This year’s Private Funds CFO Insights Survey, conducted in partnership with TMF Group, paints a picture of a booming industry. More firms are fundraising and fund sizes are getting bigger. The flipside is that the back office is under more pressure than ever before, particularly as investors are becoming increasingly stringent in examining every aspect of how a GP operates.
We brought together five leading back office experts to discuss how CFOs can optimize their performance during this hectic period. In reviewing the survey results, our panel agreed that technology and automation will play an important role, while the model of outsourcing non-core functions to fund administrators will continue to grow in popularity.
What is responsible for the growing pressure faced by CFOs?
Kwame Lewis: More funds are being raised and pricing is very competitive. What does that mean? It’s more work for the back office! CFOs need to get a lot of things done with limited resources, given the continued pressure not to increase the back office headcount too much, even though the work continues to increase.
Obviously, fund administrators like myself can step in to help, but we can only do so much. You still need people in-house to guide the deal guys, handle investor requests and manage the fund in general. The survey responses show that a permanent CFO is still considered the most important back office function by investors.
“People overestimate how automated their organization is”
Blinn Cirella: As far as investor requests go, the struggle for our team – because we’re very small – is institutionalizing the process. We constantly have bespoke requests – one institutional investor might want their own form filled out; another investor might need us to log into a portal and populate a bunch of information; then another investor might send us an Excel spreadsheet that we’ve got to upload to a data collection site.
I’ve been thinking about how to institutionalize the process and come up with one standard set of data that supports all investor requests. But it’s very difficult because everybody wants the data sliced and diced in different ways.
It’s a matter of working these requests into our quarterly closing process – and that can sometimes feel a little overwhelming because, as I say, we’re a small team with a lot of stuff going on.
Craig Friou: Our investor requests are pretty extensive. Sometimes – it’s usually not our investors directly, but their advisers – it’s easier for them to push that workload on us, and we try to politely but helpfully push back in those cases.
We try to explain to them that they actually have the data already and they can slice it however they want. It’s like teaching a man to fish, rather than just giving him a fish.
The survey shows more firms are planning to increase their back office headcount. Why do firms need more staff?
BC: It’s the increasing demands and the increasing fund complexity that’s driving firms to recruit. Everything has gotten more complicated. We’ve also got to pay more attention to cyber, we’ve got to pay more attention to ESG, we’ve got to pay attention to diversity – and all of us already have full time jobs. So, how do we do a good job on all these things, without being spread too thin and missing something important?
“You need to have a deep enough team to be able to pay attention to all of the details and do the work well”
Saw Mill Capital
I just got my audit engagement letter. It used to be six or seven pages long. This year, it’s 12 pages. That speaks to the level of complexity that we’re dealing with. The more complicated things get, the more room there is for error. You need to have a deep enough team to be able to pay attention to all of the details and do the work well.
KL: Getting people in the door to do a good job is really difficult now, compared to two or three years ago. It’s tough for everyone to find that talent. New hires are getting salaries that are 20-30 percent higher than even a couple of years ago. And as an employer, you have to be comfortable with flexibility. If they’re good people, you can’t expect them to come to the office anymore.
Two years ago, we literally couldn’t even fathom doing work without being in the office. Now we have a world where you only have to be in the same hemisphere to work.
Is more outsourcing inevitable, alongside recruitment?
Jeff Lucassen: We’ve sought to strategically outsource to third-party administrators over the past few years. Finance and accounting are not the core business of our firm – we want our finance team to focus on where we can add more value and utilize data to make better investment choices or provide more insight to our investors. We think that the team can have better career opportunities if we outsource the non-core functions to third-party administrators, and the fund administrators then provide a value-add to us. So, we’re focusing on that blend between internal resources and third-party administration.
KL: Within private equity, maybe 10-plus years ago almost everything was done internally, then more recently people started to use some kind of outsource model. Can you outsource 100 percent? No, I don’t think you can, but you can use the outsource model to farm out some of the more routine tasks. The pandemic has certainly accelerated the growth of outsourcing, because it made people realize that the back office team don’t need to be in the physical office. That’s encouraged firms to outsource to third-party providers and fund administrators, instead of hiring internally.
Is more technology and automation the solution to the pressure on the back office?
KL: Technology feeds into everything that we do from a back office perspective. The most advanced technology is probably the investor portals. Most institutional investors expect some type of portal.
Risk management and deal sourcing are beginning to use more advanced technology – but that’s still very early stage. There’s a real dichotomy in terms of some functions using advanced technology but people are still using spreadsheets to do a lot of their work – including the waterfall calculation.
“The survey showed that 75 percent of firms have an investor portal. I thought this would be closer to 100 percent”
Northleaf Capital Partners
JL: The survey showed that 75 percent of firms have an investor portal. I thought this would be closer to 100 percent. We’ve had a portal for almost 10 years and are now looking at an upgrade.
