What Worked for Private Equity in the Last Downturn

Firms that were highly acquisitive and focused on creating value at portfolio companies outperformed during the last recession, according to McKinsey.

Cole Burston/Bloomberg

Cole Burston/Bloomberg

Private equity performance will almost certainly suffer in the wake of the coronavirus pandemic. But some private equity firms may be better equipped to navigate the economic downturn than others, according to McKinsey & Co.

The consulting firm identified two of the things that set top-performers apart during the last recession in a new paper authored by consultants Jeremiah Connolly, Bryce Klempner, Paul Maia, and Tucker Ward.

“We looked briefly at two aspects of how the industry confronted the last economic downturn for hints on what may drive value in this one,” they wrote. “In brief: operating groups appear to matter; and ‘buying low’ is great, if you can.”

Specifically, the McKinsey consultants found that it helped private equity firms to have dedicated value-creation teams: specialist staff dedicated to creating value by focusing on portfolio-company operations.

From a return standpoint, having a value-creation team did not make much of a difference in the years leading up to the 2008 financial crisis: Firms with these operating groups only delivered slightly higher net internal rates of return between 2004 and 2008, according to McKinsey. In the post-recession years — 2014 to 2018 — these teams had an even more negligible effect on IRR.


During the recession, however, McKinsey found that firms with value-creation teams “meaningfully outpaced the others, achieving a full five percentage points more in IRR (23 percent) than firms without portfolio-operating groups (18 percent).”

In addition to delivering higher returns, general partners focused on portfolio company operations had more success in fundraising between 2009 and 2013. McKinsey reported that average fund size declined 19 percent for these firms, versus an average decline of 82 percent for private equity firms without value-creation teams.

“The lesson for GPs today is self-evident — albeit hard to put into practice once already under duress,” the McKinsey consultants wrote. “Options for GPs without these internal capabilities are to redirect dealmakers with operational bona fides toward the portfolio, or seek to bolster portfolio companies with strong operators to meet pressing needs.”

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The other thing that worked for private equity firms during the last downturn? Capital deployment.

Private equity firms that were more acquisitive during the 2009 recession delivered higher average IRRs and raised more capital from investors, according to McKinsey.

“It is a fact that public-market comparables are lower than they have been in several years,” the consultants wrote. “It is a fact that the PE industry has a historically large stockpile of dry powder.”

While some owners of target companies may now be less motivated to sell at current prices, the McKinsey consultants argued that many other companies are finding themselves with new financing needs as a result of the pandemic.

“Notwithstanding the recent slowdown in deal activity, it is reasonable to imagine that many PE firms will seek to continue deploying capital despite the current tumult and uncertainty,” they concluded.