Evolving Strategies in Private Equity

‍Kison: Exactly. Can we kick things off with the intro and your background?

Hugh Macarthur: I've been at Bain for way too long, about 32 years. I'm a dinosaur in the consulting industry and in the private equity industry.
About 30 years ago, a few folks and I founded our. [00:02:00] Private equity consulting practice, which was the first consulting first practice area actually ever founded at Bain Generalist firm before that, we decided that since Bain and Company actually created a successful private equity GP, Bain Capital, our cousins, we affectionately call them, even though there's no legal relationship between two companies.
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Since they were successful in private equity, that we should be in the consulting business for other private equity firms. In addition to Bain Capital to try and see if we could make a business out of it from very humble beginnings with [00:02:30] just a very few of us, it's grown to be a very large and thriving practice area for Bain globally.

Kison: How big is the practice today?

Hugh Macarthur: It's about a third of everything that Bain does. When you take it in its totality, we do commercial due diligence for GPs. We work with LPs. We work on portfolio companies once they've been purchased in order to maximize the value that's been underwritten. And we also do a lot of work with GPs and LPs on their own areas of strategy, operations, and organization.
So it's really quite a wide range of [00:03:00] topics across. All private asset classes. I refer to it as the private equity practice, but in reality, it's a financial investors practice because we started focusing on buyouts. That was the number one product that we looked at, but talking about private assets today is like talking about sports.
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Are we talking about baseball, football, badminton? There's now private credit. There's infrastructure, there's real estate, there's hedge funds. There's the LP side of the coin, the GP side of the coin, even in private equity, there's buyout, there's growth equity, there's venture capital. There are just many different types [00:03:30] of flavors now that didn't exist 30 years ago as the industry has grown and professionalized over time.
And we play in all of them globally.

Kison: What was it like starting this practice? Because it's really interesting. You said the firm was essentially generalists. And then this is the first specialized practice. Was it you just raising your hand and saying, Hey, I got an idea of how it turned about?

Hugh Macarthur: Well, we were lucky.
We certainly didn't know what we were doing. So being lucky was actually a very good thing. 30 years ago, we did have this fascination with financial investors and what they did. That's. Kind of part of our [00:04:00] DNA at Bain and our corporate consulting lives. That's one of the reasons why we founded a successful private equity firm like Bain Capital is that because we wanted to go see how do you win in industries and how do you make companies win and how do you generate results and how does that all work?
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And this was another specific application of how that works. And it differs a lot from the corporate consulting world because at that time, And in these times, corporate consulting can be months and years of activity to improve the operations and the strategy of a firm. We were talking then about doing things in a few weeks in commercial [00:04:30] due diligence, and one of these things didn't look like the other.
We were fortunate that the firm does have an entrepreneurial streak in it, and it was very entrepreneurial back in the day, still is, and said, If you guys think you can make a run at this, then go for it. We'll back you, and we'll see where it goes. That was, we're here. That was 1995.

You got it! Here's the next large section, covering [00:07:00] – Commercial due diligence: Bain’s unique differentiator through [00:12:30] – Market valuation trends and EBITDA multiples over 30 years, all with speaker formatting and accurate timestamps preserved.

[00:07:00] – Commercial due diligence: Bain’s unique differentiator

Hugh Macarthur: I'd like to say all of it.
I'll tell you that we founded the practice and the core product was commercial due diligence, which is this outside lens that we apply to assets and their industries and really try to understand how they're likely to evolve over the next five-plus years—
the holding period that a typical private equity investor would [00:07:00] have—and what the key value levers are that you could underwrite and then go build a plan and execute against in order to really create alpha, to create those excess returns that your limited partners and everyone's looking for.

That remains the core business that makes everything else go.
We have a post-acquisition business where we help actually go and do the things after we perform the due diligence.
We have, as I said, a solution that focuses on the strategy or the top of the house, as we call it, for GPs and LPs—because guess what? Big financial institutions now need [00:07:30] strategies too, in a way that they didn’t 25 or 30 years ago. All of these things hang together.
But the commercial due diligence business was the first thing that we really did that was groundbreaking in the industry.

