth and operational initiatives.

How leadership drives strategic growth and operational improvement

An effective C-suite leader in a private equity portfolio company drives operational improvement and strategic growth by balancing the internal needs of their team with the needs of the private equity firm.

“There has been a substantial shift in the way that private equity firms view the importance of talent acquisition and development over the last 15 years,” said Ryan Krumroy, senior associate practice leader at Charles Aris. “Engagement from firm to portfolio company is trending in a much stronger active partnership than in years past.”

To form this active partnership, portfolio leaders must first establish clear goals aligned with the private equity firm’s value-creation plan, ensuring the entire team understands the broader objectives, such as margin expansion, cost reduction or revenue growth.

The leader then fosters a culture of accountability and transparency within the company, empowering managers and employees to take ownership of their roles while ensuring that performance metrics are closely tracked.

They must be adept at managing change, as private equity investors often push for rapid improvements; this requires the leader to implement efficient processes, adopt new technologies or restructure teams to enhance productivity without overwhelming staff.

Strong leadership qualities are also critically important for a portfolio’s growth strategy, especially when it involves mergers and acquisitions. To effectively combine new businesses and teams, leaders must evaluate the financial, operational and cultural fit of each target.

Once a deal is in motion, they play a central role in the integration process, ensuring that the newly acquired business is smoothly merged with the existing company’s operations. This includes aligning teams, consolidating systems and ensuring synergies are realized, such as cost savings or enhanced capabilities.

Key considerations for building a successful private equity portfolio C-suite

As a private equity partner building out a successful portfolio company C-suite, it’s critical to have a trusted head of human resources (HR) to manage leadership hiring and talent development. This dedicated HR leader will be aligned between the needs of the sponsor and portfolio to attract and develop the leaders needed to execute the value-creation strategy.

Related: The ultimate Charles Aris guide to executive recruiting

Start your portfolio leadership hiring journey by developing your ideal HR framework. Ask questions like: What culture will best support the company’s strategic goals? What roles are most crucial to driving value? What is the current state of leadership in the organization? Answer any relevant questions and identify the culture you want to create.

Your next step should be finding the right HR head to carry out this mission. Sometimes the portfolio company will have a strong HR leader in place. If this is the case, ensure they have adequate support to apply your framework. Often, they will need additional support, or the function must be broken into multiple roles.

If making an outside hire, finding the right person is critical. Your HR head will need to serve as both a cultural beacon and liaison within a formal leadership hiring process that involves the C-suite and private equity firm. Input from C-suite leaders and private equity partners on this hire guarantees they will not only fit the operational needs of the company but are also equipped to mesh with the culture, carry out the value-creation plan and oversee critical C-suite hires.

The takeaway:

The shift from financial engineering to strategic growth and operational improvements as primary drivers of value creation in private equity reflects the growing importance of effective leadership.

Hiring strong leaders, particularly through a structured process involving a trusted HR partner, the C-suite and the private equity firm, is essential for aligning talent with long-term business goals and ensuring a successful exit.

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