Blog: Where Large Private Equity Got It Wrong

Where Large Private Equity Got It Wrong 

For years, large private equity (PE) firms relied on financial engineering—leveraging high debt, cutting costs, and optimizing tax strategies—to drive returns with minimal operational involvement. However, rising interest rates, inflation, wage pressures, and talent shortages have fundamentally shifted the landscape. PE firms can no longer depend on high leverage alone; instead, they’re increasingly focusing on operational improvement to deliver value. For this blog, I draw inspiration from a recently read Bloomberg article, written by Marion Halftermeyer and Layan Odeh. 

Historically, the PE model was relatively simple: firms would acquire companies through leveraged buyouts (LBOs), cut costs to boost free cash flow, and use that cash to pay down debt. Ultimately, the goal was to sell the company at a higher multiple than what was initially paid. Financial engineering—restructuring debt and employing tax optimization strategies—allowed firms to (sometimes artificially) enhance balance sheets without deep involvement in the company’s day-to-day operations. 

Adapting to a New Reality 

Now, with interest rates eroding the benefits of leverage, top PE firms such as Goldman Sachs and Blackstone have had to change their playbook. They’ve started hiring executives with operational expertise to actively manage portfolio companies. For example, Blackstone recently brought on Prakhar Mehrotra, an AI expert from Walmart known for his AI-driven strategies to optimize demand forecasting and supply chain optimization. 

This shift reflects a broader trend—operational management is now critical to achieving value for investors. Smaller PE firms may hold a competitive edge in this environment due to their specialization, agility, and focus on smaller deals. While firms like Blackstone need to deploy billions to prevent cash drag, smaller firms can thrive by deploying just a few million, allowing them to focus more on operations than sourcing deals. 

A Real-World Example 

Consider a recent deal involving twelve Burger King locations. Our team is moving forward with the acquisition of five of those locations, including one real estate parcel. In quick-service restaurants (QSR) like Burger King, a healthy rent-to-sales ratio is around 7-9% (lower is better). By improving operations—boosting sales and margins—we can justify charging ourselves, as both landlord and operator, a higher rent, while maintaining a sub-10% rent-to-sales ratio. This strategy enhances the real estate’s value while keeping operations stable, creating an opportunity to sell the property at a premium and return profits to investors.

Boosting sales and margins are more easily said than done. In the Burger King example, boosting sales involves a deeper hands-on approach with current staff and management. In some cases, it demands an overhaul. Brands are built from the bottom-up and consumers tend to notice the details—whether the staff are wearing the company’s branded gear, whether they are smiling when greeting the customer, among other items. 

Conclusion 

The landscape for private equity has changed, at least for the interim. While large firms must now adapt by becoming more operationally involved, smaller PE firms may find this new reality to be an advantage. Their ability to focus on specialized, smaller buyouts allows them to thrive in a market where large-scale financial engineering is no longer the primary driver of value. Operational excellence and strategic improvements have taken center stage as the path to profitability. 

Written by: Jasdeep Khera 

Edited by: Kathryn Atkins