What Is an Operating Partner?

Initially viewed as a career senior executive with deep experience and a good rolodex, these executives provide operational credibility and periodic or situational involvement in the companies. They have, however, evolved into a firm asset and are critical to the culture and strategy. In a period where finding actionable deals is hard and accelerating growth is challenging operating partners provide human capital and additional deal flow. Today these people are integrated into thesis validation on investments, diligence and part of the deal execution and 100 day teams.

How much can operating partners ultimately drive in performance at the company level and fit in at the Private Equity firm and where do they begin?

Numbers Don't Lie

A bit of recent results and perspective:
  • Returns in Private Equity over the last 5 years (ending 6/2013) were just under 10%. 10 year returns were closer to 15%.
  • Competition for deals to deploy capital has driven valuation on both good and also semi-broken companies (some company characteristics still solid and some with financial and human capital needs) to high levels.
  • Modeling in most scenarios to offer 8X EBITDA valuations require consideration of dangerous leverage levels (5-6X EBITDA as total debt structure) to approach even sub 18% IRR.
  • With more investments held in excess of 5 years those returns will suffer even on companies that have improved in performance.
Getting out of the gate fast is critical in Private Equity. First there will be little change to refinance to lower debt rates to create dividend recap scenarios or preserve some critical company cash. That option and company maneuver maybe gone in 2014-2015.

Strategic Plans

The compressed process of 'IOI (or EOI) to LOI to Close' does not provide adequate executive profiling or evaluation of current strategic plans in a diligence. A new plan must ultimately be developed by your team and hopefully blend in elements of what is in the company currently. It also gives some insight into how the executive team works under time pressures, addressing and debriefing in a variety of areas. This adds up to a daunting proposition to assure driving rapid value with a team unproven to new ownership.

The strategy needs to accelerate a 5-6 year hold and growth story into a 3.5-4.5 year hold, in order to enhance IRR and Limited Partner returns. Market conditions and demand will ultimately allow for an accelerated growth and an early sale, though it would be nice to be in that situation and have the choice of an early exit. Growth and EBITDA enhancement will come from a premium priced product /service in new markets and carefully choosing and exploiting niche and segment opportunities. Add ons need to be rapid and done correctly with an eye to attracting the inquisitive strategic. The 60 day to close through the first year requires executive team development and aligning with the possible 3.5-4.5 year growth and sale strategy.

The Operating Partner

Operating partners play a role to vet, develop and organize the strategic plan with the internal (or external) CEO candidate. The operating partner will facilitate relationships that augment the team early on with consultants, other executive candidates and mentoring and deploying tool kits with management. Another key aspect in this early stage is to identify B players who can become A players and middle and senior management that have the capacity and drive to take the next step up.