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Study: Need a Fast Flip? Don’t Change the Management Team

Ernst & Young has just released its fifth annual study of how PE investors create value, based on 233 of the largest exits in North America over the last five years. The idea, of course: to better understand the best practices of the industry’s leaders.

The study is a little squishy – you won’t find much hard data here – but it draws some interesting conclusions, including that half of “organic” revenue growth for PE firms has been coming from geographic expansion, as well as new offerings. Cost reductions and restructuring comes in a close second, representing just less than 30 percent EBITDA growth at those firms included in the analysis. Third are add-on acquisitions, which represented about 20 percent of revenue growth for the PE firms included by Ernst & Young.

Specific to last year, a recovery in exits certainly gave PE firms and their LPs a boost in terms of value. According to the study, PE exits by number hit 118 last year, up from 51 in 2008 and 76 in 2009, when the country was still in the throes of an economic crisis. The study credits the uptick to PE firms concentrating on their existing companies in 2009 (when they could do little else), an improved IPO market, and more choices when it came to “acquisition finance,” including exits via secondary buyouts – which nearly doubled in volume in the study’s sample set over its 2009 report.

Still, the most interesting piece of Ernst & Young’s analysis may center on “operational improvement,” which has always been the most important drive of PE’s value creation but has apparently become even more pronounced during the “low-growth economic cycles” we’ve had in recent years.

Best practices here? Backing the right management team from the outset is “paramount.” The study also found that “changing the management team during the investment increased the holding period by up to two years [and] in many cases resulting in reduced returns…” Not last – and not surprisingly –  the study found that “management teams with the relevant industry knowledge and experience, or those that have previously executed on a similar strategy, were invaluable.”

You probably get the gist, but if you want to check out the rest of the study – which also touches on 100-day plans and the growing trend of “bringing talent in-house” — you can find it here.