I recall, Kison, going up and down Park Avenue—as one did in New York in those days, that’s where all the buyout firms were located—and banging on doors, trying to explain what we did and how to generate business with my partners.

GP after GP would tell us, “I know why I need an accountant to do a deal, and I know why I need a lawyer to do a deal, but why the heck do I need a consultant to do a deal?” [00:08:00]
And we would start to talk to them about issues and areas that they hadn't necessarily considered.

“How would you like to know exactly how fast this industry is going to grow over the next five years?”
Or, “How would you like to know what the customers really think about this target company's product or service—and whether they think the prices are too high, too low, whether they're planning on spending more money with this target company or more money with their competitors?”

“And how about those competitors? Are they doing things well? Are they messing things up? Are they lower cost than your target business?”
And I don't think many dealmakers at that time—they were consumed with quality of earnings, which [00:08:30] of course we still are, and deal room data and a lot of that—but this external view was kind of a new lens entirely.

And people said, “You can really tell us things like that?”
And we said, “Sure, that's what we do for a living for the corporate world. This is just the deal application of that. We'll have to change it and evolve it and make sure it happens very fast because that's what your time need is. These are all things we know how to do. We've been doing for years.”

Kison: It sounds like a hybrid between the competency area of strategy and diligence.
I talk to a lot of these firms and I feel like a lot of boutique firms take a very [00:09:00] tactical approach at diligence, but what you described is a lot of bringing in a strategic view when you start looking beyond the scope of the deal at hand.

Hugh Macarthur: I think that's right.
You think about the way things are changing today in a contextual landscape of just the world and the economies.
Think about how fast technology is changing—and I’m sure we'll talk about it later—but things like AI is a complete game changer. And at the beginning stages of all of this, things like automation and the internet became game changers.

Unless you understand how technology is going to impact different [00:09:30] industries—and it's very transformative in many industries around the world—it’s hard to make an investment at any price and know whether or not you're making a smart bet or not a smart bet.

So that's just one example. But regulatory issues are another example. There are all different kinds of things that are impacting how industries behave and how they change.

And I would argue that the half-life of business stability is declining dramatically over time.
It’s going to continue to decline dramatically over time.
Paying more attention to the external world is important for those reasons. It's also important because the pricing of this industry has [00:10:00] changed a lot over the last 30 years.

[00:12:30] – Market valuation trends and EBITDA multiples over 30 years

When I started in the private equity world, if you looked at a buyout, the typical price would be something like five or six times EBITDA or cashflow.
Now it's twice that, or sometimes more than twice that in different industries.
So the margin for error in buying well has gone virtually to zero.
You're paying double what you paid 25, 20, or 30 years ago. And therefore, you've got to make sure that this asset really performs to generate those returns.

You're also actually doing that in a much more competitive world than [00:10:30] 25 or 30 years ago when the industry started.
Two of the most important differentiating tools that a dealmaker had was his Rolodex—if we can use that word for people to understand it back when Rolodexes really existed—because you sourced a lot of your deals in a proprietary fashion.

That means you went into your Rolodex and you knew people who might be selling a business.
And you called up the person who owned the business and you negotiated a deal one-on-one.
Now, 90+% of all the deals you'll see out there are intermediated by a bank or someone [00:11:00] like that who wants to get maximum price for the seller.

They invite all potential interested buyers and the prices are much, much higher because it's a much more competitive marketplace than it was 25 or 30 years ago.

The second tool that was very differentiating 25 or 30 years ago: your banking relationships and your banking acumen.
Because bank financing was bespoke. And the cleverer you were at creating a financing structure that was efficient, extremely leveraged, got you the kind of amplification on the returns that you wanted—then the better returns that you [00:11:30] actually generated.

Now, most of the financing in deals is monetized.
Anything that's being put for sale that's a normative asset typically has what we call staple financing, which means the selling intermediary offers the same exact financing to any buyer.

Being an expert in financial structuring—except in special situations—is no longer the value that it was in the past.
Having this deep network of proprietary relationships for sourcing deals in a non-competitive way—again, in most instances—no longer the kind of differentiator it was in the past.

So, you've got to be really good at the [00:12:00] other skills around generating returns and where the value levers are that you can confidently underwrite in order to deliver those returns.

