Over the past few years, best practice in fund reporting to LPs has been changed significantly by the internet. Traditional fund reports – printed or photocopied, then bound and sent by mail or courier – are being replaced by soft-copy documents such as PDFs.
Some GPs have moved away from hard copies by using email. However, there is now a growing understanding of the security risks associated with nonsecure email and, to some extent, an appreciation that a busy LP’s full email inbox is not always the best place for important documents to get the necessary attention.
As a result, the trend now is for GPs to provide some form of secure web-based reporting system that allows LPs to log in at their convenience to retrieve the latest information on a fund, including annual meeting presentations, tax reports and other documents, as well as traditional reports and accounts. These systems also provide LPs with an archive of historic fund documents, saving them the trouble and expense of filing and storing the large volumes of information that can be generated during the lifetime of a fund. It also acts as a data room for prospective LPs carrying out due diligence on a new fund.
The advantages of web-based reporting, in addition to the reduced filing elements mentioned above, include faster dissemination of information (particularly significant given the rapid globalisation of private equity investment), reduced costs in many cases (important to LPs as these costs are typically borne by the fund), and reduced environmental impact from printing and transporting paper documents.
The role of fund reporting
Whenever a GP considers changes to fund reporting, it is worth bearing in mind that reporting needs to meet two slightly different objectives – information and marketing. Planning for the switch to web-based reporting should cater for both these roles.
The first requirement for fund reporting is meeting the LPs’ own reporting requirements, whether the LPs are institutions investing their own capital or funds of funds managing money on behalf of clients.
In either case, LPs have to:
• collect, record and aggregate certain data across their portfolios of private equity funds;
• monitor exposure to private equity as a whole (or individual sectors within private equity);
• track outstanding commitments; or
• generate performance data.
To achieve this requirement, fund reports should:
• be distributed as quickly as possible;
• be simple to understand; and
• have historical information that is easy to access.
Web-based distribution of documents can play a major role in the first and third points mentioned above. A PDF of a fund report can be produced in minutes, rather than hours (or days) for photocopying or printing as a physical document. It can be distributed to LPs almost instantly when uploaded, rather than taking days to deliver by courier to LPs on different continents. Giving LPs access to all of a fund’s reports through a website enables them to access historic data without the need for maintaining a huge onsite filing system, pulling documents from offsite storage, or requesting that GPs search through reams of information when it is needed urgently.
The second objective role for fund reporting is a marketing tool for GPs seeking to raise further capital from their LPs. However good a GP’s news is, if an LP cannot access a report, or has great difficulty in doing so, the message can be lost. Again a good web-based reporting system – easy to access, reliable and with good support if it is needed – can help to achieve this.
Managing FOIA issues
A further factor that is accelerating the trend towards web-based reporting is the Freedom of Information Acts (FOIAs) in the US and Europe. These require certain public entities – such as governmentrelated pension funds, publicly-owned banks and some academic institutions – to disclose information they hold, to the public in response to requests made. Though intended to promote open government, requests have been made by journalists and research organisations to gain information on private equity fund investments, their performance and, in some cases, details of portfolio companies.
While details of the legislation and its interpretation in the courts vary from state to state in the US and country to country in Europe, it generally only applies to documents that the public entities have in their possession.
In the early days of the legislation it resulted in GPs visiting LPs to update them on fund performance, without leaving any materials behind.
Now various features of web-based LP reporting systems can be used to help manage potential disclosure of confidential, commercially sensitive information.
In some cases these can be functions of the system itself, in others they can be enhanced with third-party document security management products. Using these features, certain LPs’ access to highly sensitive information can be restricted. Documents can be protected from printing, copying or being reproduced through screen capture packages, and access to encrypted documents can be removed after a certain period of time. GPs should remember that web-based reporting is not a solution to disclosures that are potentially damaging to the funds or their portfolio companies, but simply a tool that can be used as part of an overall strategy for managing information flow.
Implementing web-based reporting
The decision to implement web-based reporting is, unfortunately, only the first of a number of choices that have to be made. To date, no industry standard service has been adopted – the source of significant frustration both for LPs and GPs.
Proprietary versus third-party solutions
The first decision to be made is whether to use a third-party service from one of a number of established suppliers, or to have a proprietary web-based reporting system. To date, GPs have split roughly 50:50 between the two options. There are a number of advantages and disadvantages to both.
Proprietary systems
A proprietary system can be customized to provide exactly the functionality that a GP wants, from the cosmetic, such as matching the look and feel of the public website and other corporate material, to the technical, such as being able to provide LPs with tools allowing them to analyze their investment in a fund in a variety of ways.
Once a proprietary system is developed, tested and implemented, the costs of hosting it on the servers already used for the public website are generally minimal and can be forecast relatively accurately.
The greatest disadvantage of a proprietary LP login is the initial investment, both in GP time and the cost of designing, building and testing the site. The costs reported by GPs vary enormously, depending on the sophistication of the system and the GP’s ability to drive a good bargain with developers, but range from a minimum of around $10,000 to well into six figures for the most sophisticated services.
Typical costs are in the $25,000 to $75,000 range. Estimating the value of the GP’s time that the process consumes is even harder. The first stage is to identify a suitable website developer, as the developer that designed and built the GP’s public website may not have the necessary skills in security, web database design and content management systems, required for an LP reporting system.
