An integrated approach to outsourcing

GPs may appreciate the value of outsourcing, but they want service options that are integrated with their own operations as possible.

The initial promise of outsourcing was simple and compelling. Pay someone else to tackle the basic administration tasks so that the firm is free to focus on investing and other higher-level strategic concerns. But CFOs have always been reluctant to surrender their data. Part of the compromise was also using the service providers’ systems, which while offering efficiencies and rigor, still required CFOs to shape their processes around the service provider, not vice versa.

However, those days may be coming to an end. The outsourcing boom of the past decade was driven by the massive increase in regulatory requirements and LP demands, but that also fueled the launch of a parade of new providers, with a more tech-savvy offering, with greater flexibility in tailoring processes and systems to the client.

Now there is a rise in co-sourcing where the work doesn’t move out of the client’s office, but the service provider moves in, using the firm’s systems and their own expertise to act essentially like another internal employee. Even in traditional outsourcing, service providers are striving to provide more access, flexibility and connectivity across platforms.

One thing that’s certain is the next era of outsourcing will be far more competitive. GPs are poised to enjoy better options and change providers more easily. In co-sourcing, there’s no need to do a cumbersome data migration project to work with a new provider. They simply need to swap out that provider, because the systems can stay the same.

Regulatory demands

As much as the exact nature of outsourcing may be in flux, more GPs are still looking to offload activities. Private Funds CFO’s recent Insights Survey notes that more than four in 10 firms reported that they plan to increase the outsourcing of IT, tax, fund accounting and compliance. In the case of compliance, the share of GPs planning to increase outsourcing grew from 27 percent last year to 40 percent now.

So, it appears regulatory demands are still fueling the boom. “As an industry we’ve been fortunate to have third party pressures, from investors and regulators, driving private equity firms to outsource,” says 4Pines Fund Services CEO Mike Trinkaus. “But no one can pretend that they’re outsourcing because they’ve got great partners that will help them bring forward the most automated, integrated, technologically advanced operating model. They’re outsourcing because they feel they don’t have a choice.”

Even today, though, there are a few firms that have resisted the trend. “We’re fully self-administered except for regulatory filings for our SBIC Funds,” says Mike Kubacki, the CFO of NewSpring Capital. “And we’ve been doing that for over 20 years, including the 11 years I’ve been here, working up from controller to CFO.”

Kubacki’s rationale has been that he is reluctant to give up control of their data. “We do get due diligence questions from LPs about this approach, as some prefer third-party validation, but they quickly get comfortable around the rigor of our internal staff.”

Nevertheless, the trend is certainly toward outsourcing more and more. Even longtime naysayers are finally relenting. Amy Stremmel, the CFO of HCI Equity, says: “We finally outsourced about two years ago. And that was for three reasons: the management of finance team composition as internal roles evolved; succession planning; and access to an expanded knowledge base.”

Stremmel notes that it has been a successful initiative, although she had to accept that the service provider wouldn’t be as swift at certain routine tasks as the internal team, but the quality control has made it worth it.

Relationship woes

GPs have long accepted such trade-offs. “I can pick and choose the specialized expertise, without having to manage any of the human capital issues,” says Kevin Gasque, the COO, CFO and CCO of Greycroft Partners. However, GPs may be accepting more trade-offs than they would like, simply due to the burden of switching providers.

“I’ve certainly seen instances in my career, where we’ve had really bad fundamental relationships, where we’ve ultimately decided to stick it out with because the pain and suffering of switching just felt too high,” says Gasque. “Because suddenly someone will have to own any problems that arrive during the transition to a new provider.”

And the chances of such problems arising are more than likely.

“Let’s say a firm’s been working with an administrator for six or seven years and have developed some quick trigger reports and other efficiencies,” says Trinkaus. “But the firm isn’t satisfied, so they choose a new provider. That old provider will share all the pdfs and Excel files, but the firm will be left supervising a massive data migration project and having to rebuild all those custom reports.” And given the human element involved, there’s plenty of room for errors along the way.