Absolutely! Here's the next section, covering:

[00:14:30] – Industry sector evolution: from industrials to tech and healthcare

Kison: You work with some big firms. There's a whole lower market spectrum that probably has its own average. But what have you seen in terms of industry focus or how that's evolved over time? Because we've seen multipliers go [00:15:00] up in terms of spaces that firms are investing in. What does that trend look like?

Hugh Macarthur: Kison, it's amazing. It's really exploded as well.
The classic buyout 25 or 30 years ago was an industrial company that might be a little bit of a dented can, or it might be doing fine, but could do better.
And a buyout fund would lever it up and go in and reduce the costs and make it more efficient, more valuable, and then sell it and make a lot of money.

Consumer products was also relatively popular, but I called them kinds of businesses where you can touch and feel things and people feel like they understand [00:15:30] it. But it was very much a value-oriented mentality that the industry was grounded in.

We've seen an explosion to the point where almost any industry sector is available for private equity growth.
And you mentioned you're in the software business. If 25 or 30 years ago, I said, “We're going to take fast-growing software companies, put debt on them,” people would be laughing at you.
This is just not a conceivable thing.

And now software and tech are the single largest sector in the entire buyout industry.
Healthcare was not that popular back then. That's now the second or third largest sector, depending upon the [00:16:00] year.

Really understanding how sectors behave and getting to have a deep grounding and expertise within not just sectors, but subsectors—because when I say healthcare, that’s a lot of industries that comprise 17.5% of global GDP—so getting really smart at those subsectors that you want to invest in, so you know more about where value is created than anybody else, has become one of the mantras of the entire industry.

Simultaneously, as some of these sectors have changed that the private equity investors are investing in, the types of investment theses have changed as well.

So I mentioned earlier that in my mind, the industry was always grounded in value—where is the value? [00:16:30] How can I pay a good price and make this a more efficient, more streamlined organization?

Over the last 15 years or so, we've seen the industry evolve to be much more about growth and value—much more about: how do we double, triple, quadruple the revenue growth of this business, depending upon what it is?

And a lot of that has to do with technology.
If you look hard under the hood, you’ll find technology everywhere.
It’s not just, in and of itself, a software business. Maybe it's fintech, or it's healthcare IT, or it's tech-enabled business services.

But technology is bleeding into many industry sectors and in every case, it's about faster growth. [00:17:00]
Efficiency, sure, but it's about faster growth.

The industry has had to shift from a mindset of cost and margins being primary to, in many cases, revenue growth being primary.

And one interesting study that we did, Kison, that sticks out in my mind is that we went back with a proprietary database that we have, and we disaggregated the sources of value of all the deals that have been done from 2013 through 2023.

And what we found was:

• About half of the value created in all of the deals and buyouts globally during that time came from revenue growth
• The other half of the value came from multiple expansion
• 0% of the value came from margin expansion

Which, if you're an old dinosaur like me, is an absolutely astonishing outcome—that none of the value over a decade was because margins went up on average in buyout deals. [00:18:00]
It’s extraordinary. But we were in an extraordinary period where there was this shift going on toward underwriting more growth as being the predominant driver—a controllable driver, if you will—versus margin.

And we were in this period of zero central bank interest rates, which made debt very cheap, in an era of very steady GDP growth.
That made multiple expansion almost a mathematical certainty—if you’re getting the revenue growth.

We didn’t have to have margin expansion. Now, of course, the interesting end of that tale is:

What have we seen in many countries over the course of the last several years?
Rising interest rates. [00:18:30]
Central bank interest rates are not zero anymore. They may be bouncing around, they may be coming down a little bit—but they are not zero. They are actually positive.

That is causing a reexamination in the industry of: how do we make money again?

Revenue growth is still important. I still like growth-y industries. But whatever you think multiple expansion is going to be over the next decade as a contributor to value creation, it's probably not going to be as big as it was when interest rates at the central bank level were zero.

That means I’ve got to dust off my old margin improvement playbook and figure out:

How do I make these [00:19:00] margins expand?

And that's not always about reducing costs. Sometimes it is, but sometimes it's:

“Hey, I've got a fast-growing software business—how do I get real operating leverage and make sure that I'm pursuing this Rule of 40 or Rule of 50 or Rule of 70 or whatever rule you are pursuing?”

