The Evolving Role of Operating Partners in Private Equity
With more than 11K PE firms with assets under management (AUM) of ~6T, the space is crowded with the competition for capital raising and deal flow. There are considerable headwinds at present in the market owing to increased interest rates, expensive financing costs, and lower deal valuations which have kept some of them on the sidelines resulting in a significant reduction in deals compared to 2021. The clock is still ticking on committed capital in a fund waiting to be deployed on valuable investments!
There is also pressure on existing businesses to divest non-profitable segments or the ones which are not aligned with their core strategy to generate cash and use that for paring down debt or making strategic investments.
There were 9K carveout transactions announced in 2021 with a value of $2.3T. Even though the numbers came down significantly for the first half of 2022 with ~4K valued at $641B, the activity still reflects the focus on rightsizing investments to keep PortCos profitable.
Value creation has become a hot topic with financial engineering alone unable to generate expected returns necessitating the employment of different operating models.
While operating partner roles have existed in the past and were mostly bringing execs part-time on an ad-hoc basis for specific deals, There has been a proliferation of PE firms competing on deals so will need some level of in-house operational experience to differentiate and win. Even LPs are now looking at the strength of the PE firm on operational expertise before committing capital. Moreover, the deals which are made today require significant work post M&A to generate value. This has led to a growing number of PE firms hiring full-time operating partners.
A new outlook on this role needs to address the following themes:
Diligence and Investment Thesis
Operating partners can play a key role in helping assess sector specific deals drawing upon their vast experience in that area or can deploy their functional experience in finance, operations, technology, etc to highlight risks and the investment required in short/long term to negate them.
A key aspect during this process would also be to analyze the investment thesis for a deal before submitting LOI.
What controllable factors would drive growth/value creation and the feasibility of embarking on that journey along with an understanding of risk factors
2. Human Capital
The quality of executive/leadership teams is extremely important for turning good companies into great ones.?Success cannot be achieved without the right people, the right dynamics, and the right culture. Assess whether C-suite leaders have the capabilities to deliver on the deal thesis, as well as whether the workforce has the scale or depth of skill required.?
The same executive team which took the firm from $0 to $20M may not be apt to take it from $20M to $100M or greater so continuous assessments on leadership are key to scaling up
We see instances where a newly formed exec team can struggle with:
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3. Management team partnership
A strong partnership with the management team goes a long way in ensuring growth plans are being realized.
Operating partners can work with management team on crafting a customized value creation plan which includes strategic planning, execution guidance, setting KPIs and evaluations at regular intervals.
There are instances where the Op partners sit on the board along with deal partners to help guide the Portco from growth to exit. The idea is not to micro-manage the team but to have the necessary support available to ensure delivery on value creation. There are few different models which an be adopted with in-house expertise.
4. Transformation for Value Creation
The most critical piece of this value chain would be value creation which is primarily why operating partners exist. The ability to generate outsized returns within a specific time interval to generate exponential returns is very critical for the success of the fund. This underscores the need for forming special value creation teams as part of PE operations.
These teams can be involved in every step of the process - performing diligence, partnering with management and investment teams on a post-close value creation plan based on investment thesis, and overseeing the execution of that plan.
Transaction closure triggers breaking down of investment thesis into a specific strategy working closely with the deal team and laying out an action plan around operational efficiencies, cost reduction, revenue growth channels, divestiture of non-performing assets, tech innovation investments, etc. These initiatives will then need to be prioritized and appropriate metrics be determined to drive them forward.
There are bound to be challenges on the journey owing to change in market conditions, regulations, resources, exit strategy, etc which will all need adjustments to move forward so regular checkpoints to inspect and adapt is key!
Would love to hear your experiences driving the value chain through deal conception, diligence, closure, value creation and exit!
Sid Nandi?is an entrepreneur, business transformation leader, coach, technology strategy & management consultant experienced in M&A tech diligence, advisory and value creation. His previous startup on Digital Transformations generated 30X return on exit after 4 years! He takes on interim/fractional CxO and advisory roles to drive portfolio acquisitions, strategy and growth to exit.
His current venture (Traforma Consulting) provides M&A Diligence, Tech Advisory, Post-close Value Creation towards exit for mid-market Private Equity firms. He is passionate about connecting and collaborating with Investment principals and Operating Partners in the PE world!.
Lower Middle Market Private Equity Investments | Independent Director | M&A, Strategy, Technology, Commercial Excellence, Operations
2 年Great points, Sid. Operational improvements are par for the course. It’s the other growth and margin improvement levers that drive advantage at exit