February 12, 2014
Interviewed by: David Snow
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Comp, Alignment and Skills for Operating Partners

What is the right structure for giving operating partners a ‘seat at the table’ at a private equity firm? What are compensation and alignment options? What should a corporate executive know about making the move to private equity? Senior operating executives from private equity firms Partners Group, The Riverside Company and Argosy Private Equity compare details and perspectives.

What is the right structure for giving operating partners a ‘seat at the table’ at a private equity firm? What are compensation and alignment options? What should a corporate executive know about making the move to private equity? Senior operating executives from private equity firms Partners Group, The Riverside Company and Argosy Private Equity compare details and perspectives.

Comp, Alignment and Skills for Operating Partners

Special Report: All About PE Operating Partners

David Snow, Privcap:

Today, we are joined by Fredrik Henzler of Partners Group, Don Charlton of Argosy Private Equity, and Ron Samson of The Riverside Company.

We are talking about the role of the operating partner in private equity. This is a huge trend that investors are very interested in; the private-equity firms are trying to up their game with regard to value creation and operating partners are a big part of that equation. Luckily, we have three operating experts with us today to talk about how operating partners are increasingly integrated into the culture, the fabric and the economics of a private-equity firm. First, Don from Argosy, we’ll start with cultural fit. Most operating partners come from corporate backgrounds and are plugging into private-equity firms, many of whom come from banking or financial backgrounds. How does that work and what does it look like when you get it right?

Don Charlton, Argosy Private Equity:

As it relates to whether deal partners are accepting of operating partners, they are very receptive. I respect their involvement in the banking field, though I did not come from a banking field. I came to startups for 12 years before joining this firm. So, they respect that we have run companies, these operating partners, sitting at the table, and they leverage that experience. I feel like a complete peer with my other partners at the table.

Snow: Ron, how do people from operating backgrounds plug into the other professionals at private-equity firms who have not run companies as directly as have the operating partners?

Ron Samson, The Riverside Company:

First, it is a critical issue and the deal team partners, if we call them that, and the operating partners have to work together very closely. If not, you have a serious issue within your firm. We have never had an issue within Riverside: the operating folks and the deal team partners work closely together. On any one company, you have a deal partner and an operating partner, so they are joined at the hip. They need to understand the strategy and work together to implement that strategy. Normally, that happens and we have no issue there. Yes, that’s how I would answer the question: it is critical that the two work together very well and I don’t see any obstacles to make that happen.

Snow: Fredrik at Partners Group, you are a large global firm. How is the role of the operating partners in the firm structured so that there is a harmonious cultural fit with other people in the firm?

Fredrik Henzler, Partners Group:

We are Swiss, so we are very egalitarian.

Snow: You already have that figured out.

Henzler: And very democratic from the beginning. We are a small country and we have a lot of alps, so we need to cuddle up and get along. That aside, for the long-term success of an operating system, it is incredibly important that you work among peers and that you are seen as peers; therefore, the integration into the private-equity team is important. Respecting each other’s competencies and fields of competency is important. As a global company, Partners Group has regional deal teams and local deal teams. No deal team from the U.S. will do a deal in Europe, no European team will do a deal in Latin America, so we have the regional deal teams looking for deals, structuring the deals and executing on the deals. They are partnered with somebody from an industry vertical. These industry verticals are global, because the IT space looks similar in the U.S. as it does in Europe. That means the operating partners and the deal teams mix through a lot; the team you work with today is not going to be the same team you work with the next time. That project-based approach to working helps to foster a working atmosphere where it’s less about dominating and one side always getting the rights and the last answer, but more about huddling up, building a team and executing on the deal.

Samson: David, there will always be some tension now and then between a deal partner and an operating partner. I am sure you guys have seen that as well. But, you have that in any company, right? You have that in corporate America, in startups or anywhere. You are going to have differences in terms of people or strategy or whatever, but the issue is to work through those issues like any professional deal team would, whether it be in corporate America or private equity. It is not all motherhood and apple pie—there is certainly some tension now and then, but it’s normal, it’s typical. At the end of the day, it makes us better.

Henzler: Yes, and the tensions can be very valuable because they can flush out the problem you did not think about. They can make you focus on an issue and find a solution that was not there if you would have just talked over it or left it aside.

Samson: Right, right.

Henzler: Ron is making a very good point.