Kison: We have increased the revenue. It has been a big factor to the growth.
Then we have multiple expansion. When we say multiple expansion, is it just the general valuation multipliers have gone up across the sector, or just more companies are like consolidating businesses that therefore they triage their valuation from small asset to bigger asset?

Hugh Macarthur: It's really about the fact that when you shift into growth as a mode and you're actually successful in generating that growth as an industry—which the private equity–owned assets have done— [00:20:00] you're going to get rewarded with a higher multiple over time.

As GDP continues to go up, earnings go up, my EBITDA is going up, my revenue is going up at a very fast rate, people are going to be able to pay you more for that in the future and have the same kind of interest coverage level.

So I'm manufacturing, if you will, the increase in multiple.

And of course, that's being helped along by 20 other private equity firms that want to buy that exact same asset and are willing to pay a little bit more for it.

So there's a competitive aspect, and then there’s a structural aspect of hitting those growth targets and just having EBITDA on a steady march upward in many industries over that period of time.

Let me know when you’re ready for the next one:

[00:22:30] – Changes in deal sourcing: proprietary to competitive

Kison: And software growth is so important. You're over 40 percent year over year, get a nice health evaluation. If you're like 20 to 40, it starts dropping off pretty quick.

Hugh Macarthur: It's incredible, isn't it?

Kison: And now across all industries, or is it just unfortunate to be in the software space?

Hugh Macarthur: It's across many industries. It's most prevalent in software. And as I said, tech is the largest sector in buyout by quite a wide margin. And about 90 percent of the value in anything you could call tech in buyouts is software. We've seen the rise of a lot of large software specialists that are GPs. The interest level is definitely there. And of course, software permeates, as I mentioned earlier, all of these other different subsectors. So a lot of it is software-enabled. And when people hit the growth number, they were rewarded because people thought that's clearly success.

But when I referenced earlier that out of all of the deals done, margin expansion was not a contributor to value accretion over the last decade, there's now the concern in the industry—and we have seen this blip crop up after interest rates came up—of can these businesses really make money?

They're growing very rapidly, they may be a certain level of profit in there, but if I can't believe that EBITDA or cash flow is going to grow along at some rate with revenues over time, then this business isn't as valuable potentially as the multiple that I put on it. So we're in this period right now where we're coming back to the future, if you will, of show me exactly how this business makes money and show me how it's going to make money over the next five years. Not just that you can grow fast. That's not enough anymore.

Kison: The way deals are getting sourced. It started mostly proprietary, but now it's getting more competitive, which means a lot of money for bankers to make.

Hugh Macarthur: A lot of money for bankers to make, yes. It has not gone unnoticed on Wall Street that this is a very lucrative and growing asset class.

Kison: Is it the culture for private equity to rely on banks for deal sourcing versus a lot of strategics are building their own search to find proprietary deals very proactively because they're always focused on that strategy that is supporting their corporate strategy. Is that the case? Is that what's fueling a lot of this? Is it just, here's a culture in private equity where they play friendly because you go to a lot of these conferences, a lot of matchmaking with the bankers. Is that what it is? Or are they still building their own pipeline as well?

Hugh Macarthur: It's a really good question, Kison, because it has changed over the last few years. It used to be exactly what you're describing—that I'm a GP and I get a thousand, what they call Sims, confidential information memorandums, in the door every year. And I pick out which ones I'm interested in and do triage. And then I get serious about a few and I bid on those and I win what I win. That was what much of the industry was like.

But this need to have industry sector and subsector specialization means I'm actually narrowing the aperture of things that I know a lot about, which means I'm narrowing the aperture on things that I want to look at. So I don't want to look at a thousand things that may come in the door. If

I'm interested in these eight subsectors of the software space, for example, I want to understand who are the players in this space and who might I want to acquire, even if they're not for sale right now. And I want to begin to build my own sourcing because at some point, a lot of those assets will come for sale.

