In terms of the relation between PE firms and portfolio companies, the main questions concern the level of control PE firms has over portfolio companies, the source of growth of portfolio companies and, finally, whether PE firms add significant value to portfolio companies.
PE firms, even before the transaction is closed, have a clear vision of how a portfolio company should be managed. Having the majority of votes, PE firms possess enough control to force portfolio companies to implement their strategies. PE firms believe that they understand the company better than the current managers and, as a result, they are able to more accurately assess risks. This confidence manifests in two ways, or rather, on both side of the balance sheet.
In terms of right side, it allows PE firms to take great risks and borrow more money than the companies they acquire would normally do. This money is used to finalize the transaction. According to PE firms, a high level of debt brings two major advantages. One concerns tax benefits, high interest rates yield tax reduction. Secondly, high debt demands great efficiency and commitment from managers. This risk is taken not only by the portfolio company, but also by the investors and, in extreme circumstances, taxes payers.
In terms of left side of the balance sheet, PE firms are confident that they can run chosen companies better. PE firms prepare themselves, at a very early stage, to assess the possibilities of growth in the industry and the company. They work both internally and externally to evaluate this growth. This hands-on management approach is supposed to bring the profitable return.
Do PE firms always focus on both sides of the balance sheet? The answer is no. This is evident in the shift from financial engineering towards operational engineering. Almost all PE firms use words like “add value” or “growth” as marketing tools. Worth mentioning are: Blackstone “We play a vital role in providing businesses with the capital to realize their growth potential. We uncover value by identifying great companies and enhancing their performance by providing patient capital and partnering with strong management teams”, KKR “Our approach is to combine our platform of global resources with our industry knowledge and operational expertise to help improve our portfolio companies over the long-term. Central to this approach is our belief that the private equity model can be a powerful catalyst for improving companies”. On its website, The Private Equity Growth Capital Council states: “Some suggest that private equity delivers its substantial returns mainly as a result of financial engineering and does little to create real-world value. In its early years, private equity firms could simply change a firm’s capital structure and make considerable profits. But that is no longer the case.”
While searching for data to back up claims about adding value to portfolio companies, the study “Corporate Governance and Value Creation: Evidence from Private Equity” done by Viral Acharya, Moritz Hahn and Conor Kehoe offered some insight. They examined 110 completed private equity deals made in the UK and Europe between 1995 and 2005. They calculated an average IRR on these deals of 38.6%. Most of the return came from a combination of the stock market (8.5%) and debt (21.7%); the rest (8.4%) came from private equity’s specific contribution.  As a result, we can conclude that 78% of returns come from debt and market conditions and only 22% is operational engineering.
Based on the information collected, private equity investments should be a win-win situation for both sides. PE firms bring their expertise to boost the growth of the company and, as a result, investors receive a superior return. Although this is the prevailing message, there is not adequate research and data available to confirm it.
 Page 26. Peter Morris. 2010. Private Equity, Public Loss? The Centre for the Study of Financial Innovation