Get the CFO involved when plotting new strategies

CFOs need to have a nose for new strategies. In the pfm/SANNE CFO Survey 2018, 22 percent of respondents said they were launching a new fund with a different strategy than their firm’s heritage. Of the top reasons for doing so, it came down to pursuing sector specialization (34 percent), a need to grow AUM (28 percent), investor demand (18 percent) and firm diversification (18 percent). But it also raises the question: how many of these firms are staffing up for those new strategies?

In that same survey, over 55 percent of respondents were planning on hiring one or more staff members for the back office. That can be a testament to the growth of alternative assets overall these days, but it raises the question of how many of those new hires are in the service of new strategies? As firms move into credit and real estate, or expand their investment focus, don’t they need more, or different, people to serve those vehicles?

Of course, that depends on a number of factors. But the first rule when considering a new strategy is that the CFO needs to be part of the conversation from day one. This allows for long-range planning, which can help in the selection of staff and service providers. For firms moving into new asset classes, they need to review service providers’ capabilities, technology systems and compliance needs to choose the right mix of the resources. Often new kinds of vehicles need new IR staff.

But when firms are changing things up within the same asset class, the resources may not change much, and there’s an argument that small firms should be careful in bulking up, either with cutting edge technology or higher end service providers.

No matter how radical a departure the new vehicle may be from the firm’s traditional mandate, the CFO needs to be part of the conversation as early as possible. In small firms, that may be easy, given how flat these organizations tend to be, but as firms grow, there’s a greater chance the deal team brainstorms and evaluates strategies without the CFO in the room.

The veteran mid-market firm The Riverside Company has a novel way of making sure that doesn’t happen, even as it moves into credit and hybrid vehicles. The founders named their COO, Pam Hendrickson, chairman of the new products committee. “So, the back office is there from the very beginning,” says Hendrickson. Even if a move to real estate or credit is years away, a firm’s leadership needs to share that with their operational leaders.

“We plan our resources well in advance of our activity,” says Jon Schwartz, CFO/COO of New Spring Capital, a firm that manages four strategies with over $1.7 billion under management. “We share resources across all those strategies, so our hiring today isn’t just for the current fund, but for where we’re headed in the years to come.”

But firms don’t always evolve according to plan, so if a new strategy or product suddenly makes sense, the CFO will have to discern what it takes to support that, which involves looking at current staff, technology and service providers. But for larger firms that have an extensive operational staff, it may be easier to pursue new directions without massive additions.

“We started out with a good [operational] base and infrastructure, so it wasn’t hard to decide what additional staff and support we needed,” says Hendrickson. Over the last six years or so, Riverside has expanded into non-control, credit and hybrid equity/credit funds. “For our credit effort, we added a few people who knew that world specifically, with regards to reporting and handling transactions,” says Hendrickson.

Different appeals

Different strategies will appeal to different investors, and a lot of GPs will bulk up their IR team with professionals that understand the universe of LPs for the new vehicle. “As we have been diversifying products we are also diversifying out investor base and have thus added some staff to our fundraising function as well,” says Hendrickson.

But the resources aren’t limited to internal hires. Hendrickson brought in another group to handle the agency side of the credit offering, as their current fund administrator was relatively new to the space. And when New Spring moved into mezzanine, they outsourced some of the work because it was a regulated entity with unique compliance needs. “We felt that it was worth tapping their expertise on that front,” says Schwartz.

New regulatory needs will often drive the hunt for new service providers. For example, one GP hired a custody agent for their new credit offering. And with regulators paying close attention to alternative assets these days, few GPs are looking to cut corners on compliance work.

Technology systems may need to be upgraded or changed in administering a new asset class, but given the tendency to outsource some element of fund administration, service providers will often maintain a relevant system. Several CFOs mentioned that new kinds of investments are a great opportunity to vet current technology solutions.

While there’s a focus on making certain the firm has sufficient resources, GPs still prefer to operate as leanly as possible. One GP explained that often they’ll err on the side of close relationships with service providers, rather than hiring new full-time staff.

For small firms that may be changing up their strategy over their first few funds, they shouldn’t pursue the same route as larger, more established players. Delos Capital is in the midst of raising their second middle market fund, and has broadened its investment focus to be more opportunistic, instead of tightly sector focused, although it continues to favor industries where it has a track record like industrials and chemicals.

This shift, though slight, still required some operational changes. “That shift forced us to upgrade operational performance and demand more from our legal and tax advisors as well as our fund administrator,” says Sanjay Sanghoee, the COO/CFO of Delos. “They had to look at these atypical deals and find the best structures and processes.” Sanghoee recently hired a former E&Y auditor as a controller, but that was his sole hire. He did tap a new outside compliance firm, ACA, to add even more rigor to their own processes.

But he’s stayed with his same fund administrator, FLSV, as they have a successful track record serving mid-market private equity funds like Delos, and FLSV has gradually become a de-facto extension of the Delos team itself. And while he has explored new technology systems, Sanghoee hasn’t pulled the trigger on any just yet.

“If we were managing 50 deals, we’d need a way to automate some functions, but for a firm our size, some of this technology could actually make us inefficient as we end up spending more time managing the systems rather than focusing on the portfolio companies themselves.”

Quarterly update

This includes generating a 50-page quarterly update for LPs. Sanghoee doesn’t do this alone but has input and help from the deal team. “We’re a very flat organization, and our LPs appreciate that everyone on our team plays an active role in reporting,” says Sanghoee. As Delos grows and changes, this hands-on model may not last, but for now, it works for them.

Going forward, GPs will likely continue to diversify, but as this becomes more common, there will be more support and standardized approaches. Service providers will adapt to expand their services by building up their own resources or acquiring smaller firms.
After all, FLSV was recently acquired by SANNE. Perhaps by the time Delos is ready to launch their first credit fund, FLSV will still be the one-stop shop they need in the future.