Yet, some GPs find that risk worth taking, especially if there is a provider that offers something worth the trouble. And given the boom, there’s plenty of new alternatives for a dissatisfied client.

“We recently switched administrators because they have a tech platform and services more tailored to what we do,” says Jeff Schneider, the COO of Victory Park Capital. “They have a fund allocation tool and loan administration services that better fit a credit fund, and as a firm that does mostly credit, it made a lot more sense to us.”

Better accessibility

Technology is such a core part of the outsourcing value proposition, that tech providers have been moving into the fund administration business for years. “Traditional software companies are moving into service because it feels like a natural extension of what they’re doing,” says Gasque. “And what they’ve been doing for the last several years is innovating to meet GPs’ desire for better accessibility to their data.”

To be clear, “better” accessibility does not mean the GP can download a quarterly report and find a data point from a particular portfolio company. It’s about integrating the firm’s entire data ecosystem.

“As an industry, we really need to find a way to move data across multiple platforms,” says Trinkaus. “So that if the firm has 10 different platforms, we can connect those platforms so data can flow seamlessly between them. We aren’t there yet, but it’s a goal.”

This doesn’t mean technology makes the service element any less relevant. “The real winners in this industry will be the ones that can apply cutting-edge technology in a financial services context and add highest-quality service to help the client make better use of that technology,” says Suresh Krishnamurthy, head of client solutions, SS&C GlobeOp, private markets at SS&C Technologies.

But Krishnamurthy argues that one of the blind spots some clients still have is expecting a service provider will simply be an extension of their staff. He says the role of the provider is to find ways to optimize the business and help the client make necessary changes to do so.

“Client relationships are vital, and this is a very high-touch business, but we aren’t there simply to do things as the client has been doing for years. We’re there to make those processes even better. That means the client has to be open to change.”

That said, it is only natural that as the market gets more competitive, new players will be looking at addressing more and more of clients’ pain points. The latest innovation co-sourcing, which is becoming quite popular.

“Co-sourcing is essentially no different from hiring an individual, but not having them as an employee,” says Kubacki. “In traditional outsourcing, we’re handing the process and the mechanics to someone else to manage, but in co-sourcing for us, we’re giving the service provider a license into our accounting system, and they work just as we do or on what we want them to work on as if they were an employee.”

Shifting incentive

In some cases, the co-sourcing provider can implement an upgraded tech stack, but with one key difference. “Instead of us licensing directly from the software provider, the GP would license directly as our client,” says Trinkaus. “And then we’ll come in and build out all of the accounting infrastructure, back-office infrastructure, including investor information management, capital calls, financial statements, etc.” But that infrastructure is housed with the client, not the service provider, so a GP won’t need to migrate data to a whole new system if they choose to switch vendors.

Trinkaus explains that traditional outsourcing worked well for service providers, as they made it hard to switch to a new provider, and easy to hide turnover, given the work was siloed from the client. “But we believe we deliver enough value that we’re willing to shift the incentives here.

“We sit between the software companies and the client and are able to tailor the tech to the unique structures, processes and systems for that specific client. It’s a win for them, and in the long term, that’s a win for us.”

It’s compelling enough that it has caught the attention of longtime skeptics like Kubacki: “There is always a chance that we may grow faster than we can get people in the door to handle the work. So, we are exploring co-sourcing arrangements, precisely because we wouldn’t need to be on their systems or utilize all their services. This is really about controlling our data and finding a provider that’s flexible to do things the way we want them to be done.”

Not every CFO may prize control enough for a co-sourcing arrangement, but every service provider is aware those third-party pressures to outsource are leading to a more competitive market.

“We’re seeing lots of new entrants, and some of them backed by private equity dollars, so we’re aware how competitive the market is becoming,” says Krishnamurthy. “Some might become regional players or pursue a niche strategy, say, around private credit. Our clients are evolving, and we have to evolve to meet their needs, with the acceleration of new smart technologies, like generative AI. And that’s what the very best service providers will do.”