BCG: ‘The successful firm of the future will look nothing like it does today’

There’s still a long road of growth ahead for private equity, but firms that want to succeed in the coming years will have to revamp from the inside-out.

That’s what a team of consultants from Boston Consulting Group argue in their latest paper, ‘Private equity is hot but not overheating.’

Despite indicators to the contrary – historically high deal multiples, leverage ratios and dry powder –  the private equity industry still has “significant room to grow.” This is evidenced by the low proportion of the economy controlled by private equity firms: PE-owned companies in the US had an implied value of $862 billion in 2016, compared with $27 trillion for all public companies; and just 1.6 percent of US GDP is owned by PE firms.

However, to take advantage of the growth opportunity, general partners must rethink the way they operate.

“The successful firm of the future will look nothing like it does today,” the paper reads.

In an environment of increasing competition, high multiples, digital disruption, and in many cases a changing of the guard in the upper ranks, private equity firms must “rethink organization design, double down on digital technology, and revamp their approach to talent”, the paper argues.

Firms must organize themselves with “the right balance of sector expertise and more thematic investment strategies”.

“It’s a difficult needle to thread. Given the current level of competition in the market, firms with sector-specific insights can identify targets and win deals over firms that still apply a generalist model,” the paper reads. “Yet as industry boundaries continue to blur, looking at sectors in isolation can create blind spots.”

Firms must also make sure their internal processes have kept pace with rapid growth, formalizing those that may have previously been informal.

“In 2006 and 2007 we saw funds scale up very fast without adapting their operating model, which resulted in some disastrous deals made at the top of the markets,” BCG writes. To avoid making such mistakes, GPs must remain disciplined on capital deployment.

Those firms driving the most effective operational change in portfolio companies today are bringing in digital expertise to “help companies rewire themselves”, and companies are looking for this value proposition from potential buyers.

On the talent front, GPs should develop a “holistic talent strategy” that considers which skills should be in-house and which should be outsourced, and takes into account skill sets such as those of data scientists and macroeconomists, which are becoming “must-haves” as value creation shifts from financial engineering to operational improvements.