Private equity performance mechanisms

1. Alignment of interests

One of the greatest advantages of private equity lies in the alignment of interests between investors (Limited Partners) and fund managers. Indeed, private equity managers are themselves obliged to invest significantly in their funds if they wish to raise money from their institutional partners. Unlike listed funds, where fund managers are often employees, private equity players are directly involved in the performance of the companies they manage. This creates a powerful alignment of interests.

In listed markets, although executives benefit from stock options, there's nothing like the obligation to invest to earn returns. What's more, the liquidity of listed markets, while an asset, does not guarantee this alignment.

2. Tight governance

Active governance is another fundamental lever of private equity. Unlike a passive investor in listed markets, a private equity fund is deeply involved in the management of the company in which it invests. This "tight governance" process includes daily monitoring of the company, meticulous analysis of all performance indicators, and weekly discussions with the management team. The fund is also present at board meetings, where it monitors operating performance indicators and ensures that key milestones in the business plan are met.

Private equity funds not only monitor the company's progress, but also bring in external experts to guide management in strategic areas such as marketing, acquisitions or technology. These experts, whether independent or employed by the fund, are often also investors in the capital, thus guaranteeing additional alignment. This model of active governance is very difficult to implement in listed companies.

3. Buy and Build strategies

Private equity funds often seek to consolidate fragmented industries by adopting a "Buy and Build" strategy. The aim is to buy the sector leader, then acquire smaller competitors to create a dominant industrial platform. This approach enables "multiple accretion" (buying at a lower multiple to sell at a higher one) and the exploitation of synergies between acquired companies to boost profitability.

Take the example of medical analysis laboratories: by buying up small regional laboratories and integrating them into a larger network, the funds create a much more economically powerful company, able to cut costs by pooling resources and offer more competitive prices. This strategy is used in many sectors, from healthcare to construction equipment rental, where private equity managers are creating industrial champions.

4. Compensation and performance

Another key driver in private equity is the executive compensation system. Unlike publicly traded funds, where managers are often judged on quarterly performance, private equity fund managers are evaluated based on their ability to generate a minimum annual return of 10% on all capital invested over the life of the investment, which typically ranges from 5 to 7 years. If this return is not achieved, they do not receive a performance fee, known as "carried interest."

This remuneration system encourages managers to focus on long-term performance and work to generate an absolute return in excess of 10% per annum. Conversely, listed fund managers are often rewarded for quarterly outperformance, which can lead them to adopt a more short-termist view, less focused on long-term value creation.

5. Proactive selection of champions

Private equity managers don't just invest in companies available on the market. They patiently select "champions" in structurally growing sectors. They take the initiative to approach targets before they are even for sale. This proactive approach enables them to acquire strategic information about the company and its market, often long before the business is put up for sale. This gives them a competitive edge and granular knowledge of the company's potential.

6. Preparing for the sale

When a private equity fund invests in a company, it has already given some thought to how it will eventually sell it. Throughout the investment period, the fund actively prepares the company for sale, not only by transforming it operationally, but also by making it attractive to potential buyers. Private equity funds implement strategies aimed at maximizing the company's value, while seeking to sell to a strategic buyer willing to pay a premium.