Inside Operations: Understanding the Structure of a Private Equity Firm

As we dive into Part 3 of our series, "Breaking into Private Equity: A Veteran's Guide," we turn our focus to the intricate framework of private equity firms. This week, I sit down with Paul Swaney, our founding partner, and Managing Director, to discuss the inner workings of mid-to-large cap PE firms, with an emphasis on their operations capabilities.

During this interview, Paul answers six questions for us:

1. Paul, let's start with the basics. Could you outline the typical organizational structure of a mid-to-large cap PE firm and explain the role of operations teams within that framework?

Hi Vish, let’s keep it to mid-cap to keep the scope a bit more digestible. Firstly, you are going to have an origination team, deal team, investment team, and in most firms, an operating team. If I think about a mid-cap firm with 30 to 150 investment professionals, in most cases you will have an operating team. On the investment side, the firms are typically organized into deal generalists and sector specialists. Once the firm gets bigger, you will see more sector specialists, and at a smaller 30-person shop you will see mostly generalists across a wide range of industries (unless they have a sector specialty as a firm). On the operating side, there is minimal correlation between fund size, AUM, and size of the operating team; there is also minimal correlation between what fund number they are and size of the operating team.

On the operating side, you can have a few different models, one is the industry expert model (former executive model) where you have a few Ex-CEOs running around assessing assets and helping the partner with the management team. You can also have a functional model where you have either a series of manufacturing, pricing, sales force effectiveness or other experts who deliver capability across portfolio (other specialties like procurement, supply chain). A generalist model also exists where former consultants with a few years of industry experience are utility players across assets that bring in external resources as needed to get the job done.

2. Moving deeper into the team dynamics, what are the key positions within the operations side of a PE firm, and what unique skills are required for these roles?

The key positions, which are most useful for veterans \ best entry points into the operating partner role; I see that in two ways. One: you come in as a Vice President, usually done after a few years at a consulting firm, can be done at a mid-cap shop with some scale to it (you will not be the only operator on the bench). Two: Some firms will have operating associates or analysts direct from the US military, or even some operations leadership programs from universities.

For the latter to happen, there needs to be in place a large internal consulting focus that could be cobranded and exists as a function of that. A lot of MBA grads who enter straight into operations tend to have engineering degrees or military backgrounds on the operations side of house.

I go back to an earlier article, the unique skills needed to be successful are a desire to learn, let’s call it intellectual curiosity, and those related to leadership. Leadership is a fungible skill that can be utilized. A lot of veterans when they come in will have to “work a level down” to learn the hard skills: excel modeling, supply chain modeling, communication to a broader stakeholder group, inner workings of the investment process, and simple things like setting up governance and coordination of assets. These are all moderately transferable skills from the military project management and mission execution perspective. ???

3. It would be great to get a real-world perspective. Could you describe a typical day for the operations team at a PE firm and the kinds of strategic duties they manage?

For an operating VP, a typical – but there’s never a true typical – day in the life looks like being in the office Monday & Tuesday. I was in the office for the investment committee and investment document prep because we were integrated throughout the lifecycle of the deal. I like to fly Tuesday afternoon, maybe Wednesday morning, in order to hit one or two portfolio assets that week. I’d partner with the senior management team or an “n minus two” player working on a specific functional project or more generalized project with, for example, the CFO. The goal was to help create connectivity and improve visibility to the portfolio company while also supporting discrete, ad hoc projects to help the management team with skills they may not possess or have capacity for. We tend to buy scaling businesses.

4. Collaboration is crucial in any organization. How do different departments within a PE firm work together, and how does the operations team support the investment strategy and management of portfolio companies?

The key is to work in conjunction with the investment team, essentially to help them gain a better view of the asset and to enable the management team to do their best work. In the context of a structured process from an investment banking team, there are a variety of tasks across the investment lifecycle or investment analysis, ranging from commercial due diligence to developing the value creation plan. This plan involves evaluating how the market looks and understanding the competitive forces. These tasks are undertaken by either deal team professionals or operating team professionals, and the structure varies significantly across different firms. There's no one-size-fits-all approach.

