Management companies for private funds are like a water heater or furnace, a necessity that requires care and maintenance, but doesn’t command attention until they stop working. Like so much of the industry, administering management companies used to be simpler, but with the growth of regulatory attention, LP demands, assets under management and strategic complexity, the task isn’t so easy anymore.
Which is why GPs should be aware of how much time, staff and expertise is required to service management companies today. The stakes are high, with regulatory sensitivity around fees and expenses, and investors eager for reassurance that a firm’s back office is above reproach. Debut funds may be tempted to wing it until they grow in size but waiting comes with a cost. And more mature funds should make sure their tech and processes are up to the task, not just now, but for the size and complexity of the firm’s long-term ambitions.
Fund managers have long understood the burden of fund administration and have been outsourcing to service providers, while keeping the management company books in-house. Most firms prefer to operate this lean, especially for their first few funds, and it might seem unreasonable to tap a service provider for the management company as well.
But there are risks in underestimating the burden here. Without the right infrastructure for the management company, it can court mistakes. If that regulatory filing is submitted late or incorrectly, it doesn’t just risk regulatory action, but a reputational hit that investors won’t appreciate. Especially for new firms that haven’t built trust with LPs over multiple funds.
“The focus on accurate and supportable expense allocation is higher today than ever before,” says Luis Gutierrez, a managing director with Gen II Fund Services. “That means that audits need to show everything is properly allocated. There can be tax issues as well, as an underserviced management company might not be reporting income and expenses properly.”
And there are also the unexpected tax and regulatory changes that an in-house staff might struggle to stay current with, such as when the IRS recently made sweeping reforms to how meals and other entertainment expenses are handled. Knowing about such changes is one thing. Fully understanding how they apply is another.
Gutierrez has seen instances when LPs have demanded a fund manager bring in a service provider to handle the management company, precisely to prevent these kinds of tax and regulatory problems. Management company administration might not be top of mind for investors, but that doesn’t mean it’s not an issue of interest.
“LPs want institutional grade services,” says Michael Pollack, head of client delivery and innovation at Gen II Fund Services. “And as they grow more sophisticated, they’re more sensitive to data security issues, and the reliability of the accounting package and talent.
They want real transparency into all the numbers and appreciate the neutrality that service providers can offer in their work.” LPs don’t want any surprises from that SEC audit, even if they don’t spell out their expectations around management company services.
That silence may encourage GPs to assume they can tackle the management company with the resources available. “We service clients of all sizes and strategies, and they all know how to fundraise, source deals, manage investments and even hire counsel, tax services and fund administrators,” says Pollack. “But they can underestimate the critical nature and time commitment required associated with the management company, until they realize that all the duties add up over time into a great deal of work.”
Pollack argues that the work requires a lot more staff and expertise than expected, including house-level expenses, invoice processing, bank reconciliations, travel and expenses processes; essentially all the books and records for the house-level functions. Some GPs have been known to resort to cheap solutions, believing they will upgrade down the line, but such shortcuts can be costly over time.
“Every client we have has aspirations for growth,” says Pollack. “And that means their management company has to be designed for the long-term.” But what some emerging managers might not appreciate is how big a staff can be required even during the first few years.
Pollack suggests an in-house team may need to be three to four people if GPs do it alone. “If a GP is handling their own management company, there has to be a segregation of duties, such as an accounts payable function, separate and apart from an accounting function,” says Pollack. “There have to be checks and balances, an inputter, and a reviewer, and that number only goes up with more company employees, deals to track, and assets under management.” This also requires the firm to assume the HR risks and responsibilities of that team, which can swiftly soak up the time of the internal CFO. And that’s time that the CFO can’t use to pursue more higher-level and more strategic initiatives.
Even if a firm taps an outsourced provider, it will need a financial staff in-house to partner with that third party. Service providers stress that GPs won’t have to grow finance team exponentially, but firms will still need a qualified staffer to review deliverables and help craft the agenda.
Those labor issues alone might be driving some managers to tap outside service providers as soon as possible. But even if the GP is willing to build the team internally, that doesn’t answer one of the biggest questions in management company processing: the right technology. Accounting software has been improving rapidly in speed and sophistication, with more promised leaps from AI and machine learning. That doesn’t mean any of those cutting-edge solutions come cheap or are easily implemented by a single firm.
For budget-conscious GPs, QuickBooks might seem like a short-term fix for the management company, but it’s a route rife with pitfalls. The issue is that institutional-grade technology can be too expensive for a single client to afford, leaving them to make do with a consumer option. And even if the GP is willing to pay the price, the internal IT staff will be the ones maintaining, upgrading and troubleshooting it, which should be considered part of the total price tag.
That price tag drops significantly when the institutional-grade tech is provided by a service provider, who can spread the cost across its entire client base. With regular practice, that service provider only gets better at onboarding and managing that tech, solving for the kinks or quirks that appear within the most robust systems. And the institutional-grade systems available right now have plenty to offer.
“The bar keeps rising for tech in our industry,” says Pollack. “Our dashboards offer clients real-time access to all of their data, but not merely an extract of information that a client needs to sift through. A client’s data is presented in a usable and customizable format that supports the needs of each client.”
