For private equity firms, creating value for portfolio companies is both more challenging and more crucial than ever. Financial engineering, once PE’s bread and butter, is not enough in today’s competitive environment. In most industries, low-hanging investment opportunities have long been harvested, and the companies that remain require significant work to create value.
Many middle-market firms come in as the first institutional capital a company has ever received, which tends to correlate with a significant need for operational improvement.
Add to this other factors—including a greater emphasis on environmental, social and governance factors and diversity, equity and inclusion, as well as challenges around talent acquisition and retention—and the task for private equity firms seems monumental.
Enter the private equity operating partner.
While operators have always had a place in private equity firms, the number of middle-market sponsors hiring full-time operating partners is rising. A 2019 survey by Heidrick & Struggles reported that the private equity operating partner role was “the fastest-growing position within the industry.” Previously, many firms brought on operating experts on an ad-hoc basis, hiring them to source a specific deal or consult with a particular portfolio company. While this model is still in play, more firms are rethinking their strategy to bring on operations experts full-time.
“It’s a direct response to the proliferation of private equity firms and competition over the last five to 10 years,” says Josh Woodbridge, managing director at private equity firm Berenson Capital. “Private equity firms need to differentiate to win deals in this market, and partnering with operating executives who have been in the seat of the founder and CEO can be an important element to setting a firm apart.” Earlier this year, for example, Berenson unveiled a new Operating Executives program, which marks the first time the firm has brought on operators to work with the firm full-time on sourcing and value creation for portfolio companies
There’s also pressure from limited partners, who are increasingly eager to invest in private equity firms that can prove their operational expertise. “With the explosion of funds in the marketplace, investors are asking how firms are differentiating, how they’re mitigating risk and improving their companies,” says Travis Dziubla, principal at private equity firm Lion Equity Partners. “Limited partners are looking for firms who can really bring about operational improvements.”
Functional Focus When John Broderick entered private equity after a decade and a half in executive roles at companies like Sandvik, Siemens and Danaher Corp., his first order of business was to develop a system for value creation. Broderick modeled the business system on best practices and processes used at the likes of Toyota, GE, Siemens and Danaher.
Nearly six years ago, Broderick joined Argosy Private Equity, which invests in lower middle-market companies with EBITDA up to $10 million. “We differentiate ourselves by providing a value-creation playbook for our portfolio companies. Most PE groups investing at our level don’t offer that type of systematic approach,” says Broderick. Argosy’s system is based around five functional areas of expertise: human capital, operational excellence, front office/ transactional excellence, strategy and growth.
Currently, Argosy has three full-time generalist operating partners who help portfolio companies deploy the system. This includes working with the leadership team on strategic planning and helping them execute the plan, which involves KPIs, action plans and frequent reviews of the progress being made. “Our system is not prescriptive. It is a set of best practices offered to our portfolio and leadership teams,” says Broderick.
The firm’s operating partners also work with external industry or functional experts who are deployed as consultants by the portfolio companies. Operating partners sit on the board and work together with deal partners, who hold the position of chairman.
Private equity firm LLR Partners also bases its value-creation model around functional areas of expertise. LLR currently has nearly 50 portfolio companies and a value-creation team of 23 people. While the firm doesn’t employ “operating partners” per se, its in-house team works with portfolio companies to help them excel in core functional areas, namely human capital, finance, strategy, product and go-to-market. “We wanted to create a model that would appeal to CEOs and founders and support them in their journey to growth,” says Jim Murphy, senior managing director at LLR and leader of the firm’s value-creation team. “By organizing functionally, we can get to a level of depth that moves the needle for our companies and also gives them the breadth of support they need to succeed.”
LLR’s value-creation team is involved at every step of the process, including performing diligence; partnering with management and investment teams to develop a post-closing value-creation plan (analogous to a traditional 100-day plan); and overseeing the implementation of that plan to ensure a great start in the LLR portfolio. “The next step in the value-creation team’s maturity journey is to incorporate a data dashboard to be proactive about ongoing company engagement, rather than wait for management or investment teams to reach out for help,” says Murphy. A couple of examples of this data include pipeline information to ensure booking targets will be met or financial metrics that can anticipate any future liquidity needs.
Alternative Models Structuring an operating partner program around functional expertise is just one of the models being used today. Other private equity firms organize their operating partner programs by industry verticals. For example, Berenson Capital, which invests in B2B technology businesses, has brought on operating executives with backgrounds in specific subsectors, such as compliance and life sciences, healthcare and human capital management. Understanding the particular dynamics of a given subsector provides a leg up when it comes to deal sourcing, talent acquisition and strategic planning, according to Woodbridge. In addition to industry expertise, Berenson looks for operators with a track record in a variety of executive positions, including those who have both led companies as a CEO and managed functional teams.
