Operating partners essential in competitive market

Operating partners are becoming involved much earlier in the dealmaking process due to increased competition for assets, according to panelists at the PEI Operating Partners Forum in New York on Wednesday.

An operating professional at a Connecticut-based firm said because his firm targets competitive sectors such as technology, where prices are high, he has to engage pre-deal.

Private equity firms traditionally relied on buying assets cheaply and leveraging up to realise high returns on exit. But high valuations in recent years have driven GPs to find company-specific ways to generate growth.

“What a lot of companies need to achieve their next phase of growth is different than the initial phase,” he said. “That's on the operating partner to dissect ways to create value.”

Another panelist, an operations managing director at a large buyout firm, echoed the sentiment that high valuations and multiples force a GP to have a strong operating angle.

“I firmly believe if you don't have a way upfront before you execute a deal to create value, such as improving a company's supply chain or frontline operations, you'll be disadvantaged,” he said. “Certainly in [looking at] the returns, you'll realise that.”

He added that when he started his operating career almost two decades ago, private equity was about juicing returns through financial engineering. Now, with inflated asset prices, operating partners need to find ways to add value to jump over the hurdle and other thresholds.

What's more, operating partners are becoming increasingly involved in investment theses, according to another operating professional at a healthcare-focused firm.

“Operating partners are driving the investment thesis and GPs are supporting that,” he said. “Maybe it's specific for healthcare because there are many niche companies out there.”

He also noted that by having a targeted strategy, such as niche healthcare sub-sectors, fund managers can avoid a lot of the market noise. This is especially important as more competition from both strategic buyers and other financial sponsors enters the private equity space, he said.

“Being the differentiated fund in terms of expertise and having operating partners to dig into the portfolio and dig into specific investment theses will continue to be important,” he said.

The operations managing director summarized that the key for operating partners is to position themselves correctly in the investment process. Specifically, he makes sure he is involved at the beginning of deal negotiations and is introduced to the management team.

“The nature and environment of private equity is such that you have to be better every year,” he said. “It's really that initial overcoming of the friction to start creating something meaningful.”