DATA SNAPSHOT: CFOs cold on automated waterfalls

We surveyed a small sample of CFOs and found that most aren't too keen on automated waterfall calculations. Here's why.

Using an automation system to calculate waterfalls is something that causes some hesitancy among private equity firms, despite there being a number of service providers that offer this as a product. We surveyed 15 chief financial officers and found out that only 20 percent use some sort of service provider or software for automated waterfall calculations.

“I’m not sure an automated system buys you much, except as support for the Excel waterfall or maybe vice-versa,” one CFO said.

The CFOs cited multiple reasons for not hiring a service provider. One reason that came up several times was the fact that their firms have complicated waterfalls.

“I would love to find a solution,” one CFO said. “However, I have found that the waterfalls have gotten so complicated that I don’t know how you would ever program all the steps in a system. Almost every time we run one in Excel it needs a new tweak. Our current waterfall, besides the routine ‘steps,’ also has a [minimum] fee giveback test and a waiver giveback test.

“We also have something called a distribution advance where the GP can forgo its carry distribution and instead distribute to the LPs. And it’s been my experience that no accountant ever completely trusts a system, so most likely you would need something in Excel to be sure the system is calculating correctly.”

Cost was another factor that firms took into consideration. The same CFO mentioned using an accounting system that was an industry leader three years ago, and said they were interested in working with the same programmers to build a waterfall in the system. However, they were put off by the fact that the cost would have been $40,000, and also because the third party couldn’t provide a reference from another firm using their waterfall system.

Cost can affect a PE firm’s decision when it comes to even considering automated waterfalls as a solution. “This is something we can do on our own, and if it were inexpensive it would be something I would then consider,” another CFO said.