CF: I’m very enthusiastic about using technology in automating processes. One thing that I find is that people overestimate how automated their organization is. If you ask somebody, they will tell you that things are very automated – then you really dig in, and they explain the automation, and it’ll turn out that they’re confusing a technology-enabled manual process with automation. So, we focus on the processes that people feel like are automated, but aren’t really, and train them to actually automate them.
The next frontier is going to be more on how we collect information from the portfolio companies. There are some challenges with reporting to investors. The ILPA template helps. They are our customers, so there’s always going to be a little bit of a white glove approach. We would like to get some more automation in there, but there’s just some other factors, some headwinds.
Joshua Cherry-Seto: LPs still expect a white glove, direct touch. The LPs, plus their advisers and accountants, are not used to being expected to self-service in terms of accessing reports and data. But on the internal side, the market is getting better with portfolio reporting automation. Technology can help with organizing core portfolio metrics like EBITDA and revenues, which we currently keep in Excel.
JL: In terms of self-service, context is important. Investors will sometimes misinterpret the data and have questions – I view this as an opportunity to engage with our investors. That’s another contact point with a client, another opportunity to show value-add, an opportunity to talk about how we can better serve their needs. So, we’re trying to solve 90 percent of the information needs of our clients with self-service. It’s a good thing if we can actually interact with investors on the remaining 10 percent.
How are CFOs’ responsibilities shifting in response to the key trends in the industry?
BC: The role of the CFO is really changing. The main skill set used to be Excel and modeling. Now you need to be more like a project manager – you have a very long list of things that you need to keep on top of – ESG, HR, compliance, 401(k), IT, tech, taxes, audit – and you have people or consultants that help you with that. And a lot is being outsourced, so the CFO is going to have this hodgepodge of some in-house staff and a whole bunch of consultants that they’re going to have to manage. That’s a different skill set than modeling and running waterfalls. What a CFO does in 10 years’ time is going to be very different to what a CFO does today.
JCS: Back before SEC registration, you could be very inward looking as a CFO and just focus on taking care of the books. Our journey is very much going outward – and I think that’s accelerating. We’re expected to be engaging the industry, engaging each other, looking outside the organization. The type of person who is good at doing those things isn’t necessarily the best kind of accounting person. We all have a tendency to want to dive deep into the spreadsheets and get the numbers right. But our roles now demand that we’re out there talking to people, talking to vendors, making sure we’ve got the best sort of vendor relationships.
The survey showed that relatively few firms use automated waterfalls. What explains this lack of enthusiasm for the technology?
JCS: It looks like around a third of firms are using technology for waterfalls or looking into it – I thought that was actually a pretty high number. We do not feel a push from LPs on this. LPs certainly ask about the mix of GP economics and if you’re thinking about selling part of your GP to third parties.
All that is critically important – not whether the calculation is automated. Note, the calculation is third party-audited and validated at the fund level.
Nor are we seeing demand internally. We have a couple of dozen people across three different funds who are involved from the GP side. It’s not hundreds of people in the GP. So, we don’t feel internal pressure. It’s not something that is interesting to us.
“A permanent CFO is still considered the most important back office function by investors”
BC: There will never come a day that I will rely solely on a system-generated waterfall. I will always run in Excel. There are so many inputs that it’s nearly impossible to think of every scenario that might occur over the life of a fund to be programmed into a system. I do think that as the younger generation matures, there will be more reliance on automation. Old people like me still want to calculate a waterfall in Excel and see every single input. The younger generation is more comfortable with automation.
KL: There’s definitely two sides to the waterfall calculation question. A lot of people are using automated waterfall products. As time goes on and those younger persons become more senior in the firm, there’ll be more transparency on that back end in terms of using technologies to calculate the carry allocations across the various partners. But that area for sure is the slowest growing from a technology perspective. The carry allocation to the general partners is considered sacrosanct and most people don’t yet have enough trust in the products to rely on them for waterfall calculation.
JL: It’s not an area that we have focused on, as there are many other areas that will actually make a bigger difference to the operational effectiveness of our firm and what we deliver to our investors. Of course, whenever a fund generates carry, our LPs want to know it’s been calculated correctly, and we engage our external auditors on this point. But there are lots of other places to spend our technology dollars and – most importantly – time, to improve the scalability or efficiency of the business.
One area that investors do want to see managers focusing on is cybersecurity. What should GPs do to strengthen their cyber-defenses?
CF: I think cybersecurity might be the best example of the Dunning-Kruger effect – where the less knowledge people have on a subject, the more confident they are in talking about it. A lot of cybersecurity decisions are made by people who do not have deep technological credentials and a lot of those people underestimate cybersecurity.
In my experience if you ask people what they’re doing they will tell you all the right answers – and then you dig in, and you find the answers they gave are not actually true. You will ask them how they change their password, and they’ll say they change it every 30 days. And then you press them, and they admit that they disabled that requirement because it annoyed the CFO or the CEO.
People are giving it all the right lip service. They’re saying all the right things; I don’t think they’re actually addressing the risk as well as they think they are.