For smaller private equity firms, the most effective value-creation approach may be slightly different. Lion Equity’s Dziubla serves as a jack-of-all-trades operating specialist for the firm’s three active portfolio companies. He describes his role as somewhere in between the “experienced professional” operating partner model, where firms employ industry or functional experts, and the generalist model, where executives with broad experience are employed to tackle a wide variety of topics.
Dziubla spent five years as a consultant with McKinsey before joining Lion, and he acknowledges that he doesn’t yet have the experience or resume necessary to serve as a sole advisor or executive coach for the CEOs of Lion’s portfolio companies, many of whom are in the chief executive role for the first time. However, his consulting experience means that he can identify what good business models should look like— whether that’s in strategy, operations, hiring, technology or other areas. He works closely with Lion’s senior advisors—former chief executives themselves who can draw on industry or functional expertise to provide coaching and support to Lion’s CEOs.
This model of combining a full-time operating specialist with expert advisors works well for a firm like Lion, which focuses on carve-outs across a variety of industries, including light manufacturing, business services, software and consumer. It might be less effective for PE firms with a deeper industry specialization. For them, it might make more sense to build out an internal team of industry experts rather than rely on outside advisors.
One of the biggest benefits of Lion’s model is that it affords the firm the ability to adapt on the fly. “As the saying goes, no battle plan survives first contact with the enemy,” says Dziubla, who is a former submarine warfare and special operations officer with the U.S. Navy. Having a full-time strategy and operations professional provides a competitive advantage. “I can roll with the punches and help our companies adjust our strategy as we get feedback and see if things become successful or not,” he adds. “Five or 10 years ago, a lot of funds would have said, ‘We hire consultants and pay them and then go execute.’ It’s a viable strategy, but it comes at the expense of being nimble, which is a key differentiator for creating value.”
Not For Everyone While more firms are bringing on operating partners as full-time employees, a significant number still find the traditional contract model a better fit for their goals.
Private equity firm SFW Capital Partners invests in the industrial and life sciences technology sector, including companies that provide test measurement devices, automation, technology and tech-enabled services. The businesses serve a variety of end markets. “We’re generally the first institutional capital that’s going in. We make a lot of operational and organizational changes to our companies,” says Ahmad Sheikh, partner at SFW. When it comes to operating professionals, “our goal is to have more, rather than fewer, relationships. Given the breadth of end markets and niches we cover in our investment strategy, we prefer to try to match the most relevant executive with each opportunity that we pursue,” he adds.
SFW finds it doesn’t make sense to have full-time industry experts on the payroll while the firm is focused on finding the right portfolio company. “Operators want to operate. They want to work with companies,” Sheikh says. “If you’re searching for companies for two years with an operator, they’re going to start getting antsy and want to invest in everything that comes across our desk, even if it’s not a great fit for their experience or our strategy.”
A key part of SFW’s strategy involves engaging regularly with operating executives, with a goal of reaching 10 to 20 executives each quarter. The firm has hundreds of executives in an internal database, tiered by background, experience and preferences. “When the right opportunity comes in, within a matter of hours we can try to get to the right person for that specific role,” Sheikh says.
Trust Is Paramount In a market suffused with private equity firms (who in turn are awash in cash), everyone is trying to get ahead. “Every firm is trying to go faster,” says Argosy’s Broderick. “We get a jumpstart on value creation during diligence. Gone are the days when value creation started post-close. The faster we complete talent assessments, voice of customer research, market studies and strategic planning, the faster we can contribute to professionalizing and growing the business.”
Figuring out the value-creation plan post-close is a key part of most operating partners’ responsibilities, agrees Lion’s Dziubla. “We co-create the strategy with the deal team: Here’s why we’re buying the company, here’s what we’re going to do to reduce manufacturing costs, improve sales and so on,” he says. From there, the team works together to come up with a tactical list of several big initiatives. That might include implementing a new enterprise resource planning (ERP) system over the next 18 months or bringing on a new sales leader to focus on improving gross margins.
As such, most operating partners’ roles start early in the investment lifecycle. Broderick estimates he spends about a quarter of his time on due diligence of potential investments and internal process improvements, and the rest of the time on post-close value creation.
But for all the focus on speed, gaining the trust of the portfolio company’s CEO and management team is the top priority. “An operating partner is not going to be successful in adding value unless he or she can build unconditional trust—the kind of relationship where you can collaborate and be truly authentic. That is the goal,” says Broderick. “Once you’ve formed that trust, the entire team is going to be much more likely to work together, respond to challenges and execute strategic plans.”
Meghan Daniels is a freelance writer and editor based in Brooklyn, New York