Private equity’s dirty little secret: why operating partners don’t make sense


The role of operating partner has been around for decades in PE. It has gained in popularity recently as venture and private equity firms have had to work harder to squeeze value from their portfolio companies. The theory is private equity firms need to do more than pick promising companies, they should be hands-on in the operations of those companies and increase value.

Executive search firm Heidrick & Struggles says results of its 2014 Operating Executive Compensation Report provide “a clear indication of the explosive growth in the operating executive role.”

A few weeks back I had a conversation with a well-known limited partner who has holdings in several private equity funds. The LP I spoke with was under the impression that private equity firms have to have operating partners, and that all emerging companies need the handholding of one to succeed. That same day, by coincidence, I talked with someone from one of those private equity firms who said, “I honestly don’t believe operating partners add value. I wish we didn’t have them but our investors think they are necessary.”

In my years as a private equity investor in consumer and retail and, more recently, building CircleUp (CircleUp is an online private equity platform), I have discovered that investment decisions by LPs are frequently biased by social cues from their friends, professional acquaintances and even the media. These cues are often cyclical and change every few years. Today, one of these social cues is operating partners. It has become somewhat of an urban legend that VC and private equity firms must have operating partners to help spur value-creation in portfolio companies.

Here’s the problem: In my experience in private equity, I’ve found that when an operating partner is hired to help a young, fast-growing company, rarely does he/she have the necessary relevant experience to actually help them.

A typical PE fund has a portfolio of companies of varying sizes, diverse industries, and unique demographic markets. Companies encounter very specific, specialized challenges. Even industry-focused funds, a consumer fund for instance, are challenged — in the same portfolio you can have a $20 million personal care brand growing at 100 percent a year and a $100 million food business growing at 10 percent a year. Rarely does an operating executive bring the specific experience, or the range of experiences, to address the broad array of situations and challenges portfolio companies face.

Consider these two points from the Heidrick & Struggles survey of operating partners:

  • When asked to name their industry focus, the most common response operating executives gave – 38 percent — was “generalist.”
  • When asked their functional expertise, a majority – 52 percent — said “generalist.”

If I’m an entrepreneur trying to grow my organic dog food brand and need help determining if the packaging should be red or purple, recyclable or biodegradable, 5-pound bags, or eight-ounce servings, the last person I want to turn to for help is an operating partner with “general” industry knowledge and general knowledge of how to operate a business. As a CEO myself, I’ll tell you “general” advice isn’t very helpful.

Moreover, we’d be remiss not to ask who foots the bill for operating partners, a question very much top of mind for the SEC. Frequently, operating partners “are paid directly by portfolio companies or the funds without sufficient disclosure to investors. This effectively creates an additional ‘back door’ fee that many investors do not expect,” Andrew J. Bowden, the SEC’s then-director of the Office of Compliance Inspections and Examinations, told a Private Equity International gathering last year.

When a former Fortune 500 C-level executive tries to roll up his sleeves to help a $30-million emerging brand, his heart may be in the right place, but he probably is not.

It’s time for LPs to fall out of love with the myth of operating partners. More often than not, it’s at expense of themselves and the portfolio companies.

Ryan Caldbeck started CircleUp after almost seven years of investing experience in consumer product and retail-focused private equity at TSG Consumer Partners and Encore Consumer Capital.

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