Talent tinkering: Operating partners in Asia

Adding value to a portfolio company is far from an exact science. Ask any Asian GP to name their operating partners or even define the role these executives fulfill and you are unlikely to get a uniform response. The idea of getting someone in to help manage an investment portfolio is by no means new to private equity and yet, in recent years, terms like "operating partners" and "operational value-add" have become increasingly integral to the lexicon of anyone on the fundraising trail.

"Five years ago, few GPs even spoke about operating partners," says Doug Coulter, the partner responsible for LGT Capital Partners' Asian private equity investments. "Today it's what a lot of GPs are talking about it."
The buzz is not only heard within the ranks of the international buyout firms, but extends all the way down the food chain to smaller firms. Their definition of an operating partner follows a similar arc, ranging from industry experts hired on an ad-hoc basis to full-time partners.

The question for many Asian GPs - often asked by prospective LPs during due diligence - is where these operating partners fit into their structure. The more experienced the individual, the greater his impact on portfolio companies; the more powerful within the private equity firm, the more readily he is listened to by the deals team, pre- and post-investment; the higher his compensation, or how closely it is aligned with a portfolio company or the fund, the better the chances of retention and outperformance.

"The operating partner model is important and everyone checks it," says one Asia-based LP. "It has an impact on how effective they can be and how they are managed, and also on the turnover rate. Operating partners are part of the bells and whistles everyone thinks they must have, but some are just junior members of in-house teams, while others are very present and material."

An evolutionary process

The demise of multiples arbitrage, which characterized the most recent phase of Asian private equity, has forced private equity firms to reexamine how they can deliver returns. For many, this involves paying closer attention to who they hire and how they can add value.

However, the use of operating partners - and, indeed, the length of their history within a firm -varies greatly depending on resources, investment nature and portfolio management style. KKR, for example, established a definitive operating partner model in 2000 with the creation of Capstone, an internal operations division. The model was rolled out globally and, 12 years on, Capstone has 60 consultants on its payroll. It is the yardstick by which many now measure value creation teams.

"It really has always been set up as a model of doers, not advice givers," says Scott Bookmyer, head of KKR Capstone Asia. The private equity firm eschewed the established practice of hiring external advisors in favor building its own pool of operational expertise that could be drawn upon as and when required by portfolio companies.

Part of the motivation for developing in-house consultants has been a desire to ensure the interests of those who add value are in sync with the firm and its portfolio companies - i.e. these executives are not distracted by outside business interests. Most LPs in Asia recognize the value in this approach.

"Ultimately it is about getting the alignment right," says LGT's Coulter, "If they are in-house and they are incentivized properly to drive value that would generally be preferable to an external advisor who does his job and goes away."

With this in mind, KKR incentivizes Capstone staff in much the same way as the rest of the firm: a combination of cash compensation, performance bonus and carried interest. This approach has also been adopted by many other GPs in Asia.

KKR may have formalized its operating partner model but it is by no means alone among the global buyout firms in being a long-standing champion of building strong in-house expertise. TPG Capital has a reputation for turning around troubled businesses and Steven Schneider, a managing director with the firm in Asia, agrees that operating groups are more necessary in the region than they have been in the past.

"It is important to the portfolio companies given that organic growth isn't there as much as it was in the mid 2000s," he says. "Operational processes are key to improving a company's performance for the sustainable long term."

Partner to the rescue

TPG describes its operating team as "inside orientated" with around 70 professionals and senior advisors globally, 19 of whom are based in Asia, including three operating partners and 16 senior advisors. The private equity firm has filled its ranks with former executives from companies like General Electric, Dell, Microsoft and Pepsi.

Schneider claims that any one of his team is able to serve as a CEO, CFO, general manager or functional head should the need arise to temporarily replace a senior level executive.

A vivid example of this came last July when Jin-Goon Kim, a partner at TPG, was appointed executive vice chairman of struggling Chinese sportswear retailer Li Ning following the departure of the company's CEO. Li Ning's CFO left several months later. When TPG and Government of Singapore Investment Corporation (GIC) invested in the company earlier in 2012 through a convertible bond issue, its prospects already looked bleak. Comparisons were inevitably drawn with the turnaround job the private equity firm performed at women's shoe retailer Daphne from 2009, an effort that laws led by Kim.