Snow: I would like to talk about something that is sometimes important: money. It is important for operating partners to feel they are part of the team, but then there is the alignment of interest with the rest of the firm. Without necessarily commenting on exactly how your own firms have structured things, can we talk about the different ways that firms bring the operating partners economically into the deal? Starting with Don, can you tell us some important ways that firms have structured this arrangement?

Charlton: There are varying degrees: some firms treat the function separate and do not include in the equity carry. But, from what I have heard, the majority are going to be included in the equity carry of the fund. That is the way it is at our department.

Snow: Even deals they are not working on, they will see an upside because they are part of the fabric of the firm?

Charlton: Correct. 

Henzler: That’s fairly new, right? That has developed in the last three to four years, at least in Europe. That was different.

Snow: What did it look like in the old days, keeping in mind that the old days are not that old for operating partners?

Henzler: No, it has evolved. The first operating partners often were not even part of the company. They were external—freelancers that were pulled in as needed or kept as consultants outside the GP. Then, they started getting hired and got put onto the cash and bonus and, later, they got carry in their deals. It has evolved to being part of the traditional carry pool.

Snow: Now, you spent many years as an operating consultant to private equity—what gave you comfort that Partners Group was offering the right cultural and economic fit for you to stop being a hired gun and start being a professional?

Henzler: There were three questions I asked. I worked with 40 GP’s across Europe, most of them midcap GP’s, but a couple of the large cap. First, for it to work long-term, I wanted to make sure I was fully integrated in the private-equity team and not sitting on the side or in a different function in the company. Two, that the operating partner has a voice and a seat on the investment committee, because that assures that you are treated as an equal and are able to act as such. Three, that the incentivization scheme is the same. Not only for me, as a senior joiner, but also for my junior team members in our team in Partners Group. This incentivization career scheme for an analyst joining in the industry team is exactly the same as on the investment side.

Charlton: For our next fund, that will be our structure. We have laid out a structure with a three-person investment committee: two deal partners and one operating partner.

Henzler: That’s excellent.

Snow: At Riverside, how are the operating partners brought in to feel part of the firm?

Samson: At Riverside, our two founders feel strongly about the operating teams. The operating team is very well integrated—we have a seat at the table, we sit on investment committees. Our compensation ranges, we have various models: in some cases, it’s carry in the fund, in other cases, it’s options with the company. In some cases, they are employees of the company, in other cases they are external, but only working for Riverside. So, there are various models that can work; there is not one recipe that is the only recipe in terms of compensation. But, it has to be market base, you have to fill a part of the team, fill a seat at the table. You meet all those requirements and you will have a very strong team.

Snow: There are probably many executives from the corporate side who are thinking about a career in private equity or have been approached by private-equity firms about doing something. What would be your advice to them about questions they could ask a private-equity firm that has shown interest in them to flush out exactly what their involvement might be in the firm? What are some smart questions they could ask?

Henzler: Smart questions—you probably go with Ron.

Samson: Thank you. No, it’s not that unusual for many other kinds of role that you would take. You have to ask a critical question. What Fredrik was bringing out earlier, in terms of having a seat at the table: is the operating team critical to your strategy going forward as a private-equity firm? That was important to me and will continue to be important to me. I do not want to be a part of a side group or some group that is only brought in when there are issues.  That is not of interest. It is critical, but you would ask that in any type of job you are looking for—how you will be compensated, how your vesting works, truly understanding the carry calculation and what it means to you going forward. All those questions are critical—the reputation of the firm in the marketplace, those questions you would ask in any type of job interview. That is what I would go after.

Charlton: Also, you want to make sure what the work balance is going to be. Is this the first operating partner they are going to hire? Another 40 portfolio companies they are going to be signed at day one.

Snow: Had value all 40.

Charlton: I would want to know that upfront.

Henzler: Yes, I subscribe to what you both said, but I would go one step further: if I am a corporate executive or working in a small-limit cap company, been successful as a CEO, but never had worked in or with private equity on a day-to-day basis, I would not sign on for a job at a private-equity firm the first thing I do. I would want to work in a project as a non-executive director. It is different working within private equity than working in a big corporation, small corporation or family-owned corporation. Also, at Partners Group, we would be hesitant to bring in an operating partner that has absolutely no background or experience working in private equity, not because the skills cannot be learned, but because it is a different environment. We want to make sure the person understands that environment and feels happy in working in that environment.

Samson: Yes, that is a very good point.

Charlton: Also, the size of the deals will be a big determiner. If you are buying family-owned and founder-owned businesses like us, you need a lot of EQ to sit across the table and get that alignment and that buy-in about what you are trying to accomplish.

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