PE firms look to co-sourcing for increased flexibility and control

With a greater regulatory burden and investor expectations for speedy data requests, PE firms are collaborating with admins to co-source operations

Responding to unique and timely information requests from investors and complying with new regulations can push PE firms beyond their core competencies or stretch thin already stressed resources. That is why a growing number of private equity firms are looking for co-sourcing partners who can help them retain ownership of their data while helping with administrative processes and day-to-day business activities.

A recent webinar (The Private Capital Strategy Series, Episode 12: Outsourcing and Co-sourcing for the Unknown) by 4Pines Fund Services noted that co-sourcing allows PE firms to gain the expertise of external professionals who specialize in specific areas, such as due diligence, financial analysis, legal matters, or operational improvements while allowing them to focus on investment activities.

Joshua Cherry-Seto, CFO at StartUp Health, explained that co-sourcing is a relationship between GPs ad fund administrators that supplements a PE firm’s internal resources and capabilities with the expertise and additional resources of a funds admin that uses the PE firm’s own accounting and reporting platforms.

“Co-sourcing provides greater control of and an extension of internal capabilities allowing us to be more nimble,” he said. “With the traditional model of outsourcing, things tend to get passed back and processes can break down, as the timing of various requests become quicker. So, we really need to look for solutions that are more collaborative.”

Co-sourcing non-core activities enables private equity firms to concentrate on their core competencies of deal origination, investment strategy and portfolio management.

“Co-sourcing, at a high level, is simply the GP and the fund admin operating jointly on the GP’s software to manage all of the operational aspects of the business,” 4Pines Fund Services CEO Mike Trinkaus said. “This allows a GP to retain possession and control of their data, while simultaneously allowing the provider to work within the software to manage all of the fund admin deliverables, as well as other needs.”

A more complex business

Cherry-Seto explained that many mid-size and larger PE managers still self-administer, although regulation and LP pressure are pushing more firms toward outsourcing or at least having an external check on certain functions, including valuation and reporting.

“With the growth of the private equity industry, there has been a great deal of growth and it is now a much more complicated business than it was in the past,” Cherry-Seto said. “LPs are demanding more of firms, and that has put more pressure on firms to find additional ways to get leverage, which includes outsourcing and co-sourcing models.”

A key driver behind co-sourcing is growing demand for speedy and accurate information. Firms are finding they have less time to respond to information requests, and requests are more ad hoc, so they are looking for expert third-party help.

As with any vendor relationship, it’s important for private equity firms to carefully select and manage their co-sourcing relationships to ensure effective collaboration and alignment with their objectives. Clear communication, well-defined roles and responsibilities and proper evaluation of providers are critical for the relationship to succeed.

Cherry-Seto advised PE firms to bring in outsourcers that have experience with their investments and business practices. “You want to bring in a real partner to your processes, somebody who’s really able to take the time and focus on the process so that you can have the best information,” he said. “What you need is a real relationship with your co-sourced service provider.”

‘Third-party touch’

Trinkaus noted that having a collaborative relationship between the outsource provider and the PE firms is a “winning strategy” because it allows PE firms and fund admins to develop broader data plans to address LP requests and regulatory requirements more efficiently.

Investor demand is still one of the main drivers for firms looking to co-source, especially at firms that still self-administer. Investors want to see a “third-party touch” and deeper controls around security, fraud, and books and records, Cherry-Seto said.

Additionally, co-sourcing allows smaller managers to quickly institutionalize. Trinhaus noted that when investors are doing operational due diligence, they are more comfortable seeing managers that have a “real institutional look and feel” when it comes to operations and controls.

Cherry-Seto agreed that having co-sourcing relationships is helpful when raising capital. “Operation due diligence has become much more intense, with LPs going into the details of your operations and your checks and balances,” he said. “They really want to see an institutional operation – and that’s vastly helped by having partners that are bringing in those operational pieces you don’t have in-house.”