How Operating Partners Minimize Road Blocks and Maximize Returns

How Operating Partners Minimize Road Blocks and Maximize Returns

It seems like every private equity firm has a network of operating partners as of late. It’s not hard to see why. These professionals’ main role is to work with privately held businesses to help them increase their companies’ value.

Some operating partners are employed in-house by the PE firm. Some are outsourced. Still others are a hybrid of the two. Whatever the means of obtaining an operating partner, PE firms now have access to a third more operating resources than they did just a few years ago.

This growth presents a great opportunity, both for PE firms looking to increase the value of their portfolios and for professionals with expertise in various operating specializations, such as data security or enterprise networks. Former C-level executives often find opportunity in this field as well due to their management talents and deep network of contacts.

But this growth can create friction too. As the value of the company increases, so too can the cost of operating resources. Operating partners can help ease this tension by showcasing their value to the company.

How operating partners add value

Historically, there have been three main ways that private equity firms have created value in their portfolio companies: deleveraging, multiple expansion, and operational improvements.

The deleveraging tactic, in which debts are steadily paid down to reduce a high level of leverage, was once the most common. It made up 51% of added value for PE portfolios in the 1980’s. But by 2012, that rate had declined to just 13%.

Multiple expansion, which is also known as “buying low and selling high,” can help lower a company’s risk profile and encourage a credible growth narrative. But this method’s utility is subject to environmental factors and market conditions.

On the other hand, operational improvement builds value by helping a company run better. Sell more products. Manage more efficiently. Reduce administrative expenses while increasing revenue. It is one of the most effective methods for creating market expectations for continued growth and higher exit valuations.

Operating partners have specialized expertise in operational improvement tasks. They have a deep well of operating knowledge and access to a wide network of industry contacts. They often work directly with day-to-day company managers, advising them on process and procedure. Sometimes, they serve as an Interim CEO for a short time, leading the company through a period of revitalization.

Tips for demonstrating OP value

  • Have management practices changed within the portfolio company since the PE acquisition? Look at those changes and determine which parties implemented them. How did the operating partner help?
  • Did the operating partner help prepare for and guide the acquisition? There should be a strong operations-improvement plan in place. Compare the plan at the time of the deal with the modified plan after a certain period of ownership. What has gone well? Is the investment behind or ahead of plan?
  • Build a reference pyramid by speaking with managers in the portfolio company. What is their perception of the value added by the PE firm? What about the operating partner?

With industry growth often comes friction. Operating expenses can be high, and managers want to know that company resources will be employed effectively. Operating partners can help ease this tension by demonstrating their expertise in helping companies increase value and succeed.