And when they do come for sale, I'm not expecting that I'm going to get a proprietary look and nobody else will, because again, sellers have become a lot more sophisticated. They're going to want to go to an intermediary and say, please find me the highest price for this asset in many instances. But if I've known the asset for a few years, if I know more about it than anybody else, I'm going to get speed to certainty on value faster than my competition and therefore be able to put a number in that’s fully financed and win that asset more often than not. That's really the state of play and where we're seeing the private equity industry evolve.

Kison: Leverage. Having that relationship. Be able to call and say, hey Joe, why don't we go grab a cup of coffee and chat before?

Hugh Macarthur: Absolutely.

Kison: That's really good to see that it's sort of pendulum went one direction, all banked, and then it's coming back the other way because partly being so competitive. Financing, that’s changed. We kind of mentioned the whole, there's like private sector and that's a big part of it. Now that you're seeing a lot of these funds offering different types of debt products and things. Teach me, what have we seen happen?

Hugh Macarthur: Financing for buyouts has changed a lot. In fact, it's changing even more still with the rise of private credit. So it used to be a bespoke negotiation. There were few enough deals that people talked to different types of banks, got different rates from different banks, got different leverage ratios from different banks. Having the skill to put together—and I'm just talking about a vanilla standard buyout here, not something that's very complicated—but you needed to work at it to get the most efficient capital structure at the lowest possible costs. You could make the most money.

Then, as I mentioned, staple financing became popular, which is every buyer gets the same financing package. Here it is. And there's really no ability to differentiate because we can all get the same terms of debt at the same rate, so the ability to really get a lot less in terms of cost or a better structured package went away.

Now, especially with the banks having pulled back a bit just in the post-COVID era, we're seeing the continued rise of private credit. So there are a lot of private direct lending funds in there. They understand—heck, some of these firms actually have buyout businesses alongside their private credit businesses. So they understand buyouts, they understand credit. And they're stepping up and filling the gap and saying, we will do the credit needs for this deal. And that is a different source of capital than the traditional bank.

[00:29:30] – Value creation strategies: growth vs. cost-cutting

Kison: A lot less now. The operational efficiency against your purchase price. But now you got a stake you can put in the business.

Hugh Macarthur: It makes believing in the business all the more important. Really knowing what you're buying.

Kison: Let's talk about creating value. The value levers. How's the playbook evolved?

Hugh Macarthur: The playbook's evolved a lot. We talked a lot about the fact that margins and costs were very important, and they still are, obviously, but that was a lot of the playbook in the past. And now the playbook is much more about how do I grow profitably? What is the best way in a B2B situation? What does commercial excellence look like? What does my strategic view of the marketplace look like? Are my customer segments really what do they want?

Does someone want Rolls Royce treatment and is prepared to pay for it? Does someone want the least cost imaginable and they're only willing to pay for a little bit? What's my value proposition to those different segments? Where do I focus? Is my Salesforce big enough? Is it fit for purpose? Am I selling the right messages? Is my pricing appropriate for what I'm doing? Do I change my pricing? How do I augment my pricing in certain ways? How do I make that more dynamic in a way that's going to be useful to my customer, as well as to the actual target company that I'm buying?

These are all highly complex issues that are now crucially important to the industry. I'm not saying that revenue growth wasn't important before, but if I'm underwriting things where the primary value lever is going to be on the revenue side—and let's call it B2B—all of these things are now must-dos and must-do very well in a specific industry segment.

Getting that right and knowing it's there and having the confidence to bet on the come—that the revenue at a certain margin structure will occur over a five-year period if I do the following things—that's a different act than carving out a big industrial business and saying, I know I can cut costs here. I know I can cut costs there. I know I can actually save this by selling these non-core assets and I'll be able to make that happen. It's just a different equation. And we're seeing the kinds of value creation approaches and teams in the marketplace evolve along with that kind of dynamic.

This isn't the only way that people are adding value, but it's probably each end of the spectrum, if you will. And many firms need to be good at both because they're buying fast-growing software assets over here and their industrial group is buying LBOs over there.

Kison: It sounds like it's gotten a lot more sophisticated. I feel like the traditional model, the term buy and build—you buy, you go buy some more and just valuation triage. That was pretty much straightforward. That's not the playbook anymore.

Hugh Macarthur: It's not. And we flirted with buy and build.

