Pandemic throws investor interests into focus

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It is no surprise to anyone who has spent any time in the back office of a private equity firm over the past few years that investors are absorbing team bandwidth by requesting more information about managers and portfolio companies. The pandemic has sharpened that scrutiny as LPs seek additional clarity on how managers are negotiating the crisis.

Chief financial officers report they have received investor requests for information on everything from business continuity planning (as one might expect given the events of 2020), to portfolio performance, cybersecurity readiness, lines of credit, unfunded capital commitments and capital recycling.

The picture is reflected across strategies. A CFO at a growth investor says: “Most [LPs] want to know how the portfolio companies were impacted during covid-19 and how dealflow is.”

While the CFO at a firm investing in natural resources comments that at the beginning of the crisis “LPs asked a lot of questions about our BCP and our ability to work remotely.”

The pandemic has emphasized areas of existing LP interest, including business continuity plans, anti-money laundering and know your customer measures, as well as online portals/data rooms. Around half of respondents to the Private Funds CFO Insights Survey 2021 report that LPs always ask about these three areas during due diligence, and a further third or more say LPs sometimes ask. Only slightly fewer say LPs always ask about cash management oversight (44 percent of respondents) and readiness for a cyberattack (41 percent, up from 30 percent last year).

The proportion of respondents who say that LPs never ask about cyberattack readiness policies during due diligence has fallen to single digits this year, as the shift to remote working has put the spotlight on cybersecurity and robust, efficient technologies.

“As everyone is working remotely, GPs have put in place additional systems including using more cloud services,” says Cloverlay CFO Omar Hassan. For firms taking care of IT security in-house and not relying on a provider, LPs like to see that a third party is at least reviewing their approach, he adds.

Comfort in consistency?

Some aspects of LP scrutiny remain resolutely constant – GP use of internal rate of return to demonstrate performance to investors is a clear one (100 percent of respondents use it as a benchmark), despite industry-wide acknowledgement it has its limitations as a metric.

It seems some responses to LPs’ questions change little too – 78 percent of respondents say their management fees are the market rate when asked to justify them by investors. This was also the most-commonly cited response in last year’s survey, when 77 percent said they used market rate to justify fees.

Meanwhile, historical performance has become a more frequently used justification for fees, rising to 45 percent from 38 percent last year. As the CFO of the natural resources-focused firm notes: “Management fees are not difficult to justify if you return performance.”