For more than two decades,
buyoutfunds—or nonventure private equityfunds—have been an important force inglobal corporate finance and restructuring.Top-quartile funds, in particular, haveturned in consistently strong performances,generating attractive returns for theirinvestors (Exhibit 1). In the 1980s thesector led a revolution in value creation andcorporate restructuring that continues toreenergize economies in the developed and,increasingly, the developing world. Viewedfrom corporate suites, buyout players havealternately been willing acquirers of underperforming businesses, formidablecompetitors, and, under the rightcircumstances, valued partners. Storiedfirms such as Clayton, Dubilier & Rice,Kohlberg Kravis Roberts, and TheBlackstone Group may be emblematic ofthesector, but its ranks also include many otherprivate limited partnerships, investmentbanks, and public-investment vehicles thatfollow a similar business model.That model, however, may soon look quitedifferent. A convergence ofmarket forceshas altered the competitive landscape inwhich private equity firms have thrived.More and more, they are encounteringheavier competition for opportunities toinvest, often against new competitors. Therise ofthe auction sales process is erodingthe buyout players’ ability to gainprivileged access to investments from theironce-legendary networks ofrelationships.The creative financial-engineering skillsonce guarded by a few top practitionershave become commodities, and a tougherstock market has worked against playerslooking to purchase, restructure, and thenquickly sell a company. Taken together,these changes threaten to lower medianreturns over the next five to ten years,compared with the public equity markets,and could make standout performanceconsiderably more difficult.Ofcourse, as long as there are attractivebuyout opportunities—and there will be,particularly in the European industries thatare restructuring and in less financiallydeveloped markets—the top buyout fundmanagers will continue to generate attractivereturns for investors. But the most successful
Private equity’snew challenge
A changed competitive landscape calls for adifferent business model.
Private equity’s new challenge
Neil W. C. Harper and Antoon Schneider
for investments initiated from
; excludesreturns for investments initiated in more recent years, as substantialportion of returns are still unrealized.
-year forward rolling average of returns for investments initiatedfrom
.Source: Thomson Financial; McKinsey analysis
Comparison of private equity funds with public equity market: averageannual net returns to investors, 1986–2003, %19.0Overall average
23.0Minimum returnfor top quartile