Kison: Roll-ups. Isn't that what they do? They just consolidate a sector?

Hugh Macarthur: There are lots of different things that have been called over time and they've changed dramatically over time. There's a right way to do them and a wrong way to do them. What we've learned at Bain is that a few things need to be true in order to get this right. And this has changed even a little bit since interest rates went up a couple of years ago.

[00:33:00] – Buy-and-build strategies and integration challenges

Hugh Macarthur: One is you have to be buying a stable platform, which sounds like a platitude or a tautology or something completely obvious, but there are many instances where some of these businesses that GPs are buying are themselves amalgamations of investments. There are somebody else's buy and build. Someone bought something, they bought four other things, and now they're selling it to you.

And understanding whether or not that's one company or four companies that you're buying is the first critical question, because if they have four different ERP systems, four different sales forces, that could be a company that's very challenging to then build upon and use as a platform because it hasn't been integrated. It hasn't actually been made into one company yet.

Kison: Do you look at that as an opportunity to integrate that company and then unlock some value?

Hugh Macarthur: It is an opportunity. Now, why a lot of folks don't do it is that it's hard to do and it's expensive. You have to believe that the synergies are there and that they're measurable. You absolutely need to do it in order to get the full value out of an asset today. I'm going to come back to that because that's the thing that's changed. But one thing is it's got to be a stable platform.

The second thing is it actually has to have enough fragmentation, not just for your ownership period in the industry, but for the next owner as well.

Because when you go to sell, the next owner has to look out and see lots and lots of targets that they can buy, continue this buy and build it. They don't see that same level of opportunity or greater for themselves. They're not going to pay you the multiple you want for that asset. So there has to be real fragmentation of lots and lots of owners of businesses who will be willing to sell over a long enough period.

We're talking 10-plus years, 15-plus years, not just the next five years, in order to give you confidence that’s the right kind of industry.

Another critical one has to do with the industry structure itself. This is number three. And that is, is that it doesn’t have to be an exciting or sexy industry, but it has to have stable EBITDA growth. Cyclical businesses do not make good build-up targets because when EBITDA goes down, my ability to effectively do the buy and build goes away.

And that’s why we see a lot of these things in veterinary centers. Everybody always takes Fido out to the vet, no matter what happens, no matter what the economy is. It’s not the sexiest business in the world, one could argue, but it’s going to grow at a certain rate that you can predict. So that steady growth is crucial.

And now to your point, Kison, the other thing that was always on our list as nice to have but now is must-have—are these synergies have to be real. It’s not just buying things that look like one another, but there’s no real operating synergy in there. It’s putting businesses together where one plus one equals three or one plus one equals two and a half, and actually having that work. Because the cost of debt is real. I’ve got to be able to put these things together. I may actually lose my arbitrage and my multiples.

If too many people are trying to buy these smaller businesses and do their own build-ups, my only bug spray against that is to have real operating synergies that I then go and get when I integrate these businesses at the end of the day.

Kison: You have to. You don't have a choice. You're paying more, you got to do more to make a return.

Hugh Macarthur: We agree. All those things have to be true in today’s buy and build. And buy and build is still, I would argue, the most popular way that many GPs add value. Over 60 percent of all deals in the marketplace are still add-ons, and the majority of deals have been add-ons for years.

[00:55:00] – Role of AI and advanced analytics in deal execution

Kison: I've noticed that the strategics will do a lot of things in-house when it comes to executing a value creation plan. Unless it's like a really big deal—a billion plus—they'll call Bain & Co after that. Then private equity seems to outsource everything. Everything goes to some consulting firm, shape, or form. Is that the same thing you've seen? Have you seen that change at all?

Hugh Macarthur: Yes, it does ebb and flow. The GP landscape is very different than the strategic landscape. Strategics are, generally speaking, if you're in the business and you're buying a business that's very similar in the same category of subsectors that you're in, you tend to believe that you can integrate it because you're in the business. Most GPs are not in the business. They may own it for a few years, but they're not in that business. They haven't been operators for 30 years. They don't want to be operators.

