Private equity chief financial officer is a role that seems be constantly expanding, with an egrowings list of fund administration responsibilities falling in its purview – from tax and portfolio reporting to responding to LP demands.
They can no longer handle all these tasks on their own and need to choose between hiring internally or outsourcing specific functions. pfm gathered two CFOs and two fund administrators in New York in October to discuss how a CFO can address private equity fund administration in 2017.
“The CFO role has evolved immensely from when I started talking to CFOs in the community 15 years ago,” says Jeff Gendel, a managing director focused on business development at fund administrator Gen II Fund Services.
“As the private equity business has matured, the importance of the CFO role has grown – many CFOs are now partners that receive carry and have a far broader mandate. We’ve certainly seen a shift over time, with CFOs that are more actively involved in the strategic planning of the firm and some that get involved in helping portfolio companies.”
In the past few years, the tax function has also grown significantly and added complexity.
Josh Cherry-Seto, CFO at Blue Wolf Capital Partners, explains that his firm has become more involved in flow-through investing, which has resulted in a number of administrative implications.
“There are significant tax compliance and co-ordination complications associated with that,” he says. “There’s a lot more talk, not just about the financial administration.”
Having to handle such tax-related demands on a more regular basis has demonstrated the need to have a person dedicated to the issue, and has led Cherry-Seto to explore how he could “drop somebody in who looks like they work for us while sitting on the other side of the fence.”
“Maybe there need to be more specialized services,” he says. “Maybe you don’t find an administrator who’s broad enough to service that. I tell people middle office employee number five is going to be a tax manager because so many issues are coming from there. You would have thought me crazy just 10 years ago.”
Tax is a function that fund administrators have not yet fully figured out yet, despite its growth.
“Tax is such an interesting and complicated component in the alternatives world, because there are real return on investment consequences if you don’t understand the investment structure,” says Michael Trinkaus, regional executive for North America and country executive for the US at fund administrator AlterDomus. “The dollar amounts at stake are often meaningful and it’s critical that you get it right from an operations perspective to uphold the integrity of the investment structure.”
CFOs have also received mounting inquiries from limited partners on fees and transparency – via the Institutional Limited Partners Association fee and expense template – and on portfolio company monitoring.
With the release of the ILPA fee template at the beginning of 2016 and the wider adoption from LPs, GPs are having to collect more data and communicate it to their investors. But the broad approach of the template, which some see as a long list of requests for data without any description of the concrete intent behind the collection of information, has created challenges for GPs.
“It’s just a kitchen sink approach of blending everyone’s individual requests without enough focus on what the data is used for,” says Cherry-Seto. “What question are they trying to answer? What is an affiliate? They would cause us to answer the questions differently, without which the data is misleading. Transparency is important to us as GPs, but transparency is providing insight – not lots of data without context.”
It can be particularly difficult to adopt for older funds. “The amount of information per portfolio company and the amount of reporting on fees and expenses can be significant when you are thinking of adopting the fee template for an earlier vintage fund with several years of capital activity and numerous portfolio investments behind it,” says Dalmau Garcia, general counsel and chief administrative officer at South American-focused firm Victoria Capital Partners, which has adopted the ILPA fee template for its most recent fund.
For lower mid-market funds with a dozen or so of portfolio companies, it does not always make sense to automate the data collection for the ILPA template through technology. This is also true for portfolio monitoring.
“Trying to standardize portfolio company reporting into a one-size-fits-all iLevel spreadsheet or model can be counterproductive, disproportionately time-consuming, and inefficient when you are trying to do the standardized reporting for a relatively small number of companies, especially when those companies have different accounting standards,” says Garcia, pointing out that Victoria has about a dozen active portfolio companies throughout Latin America.
As portfolio company monitoring places more demands on CFOs’ time, the role of fund administrators is growing for basic functions.
“Many CFOs are being asked to focus more on the underlying portfolio company in addition to the fund’s accounting needs, in part because of the demand from LPs regarding portfolio company performance,” says Gendel.
“That leads to a refocusing of the team on the tracking of portfolio company data and a desire to have an experienced fund administrator support the CFO and their team in the administration of the fund. We see this trend as one of many drivers of the shift to a third-party administration model.”
Outsourcing to fund administrators can address some of these demands, especially for functions that are less specialized. Hiring internally can be challenging for some lower mid-market and mid-market firms that find it hard to retain talent in the current tight labor market.
But outsourcing also comes with its own challenges.
“For most firms of our size, I think LPs prefer if we outsourced the basic fund administration function, but at the same time, you can’t be fully outsourced especially because of fund administrators who have huge turnover,” says Garcia.
“It’s very difficult when you have fund entities and/or portfolio companies that are so tailored – you need to have the same person or team following specific funds and companies, or at least you need to have processes so the next person can take over relatively seamlessly.”
AlterDomus’s Trinkaus, for his part, acknowledges that addressing turnover in the industry has been a big focus for AlterDomus.
“The key for us has been our strategy of building each team so that they resonate from a career perspective internally as well as with our clients from an execution standpoint,” he says. “Without both parties buying into the model, it doesn’t work. This idea of fitting people in a box is gone. The market is shifting away from a big bank fund administration model. Specialty providers like AlterDomus have changed the expectations of GPs as the market is shifting from a back-office model to outsourced partnership providing value across the operating chain.”
The CFOs and fund administrators gathered for this discussion agreed that technology will eventually help address many of these challenges, but it’s still early days for that.
“The technology piece is in a massive transition,” says Trinkaus. “This is one of the big reasons that GPs are strongly considering outsourcing. Many have grown up significantly over the last decade or so and have come to realize the mosaic nature of their technology platform is not the most efficient way to integrate their organizations. As a result, GPs are leveraging our expertise on the operations side to help solve some of their technology issues.”
AROUND THE TABLE
Josh Cherry-Seto is the chief financial officer at New York-based Blue Wolf Capital Partners, a lower mid-market special situations US buyout firm with about $1.2 billion in capital. Blue Wolf manages challenging situations and complex relationships between business, customers, employees, unions and regulators. Cherry-Seto previously served as a portfolio and finance manager at Grove International Partners.
Jeff Gendel is managing director of Gen II Fund Services, a New York-based independent fund administration firm overseeing $165 billion of capital for more than 95 sponsors. In addition to New York, Gen II also operates service centers in Boston and San Francisco. Gendel is responsible for business development for Gen II. Before joining Gen II, he was head of business development at PEI Media.
Dalmau Garcia is the general counsel and chief administrative officer at Victoria Capital Partners, a private equity firm focused on investing in South America, mainly in Brazil, Argentina, Colombia, Peru and Chile. The firm has raised about $1.8 billion in capital through two private equity funds and several co-investment vehicles. Before joining the firm in 2012, he was a practicing attorney at Cleary Gottlieb Steen & Hamilton.
Mike Trinkaus is the regional executive for North America and country executive for the US at AlterDomus, a fund administrator with $160 billion under administration. He was previously chief executive officer of CARTA Fund Services, which AlterDomus bought in February, and earlier in his career served as CFO of Portfolio Advisors for eight years.