This article is sponsored by Alter Domus, Qashqade and Withum.
The fund administrator M&A merry-go-round has been spinning for a few years now. With scale being such an advantage for the service providers – more product offerings, more geographies covered, more dollars to spend on technology – the impetus for the industry’s key players has been to get big quickly.
General counsel and chief financial officer, Victoria Capital Partners
Dalmau Garcia joined in 2012 to lead Victoria Capital Partners’ administrative office in New York. Focused on investments in South America, it has offices in Bogota, Buenos Aires and Sao Paulo.
CEO and co-founder, qashqade
Oliver Freigang helped found qashqade, a Zurich-based fintech start-up, in February 2018. Freigang spent much of his prior career in wealth management, including leading the carve-out of the business he ran at UBS into a private equity firm as its CEO
Managing director and head of US, SwanCap Partners
Aaron Witte joined SwanCap Partners, a Munich-based fund investor in 2013 as a senior investment director. At SwanCap, Witte focuses his practice in primary fund investments, direct equity, co-investments and secondary investments.
CFO and CCO, Sandton Capital Partners
Dimitri Korvyakov joined Sandton Capital Partners in 2012, where he specializes in distressed investment opportunities in the US and Western Europe. Prior to joining Sandton, Korvyakov served as a fund controller for The Rohatyn Group.
Managing director, Alter Domus
Sean Reilly is a managing director at global fund administrator Alter Domus, which acquired his previous fund administrator, CARTA Fund Services, in May 2017. Before moving to the fund admin world, Reilly served as CFO of Hudson Clean Energy Partners, and has worked at firms such as the Blackstone Group and Credit Suisse.
Practice leader of financial services group, Withum
As a CPA, Thomas Angell has spent the last four years leading Withum’s financial services practice. Prior to this, he was an alternative investments partner at KPMG, as well as principal at Rothstein Kass & Company, where he spent 30 years at the accounting firm.
CFO/COO, Delos Capital
Sanjay Sanhoee is chief financial officer and chief operating officer at Delos Capital, a lower-mid market PE fund based in New York City. Delos focuses mostly on industrials, manufacturing, chemicals and similar businesses but also owns a chain of fitness clubs and is rolling up large scale US flea markets. Sanghoee has a background in investment banking from Lazard and Dresdner and an MBA from Columbia Business School.
Conventional wisdom suggests that as size increases, service levels suffer. A conversation between four CFOs and three service providers in New York in late October suggests the real picture is not as simple as that.
“We have sort of gone through that cycle within the last couple of years,” says Sanjay Sanghoee, CFO and COO of lower mid-market private equity firm Delos Capital, noting that his fund administration partner was recently acquired by a larger operator.
“As they merged into that entity, some elements of the service changed for the worse,” he adds, noting that the outsourcer’s global reach immediately increased, but the nature of his access to the most senior people changed.
Yes, he still co-ordinates closely with them, but they themselves have bosses elsewhere and there is definitely some inefficiency at the parent level. “So that does create a little bit of a disconnect. Nothing that we’re not able to work through, but it is the reason we went with a boutique fund administrator in the first place: to get personalized attention and not to have to deal with big corporation dynamics.”
Dimitri Korvyakov, CFO of Sandton Capital Partners, notes that mergers are a double-sided coin: “When the fund admin merges, you definitely expect more investment in technology, better global reach and more availability of people. On the flip side, you expect your team not to change. The biggest fear when fund admins merge is the turnover.”
It’s the same basic fund administration team as before, says Sanghoee, but they are suddenly tending to 20 rather than 10 clients. “So they can get stretched pretty thin in terms of manpower,” he says. “The biggest drawback to these mergers, I believe, is the transition from a flexible and responsive fund administration SWAT team to a somewhat plodding corporate machine.” Aaron Witte, managing director and head of US for alternatives investor SwanCap, says his firm has just undergone a switch of administration partner. As a fund of funds, co-investment and secondaries investor, SwanCap required “a degree of specialization,” he says.
