The Biggest Myth in Private Equity (and How Smart Firms Do It Differently)
The biggest myth in private equity is that great returns mainly come from leverage, clever deal terms, and a favorable exit multiple. Smart firms still use those tools, but they win by building a repeatable operating engine that improves revenue quality, margins, cash conversion, and leadership execution early in the hold.
You already know the pitch decks: “buy well, add leverage, exit at a premium.” This article gives you a more useful lens for 2026 decision-making, grounded in what has changed in financing, exit timing, and LP expectations. You’ll get direct answers to the real questions allocators, operators, and deal teams ask when results stop being rescued by multiple expansion.
What’s The Biggest Myth About Private Equity Returns?
The myth is that private equity outperformance mostly comes from financial engineering, then gets “validated” by a quick exit window. That story worked more often when debt was cheap, buyers paid up, and a rising market covered execution gaps. When those tailwinds fade, the difference between a strong fund and a weak one looks a lot less like structuring genius and a lot more like operating discipline.
Even major research has started calling this out bluntly. McKinsey describes the prior decades as an environment where managers could rely on leverage, debt/tax structures, and rising valuations, then notes that debt costs rose and liquidity tightened, increasing the need for operational value creation to offset pressure on multiples.
The implication for you is practical. If underwriting assumes “we’ll refinance quickly” or “we’ll exit when the market re-rates,” the plan is exposed to timing risk you cannot control. If underwriting assumes measurable operational change inside the first 100–200 days, the plan is anchored to actions you can manage and verify.
Smart firms also treat “value creation” as a fund-level capability, not a deal-level ambition. That means the operating group, deal team, and management team share a single plan with explicit milestones, an owner for every lever, and weekly visibility into whether the levers moved. McKinsey highlights making operational diligence part of investing, setting value creation objectives before signing, emphasizing operational and top-line improvements after closing, and linking talent to value so the right leaders execute the plan.
Is Private Equity Basically Just Leverage And Financial Engineering?
No, and the quickest way to see that is to look at what breaks first when leverage is treated as the strategy. Higher interest expense compresses coverage, covenants get tight, lender flexibility drops, and “optional” projects turn into emergency cash controls. When the capital structure becomes the operating plan, the business starts making short-term decisions that reduce competitiveness inside the hold.
McKinsey points to higher-for-longer rates creating financing issues, including pressure from floating-rate resets and recapitalization timing. It also references interest coverage ratios and how quickly they can deteriorate when interest expense rises, forcing managers to rely on operational efficiency to grow EBITDA instead of hoping capital markets cooperate.
You can still use leverage as a tool, but it has to sit behind fundamentals. A resilient deal model holds up under delayed refinance timing, lower-than-hoped exit multiples, and longer hold periods. If a model only works when debt is cheap and exits are fast, it is not a value creation plan, it is a market bet.
By 2026, the better underwriting discussions sound less like “how much debt can the business carry?” and more like “what operational moves increase durable free cash flow, and how fast can they be implemented without breaking customer service, product quality, or critical talent?” That shift is not philosophical. It is an execution requirement when exits slow and debt is less forgiving.
How Do Private Equity Firms Actually Create Value After They Buy A Company?
They create value by moving operating metrics that buyers pay for: recurring revenue, pricing power, margin stability, lower customer churn, faster cash conversion, and a leadership team that hits a predictable cadence. That can include procurement, labor productivity, footprint optimization, sales effectiveness, product simplification, and working-capital discipline. The strongest firms do not “spray initiatives.” They pick a small set of high-ROI levers and instrument them hard.
McKinsey emphasizes operational diligence that identifies opportunities to improve margins and accelerate organic growth, then embeds those opportunities into operating plans and multi-year plans. It also notes that some managers pull information directly from portfolio systems and set up transformation management offices to improve transparency and initiative execution.
What distinguishes smart firms is the timing. The work starts pre-close, when diligence becomes an executable build plan rather than a report. The first 30–60 days post-close are used to lock governance, agree on KPIs, set decision rights, and make the first leadership upgrades. If major leadership gaps remain unresolved six months into ownership, the hold becomes a sequence of “almost” quarters that never compound.
You also want value creation to show up in cash, not just adjusted earnings. Margin improvement without cash conversion is fragile, and buyers discount it quickly. That is why elite firms run working-capital sprints, SKU/customer profitability reviews, pricing governance, and capex controls in parallel, then connect them to a board-level scorecard that is reviewed on a cadence that forces action.
Do Private Equity Firms Strip Assets And Cut Jobs To Boost Profits?
