The Genius of Operating Partners in PE

It's no surprise that Private Equity firm love Operators. Operators KNOW what to do. Operators know how to LEAD. Operators actually make things HAPPEN that PE firms write in PowerPoint and model in Excel. They are magical. They are mystical. They are CRITICAL to value creation. They possess secret knowledge that they will only tell you if they are retained in Operating Partner capacities and paid $1mm+ a year. 

The LPs can be skeptical.

Sponsor: "We are different! We have an In-House Operations Group (“OG”)!"

LP: "Oh, great. What do they do?"

Sponsor: "They help us underwrite the deal and then lead value creation"

LP: "Oh, that's great, so your transaction fees must be a lot lower to offset the cost of the OG and your dead deal fees are probably a lot lower because you must not hire fancy consultants"

Sponsor: "Oh no, we definitely hire fancy consultants…and our transaction fees are in-line with market. We need Bain and BCG to tell us the numbers to plug into our financial models."

LP: "How do you pay for the OG?"

Sponsor: "Oh, we just charge fees to the Portfolio Companies"

LP: "So we pay for the OG?"

Sponsor: "Well, technically, yes, but our returns more than make-up for the cost"

LP: "Oh great, can you show me an example of an A/B test?"

Sponsor: "What?"

LP: "How do you know your OG adds real value to returns at exit?"

Sponsor: "You can see it in our returns. Our returns are high!"

LP: "Your returns are average, but your gross-to-net spread is higher than average"

Sponsor: "Our portfolio is still seasoning but rest assured that our OG is held accountable to a very high standard and is the key to our success"

LP: "What is the incentive structure of your OG?"

Sponsor: "Their job is to grow profitable revenue"

LP: "That's great, how do they get paid? Are there bonuses tied to direct portfolio company results?"

Sponsor: "Well, no, but we only charge them out on an hourly basis so that the cost burden is not too high…we have a very complex performance goals system for the firm"

LP: "Your OG bills by the hour?"

Sponsor: "Yes, to keep costs low, and so we can remove them when their job is done"

LP: "Who decides how many hours they should engage? How do they know when their job is done?"

Sponsor: "The Operating Partner decides that! It's a highly aligned model. The Deal Partners are idiots and have no idea on how to actually run a business so we need the Operating Partners"

LP: "How do you support the cost of Deal Partners and Operating Partners and the OG on your management fee? Seems like a lot of people doing the same job?"

Sponsor: "The Operating Partners also charge their time to the Portfolio Companies. They work across multiple portfolio companies so it's quite reasonable"

LP: "Who gets the blame when things are going wrong at the Portfolio Company?"

Sponsor: "Both the Deal Partner and the Operating Partner, but mostly the Operating Partner. They are supposed to know how to manage the Operations of a portfolio company, hence the title"

LP: "And how do the Operating Partners resolve issues at Portfolio Companies?"

Sponsor: "They bring in the OG! That's why we have it! Always use the OG!"

LP: "So the Operating Partner is in charge of managing the resources of the OG…and his incentive is always use the OG to cover his basis…and they all get paid by the portfolio company…in good times, they bill for growth…and in bad times, they bill for turnaround?"

Sponsor: "Yes, we have a highly differentiated model"