JCS: The cybersecurity tools have become better. LPs have higher expectations of the tools that you access. But everyone will tell you, people are the weakest link. Really the risk isn’t that someone will break into your bank account and steal your money – it’s that you people are going to give the money to them. So, we spend a lot of time around the human side of it.
In terms of where we are today versus where we were two years ago, it’s night and day, it really is. Not only have we implemented multifactor authentication internally, but also for our access to third-party products like our CRM.
CF: An analogy – the bad guys are going to break into the car with unlocked doors. Why would they bother to break into the car that’s going to be more difficult? So, as long as you’re more difficult to penetrate than the people to your right and your left, you’re probably in pretty good shape.
What other trends are you seeing with investor due diligence?
JL: The funds are larger, and more investors are allocating more money to private markets, so expectations from those entrusting their capital with us are higher. With more capital being invested, investors are ensuring they take the needed time for operational diligence. Investors are just starting to apply the same practices that they apply to public markets investing to the private markets.
“LPs, plus their advisers and accountants, are not used to being expected to self-service in terms of accessing reports and data”
Blue Wolf Capital Partners
JCS: Our investors have become very focused on ESG. Our investors are asking better questions – they used to just ask if we had a policy on certain topics, now they really dig in deep. On our end, we understand so much better what it is that they want. And with that good dialogue between us, we do a better job of giving our investors what they want.
We’re not approaching ESG as a check-the-box exercise. We think that it’s a business opportunity to show the market that we have a competitive advantage, that we’re going to be a more responsible steward of investors’ capital – and that should help us in
JL: The depth and the quality of the questions are different in the last 24 months than they were three or four years ago, particularly on responsible investing and ESG. Different investors have different areas of focus. For example, ESG has always been an area of focus for European investors, but less so for North American investors. That’s changed now. Awareness is much higher overall, as are investor expectations when they ask questions, so we’re being held to account to show what we actually do – and rightfully so.
BC: Another hot topic in due diligence questionnaires is diversity. I’ve even heard that some institutional investors are saying if you don’t get your diversity right, they’re not going to invest in your next fund.
And what should firms be doing to improve diversity?
BC: I did just recently hire somebody, and I was very clear with the headhunter that I needed a good mix of candidates. I had to have a full suite of diversity, of women, of men, of different ages.
JCS: There’s a bunch more room for industry engagement. As an industry, we’re starting to talk a lot more about how we can do better on diversity and be engaged in better ways to get access to more diverse pools over time through sharing of best practices and leveraging organizations that cultivate diverse candidates.
We do see a lot of questions from the LPs about diversity within the GPs. But we only hire two or three people a year on the investment team and maybe one on the finance side. There aren’t a lot of positions. It’s easier to take a systematic approach to diversity in our portfolio companies and board of directors, where we require a diverse slate of candidates.
KL: Diversity is systemic. It starts from the school system all the way up. Harvard and these other top-tier schools, where everybody looks for talent to become their next deal guy, are becoming more diverse – but that takes time. It’s something that will hopefully improve slowly.
It’s also a matter of getting people to understand what private equity is. So, when I go to some of these schools and tell them I work at TMF Group as a fund administrator, they’re asking, “What’s a fund administrator? What’s private equity?”
There’s a lot of education that we need to be doing to let people know about our industry, beyond those from traditional private equity backgrounds.
Chief financial officer, Blue Wolf Capital Partners
As the CFO at Blue Wolf, Cherry-Seto oversees fund and management company reporting to LPs and regulatory agencies. He co-ordinates finance operations and the reporting of Blue Wolf’s portfolio companies through their CFOs and is responsible for investment and tax structuring of potential platform, add-on and co-investment opportunities.
Chief financial officer, Saw Mill Capital
Cirella joined Saw Mill Capital as CFO in 2006 and is responsible for its back office functions. Cirella has held various positions in the industry dating back to 1993. She was a director at Bisys Private Equity Services, the controller of Common Capital and a director of finance at Orien Ventures.
Chief financial officer and chief operating officer, Northleaf Capital Partners
Lucassen leads Northleaf’s corporate team and provides strategic oversight for key business functions, including investor operations, finance and corporate operations, HR, tax, technology and corporate development. He is a member of Northleaf’s management committee and is involved in global investment, asset and risk management, and investor relations activities.
Chief financial officer, EnCap
As CFO at EnCap, Friou is responsible for all finance and administration functions. Prior to EnCap, he spent 23 years at PwC. He served clients in the energy sector, first in audit and then in advisory, helping companies go public and raise capital to fund M&A and asset acquisitions.
Co-head of fund services for North America, TMF Group
Lewis has nearly two decades’ experience in financial services, focused on investment management. Prior to joining TMF Group, Lewis had spells as the CFO of ACON Investments, a $6 billion AUM private equity firm, and as a senior manager at PwC, leading its alternative investments practice in Washington, DC.