The importance of skilled human capital in private equity: How human capital will increase your profit

With a compound annual growth rate of 31% during the last 15 years, private equity has been a successful investment vehicle and has been thriving globally. During this period, which has seen some market fluctuations, it has been proven that private equity was successful in the past. Although the actual crisis makes debt more expensive and growth opportunities scarce, local and international PE firms are well prepared to increase their investments in equity. Additionally, PE firms have just successfully finished the last fund-raising wave, and are now ready to invest. So, private equity is definitely here to stay.

This is one of the findings of an international research study of 200 funds in the private equity sector conducted by Neumann International in collaboration with the IESE Business School. The study was based on the quantitative analysis of empirical data (provided by the Boston Consulting Group) from 200 funds over a long period of time; and on a qualitative analysis in the form of in-depth interviews with CEOs of private equity firms. It addressed key questions regarding value creation of private equities and the role of human capital.

An analysis of the funds over a long period of time shows a return of 13%. Taking a closer look at these private equities, it was found that top performers had returns of above 28%. Compared with a return of 10% in the MSCI world index for stocks, this makes private equity a much better asset class.

These figures and findings lead us to the underlying question: What makes a good PE firm a good PE firm? And, which factors are key to private equity success? During our empirical analysis, we looked at the four main possible factors: fund size, deal size, global reach and industry focus. These factors may have had a positive effect for some, but do not explain most cases with significant evidence. So no clear explanation can be given as to why top performers have been successful.

So what really influences private equity’s growth and success?

Neumann International’s in-depth interviews with CEOs of international and local private equities brought to light that private equity is an art that requires a great deal of creativity, initiative and intuition. The weight of the three main sources of value (leverage, multiple arbitrages and the operational value creation) has changed. In contrast to the past, when most value was created through leverage, now most of the value is generated through the gaining of operational efficiencies, accounting for more than 50% of the total value created. The reason: today’s market is much more competitive. The private equity business model now has to be more involved in the operation of a company’s strategy. Here skilled human capital is of the utmost importance. It is significant that the top performers amongst private equity firms have the best human resources. They focus on attracting and retaining talent and on developing skilled employees with a set of complementary, and thus complete, competences.

How does this skilled human capital influence growth, and what are the main competences needed?

Looking at the investment cycle of private equity - Identification, Evaluation, Closing, Management and Exit - a segmentation of specific necessary skills for each of these phases comes to the fore. The importance of matching each phase of the cycle - from its origins right up to the closing of the deal - with specifically qualified personnel is paramount to a successful PE firm: People make the difference.

Necessary skills and competences for every step of value creation

The following key competences needed throughout the investment cycle have been identified: network access, negotiation excellence, domain expertise and operational improvement capabilities.

Network access is important throughout the entire investment cycle, from the identification of a target company to the closing of the deal. During deal identification, for example, it is important to find new and profitable opportunities. During the evaluation phase, correctly assessing the value drivers is key. During the closing of the deal, the objective is to reach an agreement. The management of the investment requires identifying opportunities for the build up. And during the final phase of the investment cycle it is important to find the best way to realize the value.

Negotiation excellence is mainly needed in the closing and exit phases. This phase requires, for example, reaching a long-term contract agreement that benefits the main stakeholders (banks, managers and shareholders) and getting them to work in the same direction without conflict of interest. With regard to the exit phase, obtaining the most favourable conditions is key.

Strong domain-specific expertise is important in the evaluation, closing and management of the portfolio company. Knowledge of the intellectual property rights, for example, is key to certain investments in which an innovation or procurement/strategic sourcing experience occurs. Also, the method implemented to do this is crucial when opportunities arise for procuring better supplier conditions through the increase of buying volume. 

Capabilities for operational improvement are essential during the management of the investment. These include, for example, implementing an improved IT system, or finding new commercial channels or new marketing methodologies.

Our in-depth research left no doubt as to the direct connection of skills and competences of human capital during the different phases of the cycle to the success of the operation. Having the right people in the right places is of paramount importance. However, the strategies employed by successful private equity firms in putting these competencies to work are quite different. Essential here are the following: implementing expertise and experience; employing specialized and centralized teams; hiring the best professionals; retaining them; subcontracting lacking competencies, and selecting the best partner firm to work efficiently, skilfully and expertly in the process.

Contact

Alvaro Arias

Partner

c/Jorge Juan 15
28001 Madrid
Spain

T. +34 91 436 35 90

Email: alvaro.arias@neumann-inter.com