Pollack highlights the need for data to be flexible, so it can be manipulated into bite-sized summaries, meaning the client can devote time to analyzing information instead of compiling it. “We believe that technology for management companies shouldn’t be a burden to bear, but an asset to tap,” says Pollack.
The right systems can also alleviate certain tasks that can quickly overwhelm in-house staffs. “Without a third-party system, GPs will process their own 1099s, a deeply labor-intensive process that happens in January, precisely when GPs want to devote time to closing the year-end books and planning the year ahead,” says Pollack. It’s a repetitive, low-value process that should be automated, not just to free up staff, but to reduce human error, which is all too common in tasks like these.
“If a GP is handling their own management company, there has to be a segregation of duties”
Gen II Fund Services
And this doesn’t even address data security for the management company, which can be a burden for IT staff to maintain. When they tap that third party, the internal IT staff’s initial due diligence will address such concerns once, shifting the responsibility to the service provider from that moment forward. And the service provider is driven to invest and maintain the strictest protocols and security solutions, given the reputational risk of any such breach.
If a firm finds themselves looking for an infusion of capital, they may court an anchor investor. “That anchor investor will be keen to look at the management company’s books and can be as rigorous as any SEC audit,” warns Gutierrez. “And even if the exam goes
smoothly, they may require the GP utilize an outside service provider to service the company from that point forward.”
The reasons for this include the rigor and validation that comes with a third-party provider. “Similar to our fund administration services, we have multiple layers of review, quality control and compliance checks internally for management company services, which means there are multiple eyes on everything we deliver, ensuring a clean, high-quality product to our clients,” says Dautanya Strachan, a managing director with Gen II Fund Services. And for LPs nervous about tax or regulatory flare-ups, this can offer peace of mind.
From the first swipe of a credit card
In a firm’s early days, with so much to do, it can be hard to find the time for management company matters when fundraising is rightfully front and center.
Management company needs crop up quite early, and quick fixes can plant the seeds for problems to come. “It all starts from day one, right when the firm is launched, when that first check is cut to form the LLC, or LLP,” says Luis Gutierrez, a managing director with Gen II Fund Services. “And there are real benefits to getting the management company processes set up properly from the start.”
Gutierrez argues that set-up includes such basics as a company credit card, to avoid using personal credit cards, creating a segregation between business and personal expenses. “We often have emerging managers who engage us early on in their search for a service provider. We are able to discuss their overall needs, provide them with checklist of required items and also discuss issues they may not have considered yet,” says Dautanya Strachan, a managing director with Gen II Fund Services. “We can provide assistance and guidance in a variety of areas from obtaining an EIN, to setting up a bank account. This is especially helpful to clients as many are spinning out of larger firms where such infrastructure was already in place.”
Beyond the basics, there are three elements for an emerging manager to consider in planning their management company solution: labor, tech and expertise. However, such matters remain relevant even on that sixth or 16th fund. And that’s why it can be so difficult to gauge how many staff to hire, what technology to deploy and how to manage the processes. The best management company solution will be able to grow right alongside
Never too old, never too early
More mature fund managers may balk at upgrading how they service their management company, since their approach has already worked for years. But growth brings volume, and that might eventually overwhelm the in-house back office staff, which may not get the same time or investment as the deal side of a firm – and that’s not the manager’s fault.
“Management company operations are not as core to a GP as sourcing high-quality investments and generating returns for LPs,” says Strachan. “GPs can choose to run their management company operations in-house, but as scale and complexity grow, the time and energy required to properly run those operations start to compete with higher-priority items. This competition for time often leads to errors or missed deadlines.” And there’s no guarantee that a missed deadline or dropped ball won’t court blowback from LPs or regulators.
Older firms might also be wrestling with legacy technology or labor-intensive processes that rely on the likes of Excel to handle their management company. The older the firm, the longer the paper trail will be. And that means even if the GP is open to upgrading its processes, it is going to take longer to migrate all that data into the new system. Service
providers report having to often use forensics to map their way through old records.
It doesn’t mean that more mature firms should shy away from upgrading, as the process may involve more time and attention, but is still viable. “The longer you wait, the more expensive it will be,” says Pollack. “Conversions are hard and costly, and a prime example of where a GP doesn’t want to spend their time.”
That is why any shortcut taken today will eventually have to be paid for tomorrow. GPs may still prefer to handle their management company internally, but the standard of care is only rising, as LPs and regulators have less patience for error or informal processes. And that takes time, money and even creativity that could be applied to the firm’s central focus: delivering outsized returns.
The same investors clamoring for administration beyond reproach aren’t lowering their expectations for the bottom line anytime soon.
GPs readily accept outside tax and legal expertise, but the service providers for today’s management companies also offer a wealth of experience in their discipline.
“We have clients at all stages of maturity,” says Michael Pollack, head of client delivery and innovation at Gen II Fund Services. “And that allows us to leverage the experience of long-tenured clients to those younger managers who are on their first or second fund but want to be ready for their 12th.” Also, service providers will strive to deliver more sophisticated analysis and budgeting, cash forecasting and the like, as the client’s business becomes more complex. It’s not just manpower and tech, but the skills that come from mastering this particular element of the business.
Still, some GPs might be eager to stay lean, and muscle through the management company work in-house for the first few funds, assuming they can upgrade at some point in the future. But that may not be sustainable for reasons that have nothing to do with staffing or tech.