A New Era for Private Equity: Operational Value Creation Takes Center Stage
The private equity industry is shifting from financial engineering to operational improvements, particularly margin expansion, as high interest rates drive firms to create value through profit growth and efficiency in both mid-market and large portfolio companies.
Over the past decade, the private equity (PE) industry has largely thrived by relying on multiple arbitrage and financial engineering to drive growth across portfolio companies. The focus on buying low, leveraging acquisitions, and capitalising on industry upswings led many firms to unprecedented returns, often with minimal operational improvements. This era of financial manoeuvring, however, appears to be reaching its limit.
The landscape changed markedly with the rise of high-interest rates, which significantly increased financing costs and reduced overall valuations. These economic shifts are prompting general partners (GPs) to reevaluate their strategies, as relying solely on leveraged buyouts or riding market tailwinds has become less viable. As a result, margin expansion—improving profitability by streamlining operations and driving efficiencies—has emerged as a key strategy for delivering sustainable value growth. Today, PE firms increasingly view operational improvements as a crucial driver of returns, rather than a secondary approach to financial engineering.
Margin Expansion: The Next Stage in Private Equity Strategy
With the limitations imposed by higher financing costs, PE firms are prioritizing operational improvements over financial maneuvers. This shift marks a renewed focus on optimising the profitability of portfolio companies, or “portcos,” as a core method for value creation. Operational enhancements have become more prominent in strategic discussions, and industry data underscores the growing importance of this approach.
A recent analysis by DealEdge, a provider of performance data on buyouts, highlights the correlation between deal size and the contribution of profit growth to value appreciation. DealEdge examined North American buyouts and growth equity investments executed between 2010 and 2024, revealing that medium-sized transactions—specifically those involving equity checks between $150 million and $500 million—derive more of their value from profit growth than larger deals. For these mid-sized transactions, 4.04% of value creation resulted from improvements in profit margins. In contrast, deals involving greater equity sizes saw margin erosion, which indicates that larger buyouts may face greater challenges in achieving profitability through operational enhancements alone.
The Distinct Needs of Mid-Market Portfolio Companies
Mid-market portfolio companies, often characterized by their less mature corporate structures, typically present significant opportunities for operational improvements. As they transition from “growth at all costs” strategies to a model emphasizing efficiency and profitability, these companies become prime candidates for transformation under private equity stewardship. Industry advisers note that many of these businesses require an infusion of sophisticated operating models to enhance their profitability and resilience.
“Mid-market companies often lack the structured operations and efficiencies of their larger counterparts, making them highly suitable for operational overhauls,” explains Kevin Desai, a private equity adviser at PwC. Desai suggests that one effective strategy for driving value in these companies is to bring in experienced executives from large multinationals to take on leadership roles. Seasoned professionals, such as divisional controllers or CFOs, can help mid-market firms implement sophisticated management systems and develop efficiencies that support profitability. By introducing these experienced executives, PE firms can position portfolio companies for long-term growth, improving their overall value without relying on financial leverage alone.
Large Corporates and Operational Efficiency: A More Complex Picture
For larger, more mature companies, the path to value creation differs. Many of these corporations focus on growth by reinvesting cash flow into product innovation and sales expansion, rather than prioritizing EBITDA margin improvements. Large companies frequently allocate resources toward increasing market share and driving revenue, as their scale often demands a growth-centered approach.
“It is fundamentally harder and more expensive to create value in a very large take-private deal than in a founder-owned business,” Desai notes, explaining that the inherent complexity and size of large corporates make operational transformations more challenging and costly. However, the complexity of large-scale transformations doesn’t imply that margin improvements are out of reach.
Some experts argue that large corporates can still benefit substantially from operational restructuring. “Larger companies can be riddled with inefficiencies and legacy processes that are ripe for transformation,” says Romain Bégramian, managing partner at GP-Score, a Paris-based consultancy that advises PE funds on operational value creation. These companies may have embedded structures and dated operational models that, when addressed, offer significant opportunities for value generation. Although complex, large-scale restructurings have the potential to yield considerable improvements in margins and operational efficiency.
Regional Differences: The European Perspective
In Europe, larger PE deals have shown a stronger reliance on margin improvements to drive value creation, contrasting with trends observed in North America. According to Russel Jones, head of product at DealEdge, European acquisitions involving equity investments between $500 million and $1 billion saw margin expansion contribute roughly 10% to overall value creation. This figure stands in contrast to smaller deals within Europe, where margin improvements played a minimal role in driving returns.
European private equity firms may face unique pressures that make operational value creation a more prominent focus. High regulatory standards and diverse market demands can compel European GPs to prioritize internal efficiencies to maintain profitability and competitiveness. This environment encourages PE firms to implement operational enhancements as a core component of their investment strategies, allowing them to achieve value growth even when traditional methods of financial engineering are less effective.
Transforming the Private Equity Playbook
The shift towards operational value creation reflects an adaptation of private equity’s foundational strategies, driven by economic factors that challenge the efficacy of financial leverage as a primary driver of returns. With financing costs remaining high, GPs are increasingly expected to deliver returns through internal enhancements and profit growth rather than relying on external market factors.
For mid-market companies, the transition often entails introducing streamlined processes, optimising supply chains, and integrating advanced technologies that support cost efficiencies. In larger organisations, the focus is often on restructuring legacy systems, improving resource allocation, and eliminating redundancies that erode margins. In both cases, operational improvements not only drive profitability but also position portfolio companies for sustainable growth in a fluctuating economic landscape.
As the buyout industry embraces these operational strategies, private equity is likely to see a transformation in how firms create value. Margin expansion, through careful management and targeted efficiencies, is increasingly seen as a path to resilience and profitability. As this focus on operational improvements continues to gain momentum, the private equity industry may well redefine its approach to value creation, setting new standards for delivering returns in a high-interest-rate environment.