Having found a suitable specialist, he does not want to see a hunt for scale derail the relationship. “You understand the need for scale, but by the same token they still need to adhere to our needs; we have a very high velocity investment strategy – a lot of cash inflows and outflows, a lot of reporting requirements considering the size of our platform.”
Scale, asserts Korvyakov, has its benefits: “A significant advantage of such mergers – if it brings a global footprint – is that it feels great when you put a request in to your fund admin and by the next morning when you come into the office it is available, because somebody in Asia or in Europe was able to work on it overnight. You can communicate with your LPs faster. They are impressed; we are impressed.”
Victoria Capital Partners is a private equity firm that invests in Latin America. Its CFO and general counsel Dalmau Garcia says consolidation in the fund administration market has benefited his firm by keeping its outsourcer – a bulge-bracket bank – on its toes: “What we have seen in the last few years is that they have reacted to the consolidation from the independent providers – whom they see as a threat – by improving their service offering.”
Clients at the core
As a managing director for private equity fund services at Alter Domus, Sean Reilly is equipped with intimate knowledge of the consolidation in his sector. “My former boutique PE fund admin was acquired by Alter Domus and it’s worked out well for us,” he says, noting that the outcome from M&A is generally beneficial if the rationale for the deal always has client service at its core. “That transaction probably shouldn’t happen unless it will enhance the client service offering and delivery model, in our opinion. Expanding service into a strategic geography, adding complementary products or services like an AIFM [Alternative Investment Fund Manager], and acquiring or advancing technological capabilities all fit into this mold.”
When the primary motivation for M&A is to provide immediate revenue growth and an expanded footprint, Reilly continues, the client service suffers. A GP doing due diligence on an administration partner should delve into its M&A history, he adds: “How did the deals work out? Speak to clients that remained with the fund admin both pre and post and ask them how the transition went; what was the communication like and did everything they promise come to fruition?”
At this point in the conversation, the CFOs around the table start swapping notes about customer service nightmares. Sanghoee laments the fact that as a client you can find yourself speaking to someone who can’t fix whatever you want fixed. “When you start getting into that, it’s like you’re dealing with AT&T or Verizon; you’re dealing with these mega corporations where you can’t get the right person on the line.”
So if a CFO hits service levels that don’t cut it, how likely are they to switch? The question is posed by Oliver Freigang, co-founder and CEO of qashqade, a two-year-old fintech start-up that allows private equity and other alternatives managers to calculate their waterfall and carried interest in a fully automated system rather than an Excel spreadsheet.
Freigang disagrees with the notion that round after round of industry consolidation among fund admins is leading to increased technology investment to the benefit of their clients. “There is a huge amount of consolidation going on, which you are all experiencing as clients, but I disagree with the idea that they have invested a lot in technology. That is coming; they are starting to catch up and will continue for the next few years.”
In the meantime, asks Freigang, “what’s keeping you from moving to a new administrator?”
The answer to that question is bandwidth. “It’s not easy to change,” says Garcia. “It’s costly. From a CFO’s perspective, it is about the time.”
That stickiness is not just the administrators, adds Witte. “It’s any of your outsourced providers.” His firm’s recent switch of outsourced administrator was “a big effort and not taken lightly.”
Sandton would consider switching administrators, says Korvyakov, under two circumstances: if its entire client team changed as a result of an acquisition, or if its fund admin partner stopped listening to its concerns. “I need to be able to say I’m not happy with something. And if I see no reaction on the part of fund admin, it means that they have become too big or we have become too small for them.”
On the topic of transitioning from one admin to another, how – when SwanCap switched – did the firm manage to keep the outgoing administrator motivated to play their part in a complicated and risky process? It is a question of reputation, says Witte.
“They pitched hard to maintain themselves as our administrator, but they couldn’t offer the same level of service,” he notes. “I think they understood that the decision was a rational one and we weren’t trying to be contentious about it. So if they made our process difficult – that would get out and it would not be in in their interests.”
qashqade’s Freigang agrees: “I think reputational risk is significantly higher in this industry than in others. Even though it is a big industry in terms of volume of money, it is a small one in terms of the people. It is difficult for a new kid to get in – the sales cycle is long – which explains the stickiness of relationships. But an administrator could burn itself very quickly if it made its outgoing clients’ lives difficult.”