The second stage is to specify the detailed functionality of the system and obtain bids for development and testing, followed by management of the developer and dealing with the inevitable problems and questions that occur during the process. Finally, the system must be tested, normally in at least two stages, then launched to expectant LPs, who will immediately have questions about how to use it, how to access data through corporate firewalls and how to get a password when they have forgotten their security question.
A further issue with developing a proprietary system is that it is difficult (or even impossible) to allocate the initial investment between funds over time, so in most cases, the GP will pay the bill rather than recharge it as a fund expense. Additionally, proprietary systems are set in stone on the day that development is completed; adding new features, adapting the site to take advantage of new web technologies or responding to new security threats, involves a further process of commissioning and paying for development time.
For an LP, each new proprietary site means a new website to visit, a new registration process, another password and user name, and a new procedure for accessing and downloading information.
Third-party services
If a GP decides to buy in a third-party service, there are still a number of decisions to be made. As with proprietary systems, the costs vary widely, from a few thousand dollars per fund per year upwards.
It is easier to ascertain the total costs than with a proprietary system, although a number of services have complex and somewhat opaque pricing structures, with separate charges for various elements, including the volume of data stored, the number of users, the volume of data transferred, and setup and support fees.
Third-party LP reporting systems fall into two main groups: modules of private equity back-office systems, and standalone services generally based on some sort of virtual data room product. These systems can also be separated into software packages and services.
Software packages are generally hosted on the GP’s web servers and supported by the GP. The service elements are normally hosted on the service providers’ servers, with support for LPs provided by the service provider as part of a package.
Add-on modules for back-office systems
Over the past few years, the number of integrated services for private equity back-office management has grown rapidly. Most of them are, to some extent, modular, allowing them to serve a variety of markets (such as those of GPs, LPs and funds of funds), and most of them have now added a module that provides some form of webbased reporting for LPs.
The principle advantage of these modules is that the best of them are well integrated with the overall back office package. LP-specific information, such as capital accounts or call and distribution notices, can be generated automatically and loaded onto the LP reporting system with relatively little additional work.
In addition, these modules are typically designed specifically for private equity firms or, at worst, general alternative investment managers, and therefore require relatively little customization to adapt them to a GP’s requirements.
The biggest concern for most GPs is the level of reliance on a single supplier. Committing a firm’s entire back-office operations to a particular software platform has risks, with concerns about, at best, the supplier using this leverage to increase prices and, at worst, the supplier failing and the impact this may have on support and development of the system. Locking the firm’s web-based reporting to LPs into the same supplier further increases these risks.
The LP reporting module is also typically a small part of a large system, peripheral to the core back-office functionality. As such, it may receive relatively little focus as new software development priorities are set.
From an LP’s viewpoint, some of these modules have the advantage of allowing access to funds managed by different GPs through the same login. However, given the ferocity of the competition between the suppliers of these packages to win clients for the overall package, collaboration between them to allow LPs to access funds from managers using different systems, seems very unlikely.
Dedicated LP reporting services
The final category of services for web-based LP reporting is standalone third-party services. The majority of these services are based on some form of generic virtual data room platform used in a wide variety of applications – from legal services, to financial markets, to collaboration in research and development.
What varies from provider to provider is first, the degree of focus on private equity in general and LP reporting in particular, and second, as in every other option, price.
A significant number of different services are available for use in LP reporting, but if a service does not concentrate specifically on the private equity market, it will almost certainly require a high degree of customization to provide a satisfactory experience for LP users.
The time and costs are unlikely to be as high as those involved in specifying a proprietary system, but will still be significant; services developed specifically for the private equity industry require little or no initial setup and can be used “out of the box.”
For LPs, a key advantage of most of these services is that, once registered, they can access funds from different managers with a single login and user name; as a number of services emerge as preferred choices within private equity, the benefits of this should increase rapidly.
The final stage of implementation
Once a GP has decided on a product for web-based reporting and customized the service, there are still two important steps necessary before going live. The first is to organize all the historical documents for the fund (or funds) into a suitable format, generally that of a PDF. If fund reports were originally printed, the layout was probably produced externally by a graphic designer or printer, so original word processing documents or spreadsheets may need to be re-formatted. Additionally, final corrections may have been made to printers’ proofs and not in-house. In some cases it will be possible to obtain PDFs of the final version from the printers, but some documents may need to be reformatted and re-proofed.
Switching to web-based reporting is also a good opportunity to ensure that LP distribution lists are completely updated; a remarkable number of LP personnel changes take place without the GP being notified. Many LPs now use generic email addresses for some functions to avoid this problem, i.e. reporting@xyzpensionfund.com.
The next steps
The first generation of web-based reporting systems has been adopted quickly by the private equity industry globally. However, a significant number of GPs are still using paper or email to report, and appear reluctant to change on the principle of “if it ain’t broke don’t fix it.”
However, given LPs apparent preference for web-based reporting, the pressure on GPs to switch may increase over the next couple of years, if the fundraising environment becomes more difficult. The lack of any sort of industry platform is still a source of frustration for LPs, with large portfolios involving long lists of websites, passwords, user names and procedures to log in and access documents.
Once again, if fundraising does become harder, LP pressure on GPs to move towards a standard service, or at least one of a small group of services, seems probable.
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