InvestingPeer-Reviewed Research

Mixing It Up

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  • More and more private equity (PE) firms are differentiating themselves in terms of financial structure and scope of their portfolios.
  • These different strategic positions have important implications for managers, investors and banks.
  • Policymakers, too, need to understand the benefits and disadvantages of different types of PE firms.

In recent years, private equity (PE) firms have grappled with dwindling sources of inexpensive debt, shrinking credit — and withering criticism from the public. To compete for high-value investors and remain buoyant in this new environment, PE firms are now pursuing a range of new strategies.

Rice Business professor Robert Hoskisson joined former students Wei Shi, Xiwei Yi and Jing Jin to review the current literature and theory about today’s private equity firms. PE firms, they found, can be now be grouped into different categories based on their strategies. Understanding how these categories differ, the researchers concluded, can help investors, banks, policymakers and PE managers all make better decisions.

To analyze the different PE firm strategy types, Hoskisson and his colleagues developed a quadrant showing each PE firm’s use of debt over equity, and whether it operates niche or diversified portfolios.

While all the firms offer industry expertise and specialized knowledge and capabilities, firms that emphasize debt — such as Bain Capital — provide certain perks regarding investor-manager alignment. Known as “short-term efficiency niche players, these firms are under more pressure to make interest payments. They also offer investors the benefit of tax deductions on that interest. Niche players with long-term equity positions — such as SCF Partners — prioritize offering long-term equity capital (instead of debt) to fund the PE firms’ portfolio of companies. Niche players also offer consistent professional support and periodic injections of cash to reinforce growth plans for their acquired businesses.

The researchers also analyzed a different set of PE firms known as “diversified players.” These firms prioritize equity and keep their portfolios focused on a limited number of industries as a way to limit bankruptcy risks in volatile markets. When one such firm, Apax, took over the UK retailer New Look in 2003, for example, it focused on internationalization and higher performance. Four years later, the firm chose not to sell, despite a bull IPO market.

The scholars also examined a subset of these diversified players, one that that relies on debt investments to make investments in multiple projects at the same time. Such firms normally try to divest the companies in their portfolio as quickly as possible. Typically large in size — KKR and Blackstone are two examples — these do not have the same degree of specialized experience as the likes of Apax. A team of experts from KKR known as KKR Capstone, for instance, offers the services of general management professionals to the companies they acquire, which helps prepare them to turn around the companies and sell them off. This kind of on-site support helps the portfolio companies make whatever changes are needed to get returns as soon as possible.

Exploring these differences in positioning, Hoskisson and his colleagues write, sheds new light onto the type of strategies an ambitious PE firm can adopt to create value. Globalization and deal syndication deals are especially promising strategies, they note, as long as companies careful think through the rationales of each option. Institutional investors and banks that lend to PE firms should understand the differences in strategic orientation too. Long-term investors, such as pension funds, might want PE players with long-term orientations such as Apax and SCF Partners. Alternatively, banks — which hope to lend to short-term efficiency niche players — need to consider the risks linked to fast turnarounds.

Policymakers, too, can learn from the researchers’ four quadrants. As the public grows increasingly hostile to private equity — focusing particular wrath on leveraged buyouts — governments need to be much more thorough in vetting the advantages and disadvantages of different types of PE firms. The strong public association of high leverage and overall market risk — the kind of risk that entails the total collapse of a system or market — means that policymakers are under public pressure to control the PE space.

At the same time, reflexively enacting overly restrictive regulation can be a mistake too, Hoskisson and his team warn. Instead of one-size-fits all regulation, the researchers advise, policymakers — as well as managers, banks and institutional investors — need to understand and address the strategic diversity among general partner PE firms. Looking at the grid can help sort out the options.


Robert E. Hoskisson is the George R. Brown Emeritus Professor of Management at Jones Graduate School of Business at Rice University.

To learn more, please see: Hoskisson, R. E., Shi, W., Yi, X., & Jin, J. (2013). The evolution and strategic positioning of private equity firms. Academy of Management Perspectives, 27, 22-38.