How the most successful Private Equity firms overcome the winner’s curse

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The Private Equity industry has undergone a rapid transformation in recent years. Competition for attractive portfolio companies has intensified over the past decade. As competition has ramped up, firms have struggled with deal execution and dry powder levels have reached record highs. Price multiples and sale prices have also peaked, rendering price tags of attractive companies unaffordable for many private equity firms. This, in turn, has led to an increased reliance on strategic exits and IPOs.

Eager to compete with rising price tags, and in an effort to put their dry powder to good use, a number of Private Equity firms have fallen victim to the “winner’s curse"— the tendency for a number of firms to bid higher than the intrinsic value of a company, primarily due to incomplete information.

How to break the winner's curse

The most successful Erivate equity firms don’t allow themselves to be duped by a rising price tag and strategically avoid paying more than an asset is actually worth — even if that means going against the hype. By following a few key strategies, they are able to break the winner’s curse.

  1. Assess whether there is a common value element in all offers. An element that has the same value to all bidders will be assessed in a similar manner by all competing private equity firms. Bid cautiously as a common value asset may drive the price of a prospective portfolio company artificially high.
  2. Build relationships. Prospective portfolio companies aren’t necessarily looking for the highest bidder. Many are looking for firms that will be able to offer them both capital and strategic guidance. One of the most effective ways to avoid the winner’s curse is to forge strong relationships with the management team and solidify an intangible asset — the existing relationship. The value of this relationship will quickly gain value in the auction.
  3. Leverage relationship intelligence: Building strong relationships requires relationship intelligence. To optimize your chances of getting a discounted bid, it helps to not only have a strong connection to a target's current CEO, but also to members of the entire executive team. Using Affinity’s relationship intelligence, you can determine how strongly you are connected to various members of the organization, and can identify the most effective path to introduction.

While the winner’s curse has been pervasive in recent years, it is not insurmountable, even in the most competitive markets. By embracing the tips above, you’ll be able to break the curse and boost your ROI in no time.


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