Industry voice: Maximising ROI with your service providers
Jay Maher, of Mainstream Fund Services, and Rey Acosta, of AltaReturn, break down the importance of back-office functions, reflect on different outsourcing models, and consider how the relationship between general partners and service providers has changed in recent times.
The Drawdown (TDD): Why should small- and mid-sized funds care about improving their back office?
Jay Maher (JM): Traditionally, smaller fund managers have been more reactive than proactive regarding their operations. That’s starting to change. As the industry matures, managers of all sizes are realising that building a capable operational infrastructure can be cost-effective and provide a significant positive return on investment (ROI). The proper combination of technology and services can reduce operational overhead, eliminate key man issues, reduce manual errors, and provide investors with easily consumable information – a requirement these days from institutional investors.
Rey Acosta (RA): While fundraising has been extremely healthy for the industry overall, the majority of commitments still go to the ‘brand name’ funds. Small- and mid-sized funds continue to battle for allocations. Institutional investors have raised the bar in terms of the operational standards they will accept from all of their managers – not just the big ones. The use of commercial applications like MS Excel to run your fund accounting is liable to quickly get a GP flagged during the due diligence process.
TDD: What changes in the private equity industry are affecting the back office?
JM: Fundraising for smaller managers is competitive, and investors will allocate capital to those managers who not only have the investment pedigree, but who also have a business with a solid infrastructure. Operational due diligence (ODD) by limited partners (LPs) ensures that the proper accounting, valuation, administration, and reporting is in place and fully functional. At one time this was a ‘nice to have’ and having a high historical internal rate of return could overcome certain backoffice deficiencies. That’s no longer the case. There is a growing acceptance that the proper technology in combination with a third-party administrator is moving towards the norm.
RA: The Institutional Limited Partners Association (ILPA) has been making significant strides in their efforts to standardise reporting in the private equity industry. There is a growing number of LPs requiring their fund managers to utilise the ILPA’s reporting template as a hard prerequisite for a commitment. The Financial Conduct Authority (FCA) in the United Kingdom has also been pushing for more transparency and disclosure for alternative asset managers. A PE firm’s back office is going to need to be ready to meet these increasing demands from investors and regulators.
TDD: How has the general partner/administrator/technology provider relationship changed over the years?
RA: Cloud-based technology has been a game-changer for many industries and the investment business is no exception. For the private equity industry, technology advancements have touched every part of many firms with regards to how information is managed and shared, from the deal team to investor relations to the back office. Developing a ‘single source of truth’, in that data is stored once and shared, has created numerous operational improvements across the board. At the same time, there is a new generation of investment, client service and back-office professional that has grown up with cloud-based applications. Using a browser is now the most predominant workflow tool for this tech-savvy generation.
JM: Traditional client server applications have made it difficult or cumbersome to create an elegant workflow between the GP and administrators. Today, the co-sourcing concept allows GPs and their administrator to have a more fluid and efficient working relationship through the use of cloud-based apps. The objective here is to ensure there is a symbiotic technical and working relationship between the administrator and the technology platform being used.
TDD: What is co-sourcing and how is it different from outsourcing or insourcing?
RA: In the co-sourcing model, the GP ‘hosts’ or owns the accounting and external reporting data and technology, while the administrator utilises, not their own software, but the GP’s in-house system to assist in the fund accounting and investor reporting function. The administrator becomes a true extension of the GP’s back-office team. This relationship is facilitated when the GP employs a cloud-based system that allows easy access by all parties. For GPs, the value of having their data reside in-house (i.e. the co-sourcing model) creates a ‘best of both worlds’ solution.
JM: Co-sourcing can create an optimal working relationship between the GP, administrator and technology provider. With the evolution of today’s technology platforms, the administrator can live in the same environment as their client. This allows the GP to maintain certain functions in-house, while expanding the operational infrastructure with a service provider who works as a partner.
TDD: What variables should be considered to determine if in-house, outsourcing or co-sourcing is the best model for a given firm?
JM: The following questions should be asked to determine what the best model may be: how long has your firm has been in business? What is the size and complexity of your fund structures? What type of assets do you invest in? What is the current state of your operational infrastructure? And is your fund structure in a growth mode? Administrators themselves come in all shapes and sizes, but a bona fide one will work with you to understand what works well, where there are areas for efficiency improvements, and what the true hard and soft costs are of your current IT environment.
RA: A lot of the decision points around a purely outsourced versus a co-sourced model really come down to the level of internal controls and processes the GP wants to maintain or initiate. For funds that want to leverage the capabilities an administrator can bring but still want to maintain oversight of the workflow and keep their data on premise, the co-sourcing model can work quite well in that scenario. Another consideration is cyber-security. Email is inherently unsecure. An investor portal can help alleviate concerns about sensitive information finding its way into the wrong hands.
TDD: Can a smaller fund afford this?
JM: In a word, yes. Working with an administrator who partners with industry-leading technology providers is affordable. Service providers who understand how to optimise fund accounting processes with the right software can mean the back-office team can work with greater efficiency, ultimately saving time and money. An experienced GP knows that investing in their back-office will provide a solid ROI.
RA: Technical advancements over the past few years have certainly lowered the barrier to entry in developing a robust infrastructure. Technology costs have dropped significantly due to cloud-based architectures, and therefore what was once reserved for large funds is now more broadly accessible. No longer does one need to deal with expensive servers and maintenance. The technology available today, from the back all the way through to the front office, has levelled the operational playing field in the private equity world.
TDD: The idea of moving to a new admin or implementing new back-office software can be daunting. What do you say to those hesitant to make the jump?
RA: Unfortunately, the industry has a graveyard full of implementations that died or nearly did so. The number one thing I tell GPs looking to make the jump is to look at the client service and implementation team. How much experience do they have? (Including technical and industry experience.) How long have they worked there? How deep is the bench? Technical considerations aside, it’s the people who can make the transition painless or painful.
JM: Find a service provider/technology team that has years of experience in the private equity and venture capital industry. Research their background and what has been their experience in converting funds with the structure and amount of data that you have. Today’s technology allows for a more seamless upload and review of historical data, including data in manual spreadsheets or other industry software that is today inadequate or dated. Choose a team that can properly communicate a thoughtful and effective implementation plan that will allow its execution to run parallel to your current processes without interruption to your current reporting cycles. Also ask them for a proof of concept when appropriate.