Sometimes the client doesn’t get the response they want from an outsourcer. This was Garcia’s experience with one of Victoria’s fund administrators. When he wasn’t getting the attention he required, he started making waves. “I called the CFOs from other firms that were clients of the bank. That really got their attention. All of a sudden, they must have felt like it was a fire that needed to be put out quickly before the whole forest burned down.”
“The problem was,” says Tom Angell, financial services group practice leader for advisory and accounting firm Withum, “that the [administrators] team didn’t realize there was an issue until you called the CFO. There should be a culture of not tolerating errors. Our firm understands that we can’t add new clients unless we are convinced that we can continue to serve our current clients in addition to the new clients we bring in.”
When Reilly’s former employer, Carta Fund Services, was acquired by AlterDomus in 2017, Reilly and colleagues heard a common refrain from their clients: “In discussions with our clients when the transaction was announced, every one of them – just like you guys – said, ‘Congratulations. We are happy for you, but we want our teams to stay intact. We don’t want any turnover or client service levels to dip over time.’”
Staff turnover, however, is a fact of life and service providers need to work around this.
“In CPA firms,” says Angell, “turnover – particularly at the large firms – is anywhere from 15 to 20 percent. Ours is low at 10 percent; but it is still 10 percent. So we have to set client expectations that, yes people get promoted or they change careers, so your team will change. But the main point of contact should remain constant for a long period of time and client service will never suffer.”
Where is my data and is it safe?
The proliferation of outsourcing and cloud-based systems means that – when it comes to the security of sensitive data – this is only as strong as the weakest point in your outsourced network.
Says Angell: “What we have noticed in the market – with smaller funds especially – is that they are relying on all the outsourced service providers to have appropriate protections against data breaches. Their own systems that connect to the outsourced systems aren’t as protected. Our firm has a cybersecurity team that will perform a penetration test on the fund’s systems to see where the potential weak points are and to make suggestions as to how they can be remedied.”
Korvyakov’s experience is that service providers are sometimes behind his firm when it comes to the rigor of their cyber-risk management. “We would expect the fund admin to be a little ahead of us – not behind – in the area of data protection. Unfortunately, we occasionally experience the opposite of that.”
Sanghoee says he would like to see admins taking a proactive lead in cyber-risk: “It’d be great if fund administrators in general were to actually tell us what we need to know and what we should be doing.”
Cybersecurity was not formerly high on fund administrators’ list of selling points, says Alter Domus’ Reilly. “I don’t think fund administrators in the past have done a very good job of incorporating IT security – data security – conversations or personnel into their sales processes,” he says. “I think now what we’ll start to see – and I know we are doing it – is fund admins proactively demonstrating their understanding of the GP’s perspective on these issues, and not just forwarding IT documents as has been past practice.
“What I haven’t seen much of yet is clients asking: what happens when there is a breach? What is the incident response program at a third-party administrator? Your data is everywhere now; it is on your internal networks, it’s on your fund administrator’s cloud; it’s on the audit and tax folks’ cloud. You need to understand how that data is being protected, especially if you are the chief compliance officer.”
Limited partners are now taking a more thorough approach to operational due diligence. How often do they end up probing the third-party relationships? “We receive requests from large LPs about how we protect our data,” says Angell.
“They are reviewing our data security documentation and protocols to make sure we are compliant with current security standards.”
“We welcome our LPs to reach out to our fund administrator as well as the auditors directly,” adds Korvyakov. “It’s a chance for our LPs to do DD, but also a chance for the fund administrator to understand what the LPs require from us and the wider private equity industry.”
Korvyakov draws particular attention to SSAE 16 certification: “Many LPs are asking about it. It gives a little more confidence in the process at the fund administration level.”