Some GPs have a lot of in-house folks that actually make that work, and I would call the term: if you're specific enough about what you do and you repeat it often enough, you kind of have a playbook. Whether that's buying only software businesses and growing them incredibly rapidly and improving their profitability, whether it's doing carve-outs and taking lots of costs out—if you're doing similar things again and again, it can be worth it to have a large team of folks that’s on the cutting edge of how to make that happen.

Because that repeatability factor makes you more efficient, makes you more knowledgeable, makes you better than others at what you do. So you'll get more value out of the same asset than someone else who's not doing that.

For folks that are buying across many different sectors, different types of investment theses—some buy and build, some organic growth, some fix that dented can, the business is a little broken, we can make it better—those are a lot of different things. And most buyout firms, they don't have thousands of people running around.

They may have 100 people, they may have 50 people, they may have 200 people, but they don’t want an army of people on staff for something they may do once in five years. So it doesn’t make a lot of sense to have every possible value lever covered with someone on your team that you're paying for.

What makes more sense is that you agree that you want to have a certain rigor in your value creation plan process. You'd like to try and do the same thing in partnership with management every different time.

There may be some people on your payroll as a GP that you want involved the majority of the time—the air traffic controllers, I call them—but you're going to have an ecosystem of partners, experts, CEOs, other advisors, consultants, people that are going to be useful, that can do a lot of different types of things so that you can use them on a bespoke basis. For when you do that deal, you're going to do it once in five years. I'm not going to have that on my payroll, but I know how to put together the people who can actually help me get that value.

Kison: That sounds great. Why don't we start a private equity firm?

Hugh Macarthur: Well, it sounds great. It's easy for me to say, Kison. It's actually very challenging to execute on. And while I have thought about starting a private equity firm at times in the past…

Kison: We'd be a great team.

Hugh Macarthur: We would be a good team. We've got a little good thing going here in this dialogue right now. The unfortunate reality in the world is that when I started in this business, the scarce commodity was capital. People actually needed the money—the equity—to get a deal done. That is now not at all the case. If anything, we have a surplus of capital. There's more money chasing fewer assets than in the past.

What the world doesn't need is another dollar of private equity capital chasing those assets. What the world does need—and what is rewarded—is that differentiated angle, that view of an asset, a subsector, a thesis that plays across subsectors that's going to make a repeatable play.

That’s what LPs are looking for, and that’s what’s new and exciting in the private equity world.

So it's not that we're not going to see new firms pop up. We are going to see new firms pop up. Private equity has always been an entrepreneurial asset class, and it always will be. If you don’t have the idea on what’s going to generate alpha—that excess return—it’s going to be much, much harder to get in business and to raise capital.

[01:00:00] – Growth of private markets and increased retail access

Kison: All right, so we're not going to start a PE firm, but we can build an investment thesis. This is actually interesting. What have you generally seen as interesting investment theses in the past decades?

Hugh Macarthur: What we're seeing now is people in search of interesting, repeatable, long-term trends. One of the ones that we've done a bunch of work on is the changing demography of different countries over time. In general, there's an aging population trend that's going on in a lot of places. If you look at the U.S. with the baby boomer generation, we're going to have more people— I can't remember the exact numbers— but more people over the age of 65 than ever have existed in history.

And they need and want to do certain things. Their entertainment, their exercise, their sporting— all of the things they are going to spend money on. We're now going to have more people in that age cohort, more healthier people in that age cohort than ever before, and they’re going to spend money on a whole bunch of different products and services.

So if I can understand that, predict it, and then figure out how I want to play it, there’s a lot of value in that—particularly if I understand that better than other players who don’t.

At the same token, there’s another even larger cohort of folks in the United States that are in their household formation years. So these are people that are about to, if they can afford it, buy houses, have families— and again, when you start to have kids, when you start to buy a house, there's a predictable set of things that you're spending money on in terms of products and services. And we are going to have more people in the largest cohort of those folks, in that age range, in history in the United States.

And if you understand that, and understand what we call the spend corridor, better than others, then you're going to be able to get there first on a lot of these businesses that may be doing fine now, but they're going to take off in the future because of the way that the demographics of the country are playing out.

That’s just one example, but it's those kinds of longer-term thinking about: How is the world going to change? How are the macro and microeconomics of things going to change? And if I can get certainty around what some of those things are going to be, then I'll get ideas and investment theses around where attractive places to play might be and recognize those opportunities perhaps faster than my competitors.

