Operators seek pay balance with dealmakers

Over the past five years operating teams have become an integral part of the private equity industry. But despite the growing popularity of the role, how each firm positions these professionals within its ranks differs on a case by case basis, as does the remuneration structure.

One thing though has remained constant: operating partners still earn less than their dealmaker counterparts in the vast majority of cases. Of course there are some forward-thinking outliers who make no distinction between deal partners and operators in terms of pay, but that is very much the exception rather than the rule.

Differences in compensation between dealmakers and operators can create tension within the firm. Lower pay for operating partners, or excluding them from a piece of the carried interest pay, can result in an ‘us and them’ type mentality.

Operating partners on average get a basic salary and bonus of $745,000 per year, according to data from compensation consultants J.Thelander. In comparison, an average dealmaker with 12 plus years of industry experience can command a much higher salary (often running into seven figures) than someone who’s built their career honing operational skills (see graph). Moreover the amount of carry is also unequally distributed with most operating partners receiving only 50 percent to 75 percent of the carry that their dealmaker counterparts do, according to analysis from private equity recruiters AJF Executive Search.

Despite not receiving the same pay as deal professionals, some argue that operating partners should be happy with what they are getting. “They have to expect the deal professionals to be making more money than them,” argues one US-based compensation lawyer. “Compared to professionals that work in similar roles outside the private equity industry, they get a lot more.”

However this is not a sentiment that everyone agrees with, especially operating partners. One delegate at PEI’s recent Operating Partners Forum made the case operators are driving the returns and so deserve remuneration at least equal to their dealmaker counterparts.

INVESTOR PRESSURE

And the argument for equal pay looks set to continue as developed economies appear to be heading for more years of lackluster growth, meaning the role of value-add specialists will become even more important, according to, one GP source.

“It’s my view that operating partners who are aligned in a similar way to deal partners end up achieving the most LP-friendly result,” he adds.

Mark Nicolson, partner at SL Capital agrees with the point. He explains that in order to be fully aligned operating partners need to have “skin in the game”, either through a GP commitment or their own personal investment. It becomes important then that operating partners are given pay similar to dealmakers so they have greater ability to personally invest in the fund, the argument goes.

Both sources however temper their statements by saying each firm needs to assess remuneration of operating partners on an individual basis, beginning with an evaluation of how much value they believe operating partners bring to the table.

Unfortunately that kind of evaluation can be difficult. Looking at how much value operators bring to a firm as a whole tends to change according to the firm’s operating partner structure.

Some firms, most often the larger ones, have operating partners that focus on particular sectors or geographies. They may be captains of industry that will help the firm source deals, conduct operational due diligence and then come up with and help implement the portfolio company’s strategy post-acquisition.

These operating partners may receive a retainer fee for their work. This type of remuneration falls between a one-time contract and full-time employment, and its distinguishing feature is that the employer pays in advance for work to be specified later. Often these types of operators elect to put forward their own sweat equity in the form of a co-investment rather than as part of the GP commitment.

But for firms that have an operating partner on the payroll full-time, then the more common basic salary and bonus structure is prevalent. These operating partner models will see the operating partners work alongside the dealmakers from deal origination to exit. The seniority of the in-house operator often dictates what, if any, carried interest he or she is entitled to.

However climbing the firm’s ranks can take longer as an operator than a dealmaker, notes Heather Stone, head of private equity at law firm Edwards Wildman. For instance, achieving an executive role entitled to carry within a deal team could take as little as six years post-MBA, but the same position within an operating team that has less of a hierarchy could take twice that time, says Stone.

Yet sources note that this dynamic could be shifting. As private equity firms have to pour operational resources into driving fund returns, a clearer career path at a private equity firm awaits these professionals.

Nonetheless it still may take some time if the private equity industry is to seek an equal pay balance between operators and dealmakers. 

Firstly the nature of the operator role makes it difficult for private equity firms to match the carry structure of its dealmakers. Often operators will not work across the whole fund, but rather exclusively on certain deals, portfolio companies and are in general more project-focused than dealmakers. This makes it difficult for firms to give operators a slice of the carried interest as the most typical carry model attributes carry from whole fund profits.

Different challenges arise when an operator is given a slice of the whole fund’s carried interest. If carry is low, but the specific deals an operator worked on produced strong profits, the operating partner may feel undercompensated.  Indeed some argue the more logical approach for incentivizing operating partners would be carry on a deal by deal basis. 

But the counter argument here is that the deal by deal carry structures can get complicated when delineating exactly who gets credit for a portfolio company’s success. And sources also argue a deal by deal carry model for operators can create the aforementioned “us and them” mentality between dealmakers and operators.

All told it’s critical how well the various teams within a firm operate together. And as the rise of the operating partners’ status continues, firms have been given the message to start reflecting that in the pay structure. As elaborated above, that is easier said than done.