Expecting Operational Excellence
LPs dig deeper as fund operations become more complex
By Jeff Gendel, Managing Director, Gen II Fund Services
The current fund raising cycle combined with enhanced regulation is uncovering some important new LP trends.In addition to expected questions about returns, investment focus, unique access to deal flow and the team at the GP, there are new questions cropping up – those focused on the GP’s operational infrastructure.
During and beyond the fundraise LPs want to understand the people, processes and technology that will deliver the key financial information on their investment in the fund after they have made their commitment – and want to ensure that not only does a GP have these items in place, that they are institutional grade and provide a level of independence when it comes to the fund’s economic calculations and individual investor allocations.
Gone are the days when GPs could focus solely on investment performance, industry specialization and unique deal flow access. Now, an important part of the investor presentation is how a GP will manage key operational tasks, the quality and timeliness of investor reporting, and how the firm will stay compliant with required industry regulations.
Add to that a heightened expectation of consistency of information flow and it’s no surprise that GPs are looking more intently on how to strengthen their firm’s operations - or seeking to partner with a fund administrator to help them meet these requirements.
LPs want to see a strong back-office infrastructure.
LPs previously invested in private equity funds based almost entirely on expected performance. That’s no longer the case. Today GPs are getting peppered with questions about the back office and LPs won’t move forward unless key questions are answered.
Why the change? Increased regulation and scrutiny in a post-Madoff world. Returns are still the top consideration for LPs but other factors, including infrastructure, the culture, governance, and transparency, are no longer just purely secondary considerations.
Fund administrators are seeing changes as well. In the last five years LP’s have begun to perform intense due diligence on the GP’s operations including meeting with fund administrators and other service providers.The LPs want to take a look around, understand processes, get to know people, ensure there is a disaster-recovery and business-continuity plans. LPs frequently ask for a due diligence binder that reviews the service provider’s processes, controls and team.
Inability to answer a question or provide reliable information can be costly.
LPs are asking increasingly sophisticated questions about the back office. That’s not surprising given the rise of professionals at the LP who are purely dedicated to conducting operational due diligence. Limited Partners now have got dedicated people who are very experienced in that regard.They understand best practices and what’s appropriate for a firm of a particular size.A big part of their job is sniffing out back office concerns and identifying red flags. And alarm bells ring when GPs can’t answer questions directly or can’t provide sufficient data to support their answers.
LPs are going to request certain information and the responsiveness, accuracy, understanding and ability to communicate the answer is going to tell the LP quite a lot. Investors want to have confidence that the information they’re getting is reliable, that it’s accurate and timely, because they have their own constituency, their own stakeholders that demand this information.
Increased due diligence is putting a greater strain on private equity firms.
LPs are placing greater demands on private equity firms, requesting more and more information and reports. At some firms the situation is near the breaking point.
The volume of requests from all LPs is at a level previously unseen by the General Partner community. The data requests include far more than quarterly valuations, some ask for detailed metrics on every underlying portfolio company.
Some firms are so overwhelmed they’re in danger of making critical mistakes, passing along inaccurate data to LPs. One solution is to leverage technology; another solution is to outsource the back-office function to a third-party fund administrator, which firms are doing more often.
Increasingly, the CEO of a firm is making the call to engage a fund administrator, because the CEO wants that CFO thinking strategically and not chained to a desk. The CFO is stuck behind mounds of paper in their office and they’re really not able to provide the value to the organization that they otherwise need to be providing. That’s another effect that increased demand for information is having on GPs.
Checks and balances can make a world of difference.
Warren Buffet famously said, “It takes 20 years to build a reputation and five minutes to ruin it.” In private equity, where LPs have many choices, the smallest mistake can have large ramifications for the firm’s future. That’s why it’s critical for GPs to communicate accurately and honestly with LPs and make sure no errors are made when sharing data or answering questions.
You need another set of eyes—and nostrils—to ensure that what you’re sharing with LPs passes the sniff test.
Best practices involve several sets of eyes looking at important data. A GP can’t risk damaging their reputation by disseminating incorrect information. People trust sponsors to manage their money and one way that trust is manifested is in the accuracy of information LPs receive. And if there’s an inaccuracy, you can appreciate how someone could wonder, “well, if that’s not right, what else isn’t right?”
LPs and their advisory boards view third party oversight as quite positive and comforting. “It’s like having an extra set of eyes in the mix,” noted a leading private equity CFO. “In today’s regulatory world, having that independence changes the ballgame.”
Private equity firms need to strengthen their protection of investor data.
So far, the PE industry has managed to avoid a high-profile data breach. But how long the industry can stay out of the headlines is anyone’s guess.
When you consider what the industry has in their files, Social Security and Tax ID numbers, bank information, names, addresses—the industry controls lots of information.LPs and GPs are understandably concerned about cybersecurity.
It’s vital for GPs and administrators to have very significant technology investments to protect clients and their LPs.Firms have established strict procedures to safeguard client data and have enacted clean-desk policies so employees can’t leave confidential information on desktops at night.
Respond or be at risk
Most LP’s have sizable investments in public equities, registered investment companies, hedge funds and commodity pools. Over time, they have come to expect highly granular investment information about their holdings and performance, delivered to them more frequently and in a more timely fashion. These registered funds have made significant investments in their internal infrastructure and the vast majority now utilizes a third party administrator to meet the investor’s demands. Not surprisingly, these same investors are now requesting the same level of reporting from private equity funds.Private equity fund GPs need to respond. Taking a cue from the other asset classes, private equity sponsors will need to make more significant investments in their people, processes and technology as well as increasing their use of third party administrators.
About Gen II Fund Services:
Gen II Fund Services is an independent, specialist provider of private fund administration and reporting services to fund sponsors and investors worldwide. Gen II has the most experienced and best performing team in the fund administration industry, our principals founded the industry nearly 25 years ago and our performance has earned us accolades as the industry’s best performing firm.
Gen II offers our clients the best in class combination of people, process and technology, enabling GPs to most effectively manage their operational infrastructure, financial reporting and investor communications.For more information visit www.Gen2Fund.com