Private Equity Executives Under Pressure

Greater demands for transparency are placing huge pressure on private equity executives, says Ross McCann of Alter Domus.

As reporting and compliance requirements for private equity firms evolve and increase, Chief Financial Officers are experiencing a tremendous strain on their time, preventing them from focusing on their core activities of funding and structuring deals. Ross McCann discusses the challenges faced by CFOs – and possible solutions to their problems.

What do you think CFOs want to do with their time?

The CFO was traditionally someone who pulled together the numbers. Over time, however, they have become increasingly much more strategic. The CFO wants to- and is expected to- concentrate on more value-added functions at the core of private equity firm’s activity, including sourcing financing in efficient ways, structuring deals and progressing the lifecycle of investments.

The problem is, as back-office workloads increase, firms who have not yet outsourced this function are experiencing a massive drop in time available for their core functions. In fact, back-office work accounts for as much as half of both the staff’s and CFO’s time.

The heart of the problem is that largely low-value-added matters are being handled by senior persons whose expert skills are better used elsewhere. A CFO will not impress investors on back-office matters, nor will a private equity house differentiate itself from the competition through excellence in this field.

Why are limited partners demanding more?

We have seen the emergence of strong industry guidelines that were initially heavily pushed by a very limited number of big LPs, but are now becoming more widely demanded.  It is easy to understand their motivation to focus on this area, as larger portions of their portfolios are dedicated to private equity. This is due in large part to their disappointment at lower returns in other asset classes coupled with the exciting opportunities available in private equity investments.

If a large institutional LP has invested in 50 different funds, they want standardized information to help manage their portfolio efficiently. And, as these investments now account for a significant proportion of overall assets under management, better information on performance and irsk management is essential. It is a proactive approach that requires private equity executives to respond with reliable data and accurate analysis.

What kind of things are LPs requesting?

They want a breakdown of all distributions by source of value creation, such as whether it was a capital gain, for example. They also want a more granular view of the characteristics of the underlying investments so that they can know the overall exposure they have to different countries, industry sectors and so on.

Does outsourcing raise concerns about cybersecurity among clients, particularly as there is increased scrutiny of the cybersecurity systems of registered investment advisers?

Outsourcing does raise the question of how the GP and the service provider safely share data and is increasingly a key focal point of RFPs. Data security should always be at the forefront of the service provider’s thought process and throughout its internal and external processes. Strong risk management systems should be undoubtedly in place. A basic example would be appropriately restricting staff from sending any client information outside of the company network.

Do you think European clients will continue outsourcing more services?

We believe they will and that a growing number of managers will initiate outsourcing, because of the greater demands faced by CFOs and their teams, as we have already discussed. Today, 70% of private equity firms are already outsourcing a significant portion of their back-office work to third party administrator providers. And we don’t see this trend being restricted to the back office.

We are increasingly hearing from private equity houses with an interest in outsourcing parts of the middle office, such as treasury management and some investor relations processes, which have traditionally been predominantly in-house functions. In summary, it is critical to the success of the manager that the CFO has sufficient time and energy to devote to the specialized tasks that really matter.