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Republished from Forbes.com

Private Equity Returns: It's All About Alpha


Written By: Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma, leaders of Bain & Company’s Private Equity Group.

Private equity (PE) firms have worked hard since the 2008 market meltdown to spruce up beaten-down assets they had paid dearly for at the top of the PE cycle and extract far more value than most of their limited partners (LPs) and outside observers expected. But they also got a big boost from a warming economic climate, strengthening public equity and debt markets, and other favorable external factors beyond their direct control to help push up valuations. In the yin-yang dance between market beta and the unique alpha-generating capabilities of general partners (GPs) themselves, each played an important part in driving the recovery of short- and long-term returns. But as we discuss in Bain & Company’s latestGlobal Private Equity Report,GPs will increasingly need alpha-generating capabilities to steer their way to winning deals in a more complex and intertwined global economy.


While the specific talents for generating alpha may vary from GP to GP, the results do not: Those that can successfully develop and deploy the skills that consistently create alpha at every link of the value chain do deals that produce more hits and fewer misses. Bain’s in-depth analysis reveals that the benefits of alpha show up in three ways that explain the variance in the returns earned by GPs that can and cannot generate it.

Avoiding deals that are losers.Top-performing funds are far better able to steer clear of deals that lose money than their lower-performing peers. Bain evaluated the return multiple on invested capital of nearly 2,700 deals made by a sample of US, European and Asian buyout funds from the mature 1995 through 2006 vintages and sorted them into four categories by performance, from worst (net fund IRR of less than 5%) to best (net fund IRR of greater than 15%). The weakest performers lost money on better than half of their deals; the top performers, by contrast, booked return multiples below breakeven on just 27% of its deals—a little over half as many. The difference in the proportion of money-losing deals explains more than half the variance in the returns between the top-performing and weakest-performing funds.

Finding winning deals that win bigger.A second major performance difference between the top alpha-generating funds and the laggards is the size of their wins. Forty percent of the performance leaders’ winners (that is, deals that returned more capital than GPs put into them) earned a multiple that was better than three times the invested capital vs. just 13% among the weakest performers. The advantage of investing in winning deals that won bigger explained 30% of the performance variance between funds that were leaders and the rest.

Backing winning deals that are bigger deals.Most PE funds have demonstrated a proven ability to convert small deals into winners that return a high multiple on invested capital. It is simply easier to grow a small company into a much larger one than it is to do the same with an enterprise that is already fairly big. But Bain’s analysis discovered that top-performing funds consistently take bigger companies and make them still bigger. Among the performance leaders, deals that returned a multiple of more than three times their invested capital were 20% smaller than the average deal size in their fund’s portfolio, while the winners of the performance laggards were just half as big as their average deal (see figure). This third advantage helps to explain the remaining 15% performance gap between top and bottom performers.


It's All About Alpha

Bain’s analysis of performance-leading PE funds also found that there is no one path to top returns. Segmenting the sample of funds we examined that achieved better than 15% net IRR by their pattern of winning and losing deals revealed three distinct routes to success. Funds in the first cluster, representing about 29% of the total, appear to rely on sheer luck, having invested in one or two exceptional deals that more than compensated for many money-losing ones. However, GPs managing the funds in the other two clusters followed what appears to be a repeatable process for creating alpha.

The first of these groups (38% of our sample) comprised funds whose hallmark investing style can best be described as “consistent.” With better than two-thirds of the deals in their portfolios achieving a multiple of between one and five times their invested capital, they managed to steer clear of deals that end up losing money. They were also less likely than their high-performing peers to back deals that generate exceptional multiples exceeding five times their invested capital.

The second cluster of top performers swing for the fences on every deal they do—but like big-league sluggers, they strike out a lot. Comprising one-third of the funds in our sample, these heavy hitters earned multiples exceeding five times their invested capital on 15% of the deals they did, but they ended up with about as many money losers.

There are important lessons for GPs in these findings. With asset prices high and showing no signs of coming down, they will need to stretch every link of the value chain—from deal sourcing to exit—to steer clear of bad deals and spot deals that have peak-performance potential and to find ways to consistently reap their full value.

Read the full report: Global Private Equity Report 2014

  1. by Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma, leaders of Bain & Company’s Private Equity Group.
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Posted by on in Union Bay Partners Blog

We've launched our new web presence, and hope you subscribe and enjoy.  We'll be posting articles on this blog that we find interesting.  Visit again soon!

Brian & the UBP Team

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As a part of my work with PitchBook, I have been working closely with Doug Tatum founder and Chairman Emeritus of Tatum, the largest Executive Services firm in the U.S. and the Edward Lowe Foundation in creating the website, growtheconomy.org. This site illustrates the effect of Private Equity capital on employment and revenue growth by MSA across the country and results of the research are staggering: From 1995 – 2009, private capital-backed companies grew sales by 132.8%, while the United States grew sales by 28.0% and grew jobs by 81.5%, while all other companies in the U.S. economy grew jobs by 11.7%.