Last week Hong Kong-listed Li Ning saw its stock drop 13.8% after announcing it would raise up to $241 million through a convertible securities offering, with the proceeds earmarked for a brand revival plan. It appears the market - admittedly a short term-oriented creature - has little faith but should Kim manage to work his magic once again he is likely to be handsomely rewarded.

TPG's operating partner incentive program comprises a base salary, a regional performance-based bonus and an individual performance-based bonus. In addition, operating partners receive "vintage shares" in the portfolio companies they work with, which is essentially a means of awarding carried interest but on a more specific basis. There may also be opportunities to co-invest when sourcing deals - a vital component in aligning respective interests.

CVC Capital Partners also stresses the need for operating executives to be able to fulfill an interim management role, although the need has yet to arise in Asia. Allen Han, a senior managing director at the private equity firm, describes the ideal résumé as "five years management consultant experience and 10 years of operating experience."

The private equity firm has three full-time operating professionals in Asia, plus six in Europe and one in America. The Asian representatives are each responsible 3-4 portfolio companies, supported by a global network of industry advisors who offer sector-specific expertise and sometimes act as a source of deal flow.

"It usually will involve a typical directors' fee but if they help originate the deal we offer co-investment rights," says Han. "It has been quite effective in Europe and North America, and in Asia we have had a number of deals sourced through industry advisors."

In this way, global firms have naturally been ahead of curve as they react to prevailing trends in Europe and America and export and adapt them to Asia. However, several Asian players also claim early-mover advantage, Unitas Capital among them. The firm's senior leadership comprises eight partners, half on the deal side and half on the operating side. The latter include three former CEOs and one former division head at a multinational.

"There is a significantly higher degree of integration compared to what you would find in a lot of other PE firms," says John Lewis, Unitas' CEO. "The reason we do this is that we believe an ex-CEO has more to bring to the table than what is fully utilized by private equity firms."

In keeping with this approach, operating partners receive the same level of compensation as deal partners, with carried interest shared out between them all. Lewis argues that an incentive model tied to the performance of the fund rather than individual companies is vital in forming a cohesive team.

The specialists

Although Unitas targets control deals it rarely seeks to take operational control, instead empowering and incentivizing existing or imported management teams to run businesses. This is in part a reflection of case-by-case needs in Asia and in part a product of specialization - the GP exclusively targets the industrial and consumer-retail spaces.

Other PE firms with a specialist investment thesis have also tailored their operating partner approach to suit their expertise. Silver Lake, for example, set up a value creation team (VCT), which numbers 20 operational professionals globally and is the fastest growing part of the firm in terms of head count. Five are based in Asia and spend a substantial amount of time working on opportunities in the region, particularly China.

The VCT includes full-time employees and special advisors who have other interests. As a technology specialist, Silver Lake's network is deep and many people within the sector have worked with the private equity firm before as investees, customers of investees or consultants. While special advisors are brought in when required as opposed to being held on retainer, there is preexisting familiarity on both sides. Compensation is described as running the gamut of cash, carry and retainer, depending on the situation.

"With technology, more than any other sector, you need industry expertise," says Ken Hao, head of Silver Lake Asia. "You can't put a hardware guy in an internet company and you can't put a software guy In a specialized Chinese communications company. The issue of fitting an operative executive into a portfolio company is the tricky part."

The idea of leveraging an extensive network of external advisors is also integral to EQT Partners. The private equity firm's approach, which was developed in Europe and has been carried over to its operations in Asia, is based on a global database of 650 experts who are divided into seven tiers based on how closely they work with the firm. About 50 are located in Asia, and a handful of them are "tier one" advisors.

"Tier one advisors are almost full time staff but they are not strictly employees," explains Martin Mok, a partner with EQT in Hong Kong. "They act as consultants and devote around 50-60% of their time to EQT, normally sitting on two or three boards."