Kison: You know, with AI in play, it's like every industry is going to be evolving, shaping quickly. But I get what you mean—like, where’s that big trend you see that’s going to indicate where the puck’s going.

Hugh Macarthur: Absolutely right.

Kison: What is it? What are we betting on?

Hugh Macarthur: I had a very wise partner once tell me—this was probably two decades ago, maybe even a little bit longer—"Never, ever bet against technology." And he meant it in the case back then of retailing. This was the beginning of e-commerce, and he was very wise because that remains very good advice today: Never, ever bet against technology.

Now, timing is important, and understanding what technology is going to do is even more important than that. And as you mentioned, AI is the zeitgeist for technology—everything. And not everything is generative AI, but some things are. And I think the rate of change and the amount of impact that AI is going to have in any given industry is very different from one another. It also may take a little bit longer in many industries to have the kind of transformative impact that a lot of people read about or talk about in the newspapers or on TV these days.

The transformation is very difficult. There are some things where it's easy to see how a bot might be able to answer student questions at an online university faster and more efficiently than a person can, and you get that accuracy rate up and you say, “Gee, that's a great use of AI. Having that bot answer student questions—that is a tremendous productivity enhancement idea.” That is not a transformative idea that changes an entire industry.

What I'm seeing, at least from my vantage point, is lots of ideas about where this might go in time, but how fast we get there and how transformative these things really are in different industries by when—those are very much up in the air.

[01:04:00] – Common mistakes PE firms make during acquisitions

Kison: I know we're getting close to time here. I gotta ask, what's the craziest thing you've seen in M&A?

Hugh Macarthur: The craziest thing I've seen in M&A— or at least one of the most surprising things— was during one of these hyper capital velocity cycles that we were talking about. It was 2006 or 2007, I can't remember when, and this was when the advent of the club deal came about, which were two or three or four— in some cases as many as six— GPs coming together because none of them had a big enough fund by themselves to write a check. But if they pooled their money, they could actually go buy a big public company and take it private.

And I remember I was doing a phone call, and three GPs had gotten on the call, and they wanted to talk about taking a big asset private. I said, "Okay, that's great. What's the investment thesis?" And I would say for the next 40 seconds, there was complete silence on the other end of the phone. And I began to realize that these GPs had not even discussed amongst themselves what the investment thesis was. It was much more, “We have a lot of money and we can do a deal,” in my mind, versus, “We know what we're going to do with this company.” And this was a multibillion-dollar take-private.

That was one of the wildest things I ever heard— was realizing that people got all excited that they had enough money to do a deal— very smart people. But then we had them on the phone and it's, “What are you going to do with this asset?” And I got silence for about a good 40 seconds. At the end of that 40 seconds of silence, the comment I got back from one of them was, “That's our next discussion.”

Kison: Real deal fever is the theme of the podcast. You’ve got to build a good investment thesis and stay focused on it.

Hugh Macarthur: It is. And it's actually hard to do. We talk about it like it's the simplest thing in the world to do, but this is— or this has been— the private equity business for most of its existence: a pretty undefined industry. It's not like, “These are where you play. This is where you don’t play. This is so-and-so's pool over here. This is your pool over there.” It’s not set up that way. There are no rules. It’s very challenging.

And it's only really been in the last few years where that specialized knowledge and that angle has just become so important for generating alpha that you've got to have it. And by definition, if you're becoming more specialized, you're closing down the aperture of things that you're looking at. Because you know these spaces over here and how they behave— but that means there's a whole bunch of other spaces that you don't know, and someone else does know, because they're investing in those subsectors the same way you're investing in your subsectors.

I think it's been a healthy thing overall— this specialization in the industry makes it more possible to earn differentiated returns while continuing to pay competitive prices. It's also forced the discipline of sticking to your knitting by defining what the heck your knitting is and what it isn't in a more specific way.

Kison: It's still so easy to get deal happy. It is. We see these capital acceleration cycles— we just saw it prior to 2022.

Hugh Macarthur: Right.

Kison: This has been a great conversation. I appreciate you taking the time, helping me become a better M&A scientist.