Operating partners Earlier modules – Module 5 in particular – identified the growing requirements for private equity firms to add operational value to their investee companies. This has led in many cases to a significant change in the make up <strong>of</strong> many firm’s executive teams, which have broadened to include individuals with significant, senior level operational experience <strong>and</strong> a deep underst<strong>and</strong>ing <strong>of</strong> a particular sector or market. Although investors have always used external consultants <strong>and</strong> expertise to help them appraise <strong>and</strong> develop companies, the incorporation <strong>of</strong> operating partners into the team brings this expertise into the equity ownership <strong>and</strong> carried interest return pool, making them an integral part <strong>of</strong> the team with a reward structure better aligned to the creation <strong>of</strong> value. Specific models <strong>of</strong> operating partner involvement vary between firms. At one extreme, major industry names are hired; for example Louis Gerstner (former IBM chairman, currently chairman <strong>of</strong> Carlyle), Jack Welch (former CEO <strong>of</strong> General Electric, at Clayton, Dubilier <strong>and</strong> Rice) <strong>and</strong> Paul O’Neill (former US Treasury Secretary, special adviser to the Blackstone Group). Expertise is also, in many firms, tightly integrated into the process by building deal teams around industry sectors, which helps not only in sourcing <strong>and</strong> appraising investments but identifying opportunities to add value quickly post investment. An alternative to sector specialisation is a focus on more generic business capabilities that can be applied across a range <strong>of</strong> investee companies. This can incorporate areas such as supply chain management, sales force management, management development or even highly specialist areas such as the provision <strong>of</strong> health <strong>and</strong> medical benefits (a significant <strong>and</strong> growing expense for many companies). Related to this latter approach is the provision by some private equity firms <strong>of</strong> shared purchasing <strong>of</strong> goods <strong>and</strong> services, designed both to reduce cost <strong>and</strong> increase the efficiency <strong>of</strong> the procurement process. Whilst this greater involvement in operational issues is becoming widespread across the private equity industry, the approach is not universal. Some firms identify fundamental difficulties with its adoption, primarily centred on the potential for disruption <strong>and</strong> discord it can bring. The risks it can entail include: • friction caused by imposing a senior industry figure on top <strong>of</strong> an existing management team; • a lack <strong>of</strong> underst<strong>and</strong>ing <strong>of</strong> the private equity approach by operating partners who come from a major corporate background; <strong>and</strong> • the added degree <strong>of</strong> risk entailed in backing a company with an incomplete team, <strong>and</strong> relying on an operating partner’s input. Aftercare – who does it The question <strong>of</strong> where, <strong>and</strong> to whom, a private equity firm should allocate responsibility for aftercare is a source <strong>of</strong> perennial debate within the industry. Broadly speaking, there are three approaches: • the original deal team retains responsibility for the investment; • responsibility is immediately passed to a dedicated, specialist aftercare team; <strong>and</strong> • there is a phased transition, with the original deal team retaining the relationship for a period <strong>of</strong> time – one or two years – before the aftercare team takes over. The arguments in favour <strong>of</strong> the deal team retaining responsibility are: • they will have the deepest underst<strong>and</strong>ing <strong>of</strong> the company at the time the investment completes; • they will have built a relationship with the management team, <strong>and</strong> a first h<strong>and</strong> underst<strong>and</strong>ing <strong>of</strong> their strengths, personalities, areas <strong>of</strong> potential weakness <strong>and</strong> development requirements; <strong>and</strong> • they will have clear ownership <strong>of</strong> the value creation <strong>and</strong> realisation strategy, having been primarily responsible for developing it with the company’s management. The potential drawbacks to this approach, however, <strong>and</strong> arguments for a dedicated team include: • the personalities required <strong>of</strong> investment executives, to find <strong>and</strong> drive investments through to completion, do not always suit the different dem<strong>and</strong>s associated with aftercare; • the investment team may not have the specialist sector or operational skills required to add value; <strong>and</strong> COPYING WITHOUT PERMISSION IS UNLAWFUL THE FUNDAMENTALS OF PRIVATE EQUITY 9
Module 9: Secondaries <strong>and</strong> their alternatives COPYING WITHOUT PERMISSION IS UNLAWFUL THE FUNDAMENTALS OF PRIVATE EQUITY
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