he private equity industry has shifted its return expectations from financial engineering to operational improvement, but the portfolio company finance functions tasked with delivering those improvements lack the infrastructure to measure them.
Private equity returns are no longer built on multiple expansion and cheap debt. The structural tailwinds that drove the industry for a decade have receded, forcing sponsors to generate yield through direct operational improvement. This shift fundamentally changes what general partners must underwrite at deal close, requiring aggressive margin expansion targets to satisfy benchmark return expectations.
The investment thesis now depends on complex pricing, procurement, and labor restructuring programs that must be executed immediately post-close to compound value over the hold period.
The infrastructure required to deliver those targets rarely exists inside the acquired companies. The finance function of a middle-market target is built to report on historical performance, not to track whether forward-looking operational improvements are materializing.
The gap between what the investment thesis demands and what the portfolio company can actually measure has become the primary point of failure in modern buyout transactions. When the sponsor cannot track the operational changes they underwrote, the value creation plan stalls before it can be adjusted.
The new baseline
Between 2010 and 2022, multiple expansion and leverage accounted for fifty-nine percent of total private equity returns. That era allowed sponsors to generate acceptable yields without fundamentally altering the operational trajectory of their portfolio companies. The current environment requires a different approach, with operational value creation now serving as the dominant driver of returns. Sponsors are underwriting ambitious margin improvement initiatives during diligence, assuming the portfolio company can execute complex pricing, procurement, and labor restructuring programs immediately post-close.
Delivering the benchmark two-and-a-half times return over a five-year hold period now requires approximately twelve percent annual EBITDA growth, compared to the historical requirement of approximately five percent. The pressure to more than double the organic growth rate forces general partners to underwrite operational improvements that stretch the capacity of the management team, and the value creation plan carries the full weight of the investment thesis in a way that multiple expansion once absorbed.
PE Return Drivers
Chart 1 · When Private Equity Depends on Operations
59 percent of returns came from tailwinds that no longer exist
Sources of total private equity returns, 2010 to 2022. Multiple expansion and cheap leverage are no longer reliable. What remains is operational.
Sources of total private equity buyout returns, 2010 to 2022 deals. Multiple expansion and leverage together accounted for 59 percent of returns over this period.
Infrastructure deficit
The expectation of rapid operational improvement collides with the reality of middle-market finance functions. These departments were designed for historical financial reporting and compliance, not forward-looking operational tracking, and measuring whether a specific pricing initiative successfully expanded margins or whether a procurement change reduced cost of goods sold requires real-time data infrastructure that most portfolio companies do not have. When sponsors attempt to force operational value creation through an inadequate finance function, the resulting data arrives delayed, fragmented, and disconnected from the daily realities of the business.
Private equity-backed finance functions operate at a median cost of nearly three percent of revenues, compared to approximately one percent in the broader corporate sector. That premium pays for manual reconciliation required to force a legacy accounting system to answer private equity board questions, and the finance team spends its capacity translating historical data into the sponsor's format rather than building the infrastructure needed to measure the operational improvements the sponsor underwrote. The cost is high. The output is backward-looking.
PE EBITDA Growth Gap
Chart 2 · When Private Equity Depends on Operations
The target doubled. The delivery did not.
Required annual EBITDA growth to deliver benchmark returns. The old model needed 5 percent. The current environment requires 12 percent.
Old model — 2010 to 2022
5%
Current model — 2023 onward
12%
Old model — 5% annual EBITDA growth
Current model — 12% annual EBITDA growth
Remainder to 15% scale
Source: City Shift Finance · Verdad Capital, analysis of 993 LBO deals 1996–2021 (Capital IQ)
Required annual EBITDA growth to deliver benchmark 2.5x return over five years. Verdad data covers PE-backed companies with publicly disclosed financials via public debt issuance.
Margin stagnation
Independent review of nearly one thousand leveraged buyouts over a twenty-five-year period shows that post-acquisition EBITDA margins average exactly the industry standard, sitting fifty basis points below pre-acquisition levels. The operational improvements underwritten in the deal model frequently do not materialize, and the portfolio company's inability to measure them, track them, or adjust them in real time is the consistent condition across the data. When the finance function cannot connect operational changes to financial outcomes, the sponsor loses visibility into the very initiatives they depend on to generate returns.
General partners that focus on operational value creation achieve higher internal rates of return than their peers, yet few managers provide the transparency required to execute those plans, and operating partners who need full access to the portfolio company's financials to drive change are routinely working with data that is thirty to forty-five days old. By the time the board pack arrives showing that a pricing initiative failed to expand margins, a quarter of execution time has already been lost. The gap between the underwritten operational improvement and the actual financial outcome accumulates across every reporting cycle.
Private equity buy-and-build strategies peak at one or two add-ons, then fall below standalone returns as integration debt compounds faster than synergy realization.