David Birch of Cognetics research and M. I. T. coined the term “Gazelles” to represent these companies. Gazelles are defined as companies growing at least 20% year over year for four years straight. There are no correlations with “small business” which though they represent the highest employment block, don’t actually grow employment, nor are they “high tech” which many Venture Capital investors hope to foster.

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We often get the question as to why we’re doing this, and why in the Pacific Northwest.  Well, the PSBJ just answered the question: in addition to Portland, Vancouver, and the rest of the PacNW, Seattle is home to close to 95,000 small businesses (ranked 13th in the country)!

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Posted by on in Union Bay Partners Blog

The only certain thing about taxes in the US right now is that they’re uncertain.  Your point of view can and should inform your plans . . . Fortune has details about Obama’s plans relative to M&A.

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Republished from My experience as a private equity CEO.

My experience as a private equity CEO
Armand F Lauzon Jr
02 Feb 2012

In the past 10 years, I’ve been the chief executive of three companies owned by the Carlyle Group, a major private equity firm. I’ve watched with interest, therefore, as the private equity industry in which Mitt Romney thrived has been portrayed as dedicated to corporate raiding, to profiting as it destroys. In the companies I’ve run and the private equity industry I’ve observed, nothing could be further from the truth
Private equity firms exist for one reason: to create value for shareholders, the largest percentage of which are public pension funds. Firms do this by finding and investing in underperforming businesses that have potential for growth.

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Repost from What Private Equity Can Do for Your Company | Entrepreneur.com.

What Private Equity Can Do for Your Company

Looking to grow or get liquid? If so, private equity might be a better option for you than venture capital.

Most business owners have heard all about venture capital funds as a source of funding for startups and early-stage companies. But what about more advanced profitable companies — where can they go for their millions?

Private equity — or “PE” — is the umbrella term for a broad range of funds that pool investors’ money together to increase their buying power. Unlike most mutual funds, in which fund shares trade on active public securities exchanges, private equity funds attract investors who are willing to hold shares in privately held, non-traded funds (hence the term private equity). These big-dollar private equity funds are trolling the business landscape for new investment opportunities — and that means you.

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According to the PSBJ, sales of businesses are up 3.9% over last year, and the most since 2008.  Anecdotally, we hear the same trends are at play in the PacNW.

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Posted by on in Union Bay Partners Blog

I was recently honored to participate in the Alliance of Mergers and Acquisitions Advisors’ annual M&A Market Update Panel.  We had a lively conversation on where we saw the industry moving and if there was a recovery in sight.  We unanimously concluded that, based on the high cash reserves of strategics and the overwhelming capital overhang in the private equity universe, this was going to be a banner year for corporate transactions.  On the private equity side we see approximately $450 Billion in total unfunded commitments, with just under $232 Billion from the vintage years 2006-2008.  If you lever this up 3.3x we’re looking at about 3/4 of a trillion dollars in deal flow over the next 2 years.  Considering 2007, the most active year in Private Equity, saw $570 Billion in deal flow, the next two years will challenge that top spot.

With me on the panel were Steve Brady (National Managing Partner of Grant Thornton’s Transaction Advisory Services (TAS)), Graeme Frazier (Founder and President of Private Capital Research LLC), Charlie Welsh (Co-founder of Mergermarket) and Andy Schmucker (Managing Director, Head of Strategic Advisory, Head of Financial Sponsors Coverage for Janney Montgomery Scott LLC)

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Another Year of Lethargic Growth in the Consumer Products Industry?

Friday Morning Dealmakers Column

Consumer spending, largely tied to employment growth, will likely maintain its slow uptrend in 2012. Interestingly, corporate profitability has increased sharply over the past two years reflecting rising worker productivity and an ability to pass through higher costs. However, few companies are willing to expand or invest due to inaction in Washington and fear of a further tightening in the regulatory environment. They seem inclined to only add to the workforce if and when there is a more defined upturn in business, rather than bear the burden of higher costs in anticipation of recovery. Thus, it seems a 2 percent real GDP growth is a reasonable expectation, followed by a similar increase in employment and consumer spending. Importantly, this does translate into higher retail sales, but a rising tide will not lift all ships. Market share will be an integral part of vendor and retailer sales growth this year.To learn more about this and other industry trends, register for “Consumer products: Deal successes, challenges and trends,” a webcast presented by McGladrey on Wednesday, Feb. 8, 2 p.m. EST, with guest speakers from PitchBook and Harris Williams.

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We are Union Bay Partners.  We invest in growth opportunities across stages and sectors where we have skills or expertise to help build enterprise value. We primarily target companies headquartered in the Pacific Northwest. We focus on business or consumer products and services.

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