The Operating Partner in Private Equity

Mechanism

In the order settling its case against Monomoy Capital Management, L.P., the Securities and Exchange Commission described an in-house Operations Group, whose members the adviser sometimes called "Operating Partners," providing "operationally-focused services related to making business improvements for portfolio companies' operations" (Advisers Act Release No. 5485, April 22, 2020).

Engagement takes three forms: a sponsor employee, a part-time senior or executive adviser, and an affiliated consultancy contracted separately. Heidrick & Struggles describes the adviser role as one that "can consume 5–50% of the individual’s time," and its 2024 survey of 251 North American operating professionals found 88 percent working full time and 19 percent self-employed.

The same survey covers base salary, bonus and carried interest, and lists four non-cash forms: carried interest, warrants or options, direct equity participation, and co-investment rights. For operating partners at firms with a most recent fund under $500 million, it reports a self-reported mean 2024 base salary of $340,000 and mean carried interest of $1.972 million from the most recent fund, from six responses. The payer is a separate question. ILPA Principles 3.0 (2019) tell limited partners to understand whether an operating partner is paid "directly by the GP or by the portfolio company," and recommend that fees paid by portfolio companies to affiliated operating partners be fully offset against the management fee.

Disclosure turns on the payer. A violation of Section 206(2) of the Advisers Act "may rest on a finding of simple negligence" (Release No. 5485). The Commission's 2019 fiduciary interpretation requires an adviser to eliminate, or make full and fair disclosure of, conflicts so that a client can give informed consent (Release No. IA-5248). Form ADV Part 2A, Item 5.C, requires a description of other fees and expenses clients may pay.

The 2023 private fund adviser rules, including a quarterly statement rule that would have required disclosure of fees and expenses, were vacated by the Fifth Circuit effective June 5, 2024 (National Association of Private Fund Managers v. SEC, No. 23-60471), and the SEC's rulemaking page lists no re-proposal as of October 10, 2026. Disclosure of operating partner compensation therefore rests, as in Monomoy, on Section 206(2), the 2019 fiduciary interpretation and Form ADV Part 2A.

Worked Example

Assume a hypothetical $100 million fund with a management fee of $2.0 million a year and an operating team that costs $1.5 million a year. If the sponsor absorbs the team inside the fee, it receives $2.0 million and spends $1.5 million. If the team bills portfolio companies $1.5 million and the fund agreement offsets 100 percent of portfolio-company fees against the management fee, as ILPA Principles 3.0 recommend, the fee falls to $0.5 million and the sponsor again receives $2.0 million in total. If the same billing carries no offset, the sponsor receives $2.0 million plus $1.5 million, or $3.5 million, and the added $1.5 million is borne by the portfolio companies in which the fund holds positions.

Monomoy shows the scale: the SEC found that portfolio-company reimbursements were approximately 13.3 percent of all revenue Monomoy received with respect to its second private equity fund from April 2012 through December 2016 (Release No. 5485).

What It Means for a Limited Partner

An allocator reads the arrangement through three questions: who employs the individual, who pays for the work, and what offsets the payment against the management fee. In Monomoy, the adviser emphasized the value its Operations Group added, yet the fund's partnership agreement did not mention the group or disclose that portfolio companies would pay for it, and a Form ADV statement that the adviser "may be reimbursed" did not fully and fairly disclose routine reimbursement (Release No. 5485). The Commission's 2020 risk alert separately flagged inadequate disclosure of the role and compensation of operating partners who are not adviser employees.

ILPA Principles 3.0 state that fees exempt from the offset provisions "should be rare, but clearly defined in the LPA." ILPA's 2021 report on market fund terms observed that the fee offset "has been eroded by exclusions for fees paid to so-called 'operating partners' and other GP-related parties for certain services," and ILPA Principles 3.0 recommend that any fees generated by a GP affiliate, such as an in-house consultancy, be reviewed and approved by a majority of the limited partner advisory committee. A due diligence questionnaire response should state each point in writing.

In Life Sciences and Healthcare

In the Heidrick & Struggles survey, 14 percent of respondents named healthcare and life sciences as their industry specialty, behind technology and software at 19 percent and industrial at 16 percent. Compensation raises a further constraint. Where an operating partner or the sponsor is in a position to refer or arrange for federally reimbursable items or services, the Anti-Kickback Statute, 42 U.S.C. 1320a-7b(b), reaches remuneration paid for that position: it is a felony, punishable by up to 10 years in prison, knowingly and willfully to offer or pay remuneration to induce referrals of items or services payable by a federal health care program.

The personal services safe harbor, 42 C.F.R. 1001.952(d)(1), requires a signed written agreement with a term of at least one year that covers all of the services, and a compensation methodology set in advance, consistent with fair market value, that does not take into account the volume or value of federal program referrals. A fee that varies with such referrals does not meet that condition.

Governing Authority and Sources

• SEC, In the Matter of Monomoy Capital Management, L.P., Advisers Act Release No. 5485 (Apr. 22, 2020) (source)
• SEC Press Release 2016-100 (June 1, 2016), Blackstreet Capital Management (source)
• SEC Office of Compliance Inspections and Examinations, Risk Alert (June 23, 2020) (source)
• SEC, Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Release No. IA-5248 (June 5, 2019) (source)
• SEC, Form ADV Part 2, Instructions for Part 2A, Item 5 (source)
• SEC, Private Fund Advisers rulemaking page, recording the vacatur in National Association of Private Fund Managers v. SEC, No. 23-60471 (5th Cir. June 5, 2024) (source)
• ILPA, Principles 3.0 (2019) (source)
• ILPA, What's Market in Fund Terms? (2021) (source)
• Heidrick & Struggles, 2024 North American Private Equity Operating Professional Compensation Survey (source)
• 42 U.S.C. 1320a-7b (source)
• 42 C.F.R. 1001.952 (source)

Frequently Asked Questions

What does an operating partner do in private equity?

An operating partner helps portfolio companies carry out operational improvement plans. The SEC's Monomoy order describes operationally focused services for making business improvements, including lean manufacturing programs across the portfolio. ILPA Principles 3.0 describe operating partners as engaged to execute specific strategic growth plans.

How is an operating partner paid?

Pay can combine cash and non-cash interests, and the payer varies. Heidrick & Struggles' 2024 survey of 251 operating professionals covers base salary, bonus, carried interest, warrants or options, direct equity and co-investment rights. ILPA Principles 3.0 add that investors should learn whether the sponsor or the portfolio company pays.

Must a sponsor disclose operating partner fees to investors?

Yes. An adviser must make full and fair disclosure of the conflict when portfolio companies pay it for operating partner services, as the SEC found in Monomoy (2020) and Blackstreet (2016). The SEC's 2020 risk alert also flagged inadequate disclosure of who bears the cost of operating partners who are not adviser employees.

Related Reference

This entry belongs to the healthcare growth equity thesis. Related entries: Growth Equity, The Mid-Market in Private Equity, and Due Diligence Questionnaire.