Private equity firms are grappling with the challenge of returning cash to investors as higher borrowing costs, volatile markets, and economic uncertainty take hold. The impact is being felt across the industry, with difficulties in raising new funds and longer holding periods for assets.
Despite these headwinds, the aggregate capital raised by buyout funds reached a record $500 billion in the past year. This was due in part to the resilience of the technology, media, and telecommunications sector, which led the way in terms of investments. Application software companies, in particular, were the focus of deal activity.
However, the overall trend is one of caution, with global private equity and venture capital investments decreasing by 16.8% to $24.45 billion in January compared to the same period the previous year. The number of deals also declined to 959 from 1,134. The largest announced transaction was Vantage Data Centers Management receiving $6.4 billion in equity investment.
A Shift in Focus
In response to these challenges, private equity firms are rethinking their approach to value creation. Traditionally, they have relied on debt, restructuring, and exploiting market gaps to generate returns. However, as these levers become less effective, there is a growing recognition that investing in human capital is key to driving success.
A recent article in the Harvard Business Review suggests that private equity leaders need to shift their focus to building strong management teams, developing talent, and fostering a culture of innovation at their portfolio companies. This will require a new mindset and a willingness to invest in the long-term success of these businesses.
Tying Pay to Performance
One way that private equity firms are aligning incentives is by tying the pay of dealmakers and senior employees more closely to investment outcomes. Firms such as Carlyle Group, KKR & Co., and Apollo Global Management are transferring a portion of employees’ fee income to shareholders in order to prioritize predictable profits.
Adjusting pay formulas to focus on generating returns is becoming more common, with the potential for increased pay in boom years and decreased pay in lean times. This approach aims to balance the interests of dealmakers and shareholders, while also encouraging a longer-term perspective on value creation.
Investing in Human Capital
Private equity firms Ascend and Springline Advisory are taking this idea one step further by making strategic investments in accounting firms. By focusing on human capital development, they are enhancing the capabilities and growth potential of these firms.
Ascend’s recent deals with HD Davis and PP&Co., for example, involve adopting an alternative practice structure common in private equity deals with CPA firms. This approach brings new professionals and partners into the fold, providing a fresh perspective and additional expertise.
Similarly, Springline Advisory’s investment in BGBC Partners aims to scale the business while maintaining a client-centric approach. By investing in human capital, these firms are positioning themselves for long-term success and demonstrating the importance of this strategy for private equity.
As the private equity landscape continues to evolve, it is clear that investing in human capital will be critical to achieving strong returns. By focusing on building strong management teams, developing talent, and fostering a culture of innovation, private equity firms can navigate the challenges ahead and position themselves for success.
Key Points:
- Private equity firms are facing challenges in returning cash to investors due to higher borrowing costs, volatile markets, and economic uncertainty.
- Despite these challenges, the aggregate capital raised by buyout funds reached a record $500 billion in the past year.
- Private equity firms are rethinking their approach to value creation and recognizing the importance of investing in human capital.
- Tying pay to performance and making strategic investments in accounting firms are examples of how private equity firms are aligning incentives and enhancing capabilities.
