Life used to be so much more straightforward for private equity funds: one simple fund structure with everything done deal-by-deal. That left chief financial officers as little more than glorified book-keepers – a far cry from the current situation where they are expected to serve as everything from compliance experts to technology chiefs.
Andrew Sutton, an outsourced CFO currently working with multiple clients, sat down with EisnerAmper’s Peter Cogan and Patterson Chiweshe to discuss just how the role has changed since Sutton first became a CFO in the private funds industry in the late 1990s.
Andrew Sutton: When I was an auditor, one of my clients was a Tier One buyout fund. They didn’t have a CFO, but had a comptroller who was their former audit senior accountant. However, he was an accountant with no transaction experience whatsoever. Back then, even if called CFO, they had no true CFO responsibilities. Limited partners were simply happy the fund had a CPA in the office.
This is back when fund structures were simple. Funds literally had a single partnership and everything was transaction-by-transaction with no management fee offsets. Carried interest was paid on a deal-by-deal basis. There was no preferred return and no clawback. It was essentially: ‘We sold a company; I am sending you 80 percent; I am keeping 20 percent.’ Now, the industry has migrated to greater transparency and institutional investors have driven and standardized more beneficial market-standard terms.
This is largely driven by the increase in capital commitments, fund size and sophistication of institutional investors and their consultants. Prior, if your track record was one of nothing but success, you could say ‘take a walk’ when investor demands were too stringent.
Peter Cogan: You didn’t have the role of an outside administrator at that time either. The CFO role was really debits and credits, keeping the books of records and getting the allocations done. Investors’ questions were largely limited to ‘where’s my K1.’
The whole investor relations side entailed making sure that distribution notices went to the investors when capital calls happened and there was cashflow. You’re right: At that time it was more of a comptroller role. You typically had one of the key GPs assuming the operating partner role, making sure everything moved ahead.
Sutton: There was also the inside of the management company, dealing with the personal situations of partners, individuals who were probably already wealthy. They had certain expectations, and most had no interest in anything operational. That’s how it was in 1997 when I first became a CFO. As the youngest guy in a group of wealthy, successful people, I became the HR expert, benefits expert, IT expert, facilities expert, even the guy in charge of the office renovation. There were so many different hats.
Cogan: There was also a high reliance on the tax and audit professionals to get the right information. We assumed a component of the CFO role, even though we were the auditors, and became a key component of the relationship. On the consulting side, the typical PE funds spent their dollars on M&As. Now they’re spending the dollars on compliance.
Sutton: Those were the drivers for so much behind the tax structure. Then it began to migrate to financial due diligence. Since 2012, there has been a greater compliance burden. Firms need a head of compliance now, which is often rolled into the CFO position – yet another hat.
Cogan: There weren’t SEC requirements at the time. There wasn’t FATCA. If you had holdings of more than 5 percent, you only had to file a 13F form.
Patterson Chiweshe: The extent of the compliance function was probably limited to the K1 filing for investors, the tax matters and regulatory filings of their publicly traded portfolio companies. The regulatory environment started to change when some of the major private equity firms went public and with the advent of advisor registration.
Sutton: You can’t overemphasize just how technology has impacted the CFO role. When I first began, emails were nascent. Everybody started with QuickBooks and Excel spreadsheets. Today, several of my clients use Investran on a cloud basis and SunGard as an LP portal. Accounting systems may need to be spread over multiple locations, rather than one, which enables you to outsource the day-to-day accounting to less-expensive zip codes. For example, using an outsourced accounting firm in Manhattan is challenging because costs are very high. If outsource firms are located in Albany NY or India, the technology lets you outsource at a much lower cost.
Chiweshe: LPs are a very different bunch today than they used to be. The game is effectively the same, but their demands and expectations are more sophisticated, reflecting a maturation of the industry. When a fund is undergoing fundraising, manager due diligence is more extensive than it has ever been before.
What is interesting about the demands and investor expectations is that CFOs now need to behave in an almost concierge-like manner, an adjunct of investor relations. This creates some sort of competitive differentiation between one manager group and another.
Sutton: I oversee administrators, but also have a broader business role for my clients. The private fund industry has undergone vast change since my initial exposure as a Big Four junior accountant in 1988. My first transaction exposure was the RJR Nabisco deal won by KKR. The hostile takeover of a leading global company was unprecedented. The interesting thing about my career has been its continued variability. It really is never the same. Every day, every week and every month, something happens that is interesting and unique.
This article is sponsored by EisnerAmper and appeared in the supplement CFO 2.0: The New Frontier published with Private Funds Management in November 2017.