Back to the Future in Private Equity
Gone are the days of cheap capital. Now, alpha will be created through operational excellence over financial engineering.
Little alarm bells ring in my head whenever I hear or read a different version of the same topic multiple times in the span of a week. That happened this week, and it’s all about quality.
At Energize, one of our core values is “Quality is contagious.” If you do a world-class job at something, others will see it and raise their bar, too.
The nuance about quality is that it can evolve.
Quality in private equity over the last 5-10 years has been about financial engineering and your ability to use cheap debt to create excellent outcomes. Persistently high-interest rates make that a much more challenging proposition now.
Quality in venture capital meant fast-growing companies that could spend their way into massive growth numbers with an attitude that the bottom line would be figured out eventually.
Both cases were market-driven forms of subsidies. They worked because you could count on multiple expansions and the continued flow of cheap capital.
Growing the top line with cheap equity or debt is much easier; capital is cheap. You can offer discounts and/or pay any customer acquisition cost. Giving away money is easy, but building a company is hard.
“Only when the tide goes out do you learn who has been swimming naked.”
- Warren Buffet
Today, quality is about sourcing and running assets that are both growing and can generate cash flow. It’s no longer enough to grow, you need moat as customers reduce non-critical software budgets and need to operate your business with more efficiency. That’s the “new” definition of quality - though it’s likely one we should have never left behind.
Echoing Marc Nachmann, Goldman Sachs’ Head of Asset Management, “When private equity started out, it was about really good deal sourcing and then doing a lot of operational work to improve companies.”
The following ten years of private equity will be about operational quality. In a way, we’re going back to the future.