Private Equity winners and losers – Is your business model ready?

The fund landscape is changing, creating more winners and losers in an increasingly polarised ecosystem. The pandemic and long-term megatrends are forcing strategic and competitive shifts in private equity markets that will have far reaching implications on fund business models and internal processes. In particular, they are driving a “collapse-of-the-middle”, as successful fund business models migrate to either large one-stop-shop private-asset “supermarkets” or niche specialists. Traditional mid-market funds are steadily coming under increasing pressure and will need to find new sources of differentiation in order to attract new funding, talent and investment opportunities.

Low interest rates and aging populations in China and the developed world, continue to drive vast sums of money into private equity. In response, large, industrialised, listed funds like KKR, Carlyle, Blackstone, Partners Group and EQT have emerged to manage this deluge of fresh capital. These firms can efficiently diversify private asset risk across a vast array of different assets, currencies and investment strategies in one go. They operate differently than private equity partnerships, with more structured processes and a higher level of IT automation.

Another winning spot is to become a niche specialist. And here, thankfully, there are many different ways in which funds can specialise. A general trend since the global financial crisis has been to move down with the emergence of diverse lower mid-market players. They rely less on debt and help smaller growth companies make the jump to scalability. Many of these platforms operate on a deal-by-deal basis with low management fees. But niche specialisation is also taking place by developing superior experience and know-how in a specific geography, industry, or deal-type.

So, where does this leave the traditional mid-market private equity partnerships? The short answer is – in a bind. The large multi-asset funds are raising the minimum efficient scale and the niche specialists have greater depth of experience in specific deal types. Mid-market funds will either need to move-up and become a multi-asset “supermarkets” like EQT, or select a niche in which they can differentiate. However, either route means a lot of change in often change-resistant partnerships.

Another route for mid-market funds is to differentiate on the depth of value-add during the investment cycle. That is, to find more challenging investment cases, that require more operational heavy lifting, like buy & build; and then deliver the operational capabilities to accelerate and/or de-risk implementation. Funds like Aurelius and Gilde have excelled with this approach for different target types. Each has mastered operationally challenging investment cases.

A common denominator in this context is the strengthening link between investment returns and the quality of portfolio company management processes. This trend is evidenced by the increasing attention paid to talent management across all fund types, and the growth of specialist advisors like Humatica.

Given observable trends, the pace of change in private equity will likely increase. It will demand more agility and adaptation from fund organizations. So now is the time to look in the mirror and re-think what change is needed to remain relevant tomorrow.