Cost reduction is a real lever, and it can be done well or badly. The outdated part of the story is the assumption that “cutting” is the core playbook and that it reliably produces great exits. If the plan is mostly cutting, the company often loses capability, slows growth, and becomes harder to sell at a strong multiple unless the market is paying for anything with a pulse.
In the current environment, the more reliable path is targeted productivity paired with commercial improvement. That means cutting cost-to-serve where it is wasteful, investing in sales coverage where payback is provable, and upgrading the operating rhythm so performance does not depend on heroics. McKinsey’s message is that operational improvements and top-line initiatives have become necessary to offset multiple compression and deliver targeted returns.
If you sit on a portfolio company board, a simple test protects you. Ask whether every major cost action has an owner, a measurable output, and a clear “do not break” list tied to customer retention, product quality, compliance requirements, and critical roles. When those protections are missing, cost moves drift from productivity into capability damage, and the exit story weakens.
Also watch the sequencing. Smart operators stabilize service levels and product quality before pulling aggressive cost levers, then reinvest part of the savings into the commercial engine. That creates a company buyers want to own, not a company buyers want to “fix.” The difference shows up in diligence findings, not in the narrative.
How Do PE Fees Really Work (2 And 20, Offsets, Transaction Fees), And What Should LPs Watch?
You already know the headline terms. What matters in real net performance is the detail: management fees across the fund life, how transaction fees and monitoring fees are handled, what gets charged to the fund versus the management company, how broken-deal expenses are treated, and how consistently reporting matches the governing documents. When fee and expense practices vary deal by deal, LP trust erodes and fundraising becomes harder.
Harvard Law School’s corporate governance coverage on fee variation highlights that PE fees are not uniform and that variation can show up across management fees, carried interest, and portfolio-company charges. That is exactly why sophisticated LPs push for clearer disclosure and tighter definitions.
Fee transparency is also getting more operational. ILPA released the ILPA Reporting Template v2.0 (dated January 2025 on the resource page), aimed at standardizing reporting for fees, expenses, and performance across private funds. If you raise institutional capital, this is no longer a “nice-to-have.” It is moving toward a baseline expectation in reporting conversations.
If you are an LP, the practical checklist is straightforward. Demand consistent fee/expense categorization across funds, confirm the treatment of portfolio-company fees and offsets, verify allocation policies for shared expenses, and require reporting that supports easy cross-manager comparison. If you are a GP, treat clean reporting as a competitive advantage, not as a compliance chore that gets delegated and forgotten.
Why Are Exits Taking So Long, And What Are Smart Firms Doing About Liquidity?
Exits slow when buyers and sellers disagree on valuation and when financing capacity shrinks relative to purchase price. That creates longer holds, heavier reliance on operational improvement to “grow into” the exit, and more creativity in routes to liquidity. You feel it in board meetings: the question shifts from “when do we sell?” to “what has to be true to sell well, and how quickly can you make it true?”
McKinsey notes valuation mismatches at exit and the potential for extended hold periods, also pointing out that private valuations can lag public-market conditions due to slower exits and financing activity. When mark-to-market is delayed, the incentive is to wait. When fund-level liquidity needs rise, waiting becomes expensive.
Smart firms adjust underwriting and governance for longer holds. They stop treating year 3–5 as “steady state,” then build a plan that keeps compounding value even if the hold runs longer than expected. Operational momentum early in ownership matters, since it gives the asset more exit readiness when a window opens.
They also run liquidity management at the portfolio level. That includes prioritizing which assets should be positioned for an exit first, which assets need operational triage to protect downside, and which assets should be held longer to deliver the best risk-adjusted outcome. PwC’s deals outlook content signals that the market is watching the exit environment and deal conditions closely, which feeds directly into how firms plan liquidity rather than assuming it.
The Biggest Myth In Private Equity
Myth: Returns come mainly from leverage and exit multiple expansion.
Reality: Top firms win by driving measurable revenue, margin, and cash-flow improvements early in the hold.
Build The Operating Engine, Then Let The Market Be A Bonus
You protect performance in 2026 by underwriting what can be executed, then building governance that forces execution. Leverage, refinancing, and multiple expansion still matter, but they cannot be the only plan you can explain with a straight face in a boardroom. When diligence converts into an owner-assigned operating plan, when talent decisions are tied to value, and when cash conversion is managed with the same intensity as EBITDA, outcomes stop depending on perfect timing. If capital is being allocated or raised, the standard should be simple: prove operational capability, report cleanly, and run each asset as if the hold lasts longer than expected. That discipline is what separates firms that survive a tougher cycle from firms that keep explaining why the model “usually works.”
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