The most important advice I give to new operating professionals is to learn everything you can. When assigned a task you've never worked on before, treat it as a learning opportunity to grow from. In some cases, I've had operations professionals run deal models in a pinch. Likewise, I have had deal professionals come out to sites to conduct manufacturing assessments with me as their guide.

The overarching idea is that there's a range of work to be done to underwrite the asset. The crucial aspect is how you integrate into the gears of this process and better inform the Managing Director responsible for the investment, as well as the investment committee, who are ultimately the customers.

5. Many veterans entering the PE space might be curious about growth opportunities. Can you illustrate the typical career trajectory for someone on the operations side of a PE firm?

We have seen a couple of different career paths. I've seen team members come into the operations side, initially working on a couple of different assets doing discrete tasks at various assets. As they gain seniority, they're often assigned to more substantial projects. A notable example is a team member who took on contracting, set up a war-room for it, and just nailed that, supporting the team to add 8 figures of EBITDA to the asset. This success led to his advancement into larger roles, like interim management.

Other team members, with just one or two years of experience, have progressed to roles like interim Chief of Staff for the CEO. This career path, contrary to the thinking I have seen on LinkedIn, can be a growth role if used effectively. Such experiences pave the way to positions like junior operating VPs.

My thesis is that we can take any military veteran and in 8 years train them to become an Operating Vice President or a Business Unit General Manager, overseeing a P&L worth several hundred million dollars, within an eight-year period. This is not a long putt.

6. Operational improvement is often where PE firms add significant value. Can you elaborate on how operations teams identify and implement improvement opportunities in portfolio companies?

Vish, there are a couple of different things to consider. A common belief in the business world is that once a PE firm acquires a company, all the value has already been extracted – but this couldn't be further from the truth. When a PE firm does its job right, you are buying a growing business, and growing businesses are constantly adding, due to growth, and removing inefficiencies. You're not just increasing the top line; you're also adding structure and shoring up new processes along the operational maturity frameworks.

As you scale up revenue growth, you must correspondingly increase the operational maturity of the business to prevent what I call 'diseconomies of scale.' The diligence process is when our team assesses how to add value. I favor assets with optionality. For example, if the market is growing at a single-digit rate and slows down, can we grow through acquisitions? That could be significant. During diligence, we conduct a market scan, tour the factories, and ask ourselves, "Can we cut costs? How many trucks do we roll out a year? What's our rate for re-dispatching them?" The goal is to find inefficiencies. We consider, "Have we benchmarked their procurement?" We compare their raw material costs using databases and external advisors, aiming for a 10-15% improvement in procurement. We examine the sales force's market approach, their share of wallet with key customers, the pricing opportunities, and whether their gross margins are consistent, especially with high-volume customers. Sometimes, it's the opposite.

We also look at other aspects, like "Do they have sufficient SG&A to execute their plan? Can we introduce new products? Should we conduct a product portfolio assessment?" These considerations can lead to 12-15 core value creation initiatives. These initiatives assess each asset's operational maturity and exploit it by building a value creation plan which is underwritable and adaptable, providing options if things don't go as planned. I tend to avoid underwriting single-product lines or taking brand risks. While many successful firms do, I prefer investments with more flexibility. My advice, particularly to veterans, is to choose businesses where you're not speculating on the market. Instead, focus on those where you learn core operational skills that apply to any business. This approach, undertaken during the diligence process, results in a value creation plan that can be sustained under any market condition.

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Conclusion:

Paul's expertise offers us a compelling glimpse into the architecture of private equity firms, from the strategic roles within operations to the collective effort that propels a firm's success. For veterans like myself looking to chart a course in PE, the journey is not solely about capitalizing on skills honed in service, but also understanding the symbiotic relationship between various departments that drive investment triumphs. Join us next week as Corey discusses case studies illustrating the tangible impact of these roles through the experiences of veterans who've successfully navigated the PE landscape. Their stories to serve as a pragmatic blueprint for others looking to make a similar transition.