Advisors in tier one and tier two account for around 15% of the global pool and they are kept on retainer. While the first tier is exclusive to EQT - and compensated to reflect this - tier two advisors are paid less and have the option to take on projects elsewhere. Neither group received carried interest from the fund but the real incentive lies in co-investment opportunities. As with TPG, this is seen as a means of aligning interest, but EQT adds a twist: co-investment is mandatory.

Mok claims the external advisor approach is particularly effective in China where owners are reluctant to give up control to outside investors and so PE firms try to add value by supporting the incumbents. "Going into a firm with 10 guys sitting on the board full time can be like having too many cooks in the kitchen," he says. "It takes away the accountability."

No consensus, but who cares?

In keeping with the amorphous definitions and modes of operating partner across the region, not everyone agrees with this approach, even within a China context. But as the operational partner philosophy filters down to Asian GPs that can't rely on global networks and resources, models will inevitably deviate, throwing up compromise solutions.

Lunar Capital is an interesting example. The private equity firm targets control deals involving mid-market consumer companies in China. Although it has a fraction of the resources of a global buyout firm, its operational partner model is not that far removed from a KKR or TPG, emphasizing the need for in-house expertise. The problem is that a GP of Lunar's size is unable to maintain a dedicated team in this area. The private equity firm's solution is to hire individuals with relevant expertise before making an investment, uses them during due diligence and then offers them a salary-plus-equity package as CEO of the portfolio company.

While firms like Lunar are still the exception in China, and indeed in Asia, the trend for operating partners taking centre stage is likely to gain more traction in the region. There may be no consensus as to which approach is most effective, but this misses the point. GPs have to convince both investees and LPs that the model they employ works for their particular fund size and strategy. There is no turning back.

"I think the emphasis on value add will be a sustainable trend," adds TPG's Schneider. "If the world continues to be a difficult place in which to invest, with no hyper growth, really smart business owners are going to want to be doing business with private equity firms that have the ability to help them. Not just by funding financial structuring but by rolling up their sleeves and helping the business grow."

SIDEBAR: Headhunting - Asia's got talent?

While many GPs have a clear idea of what they want in an operating partner, the role can still prove to be extremely difficult to fill. This is only likely to be exacerbated by the growing demand for such individuals across Asia.

"Finding top talent is always a very challenging task but especially in Asia where skills are always in shortage," says Allen Han, a senior managing director with CVC Capital Partners. "However, it has not been unusual for us, because of CVC's reputation, to find candidates are attracted by the opportunity to work in one of our portfolio companies."

While the likes of CVC and other large private equity firms are able to leverage their prestige, this doesn't necessarily work for the wider middle market. Vanessa Moriel, executive vice president at executive search firm Aims International says there is huge demand from PE firms for portfolio company CEOs. And beneath that lies a niche that is even harder to fill: professionals who not only have operational experience but are also familiar with private equity.

Although talent is scarce in some parts, many seasoned professionals in Asia see private equity as a means of fast-tracking their careers. Richard Folsom, co-founder of Japan-focused Advantage Partners, says one the biggest headaches is the best and brightest local hires are drawn towards the established corporations, government ministries or large financial institutions. That said, there is a growing appreciation of private equity as a short-cut to a CEO role.

"Private equity is more willing to take someone on in their prime, when they are in their 40s or early 50s, it gives them that opportunity to be in that senior role plus have the opportunity to make a substantial equity return in the process," Folson says.

Aims' Moriel sees a similar trend in Asia as a whole as experienced corporate executives turn to operational positions with private equity firms due to the potentially large financial rewards.

Han of CVC laments that it is still "extremely rare" to find candidates that can offer the ideal combination of corporate and private equity experience. He contrasts the situation with Europe where CVC recently hired two new operating partners, both of whom had previously worked with other private equity funds.

Asia will eventually evolve along similar lines but it takes time. It is only through private equity firms in the region making greater use of operating partners that the talent and experience pool will deepen.

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• Topics
• Investments
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• Greater China
• North Asia
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• Southeast Asia
• Asia
• GPs
• buyout
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• Operating partners