The cloud crowd

As any chief financial officer will tell you, building or upgrading a firm’s IT system is an expensive project. So when a software provider tells you a “cloud solution” can result in significant savings, it’s sure to catch a great deal of interest. That’s certainly been the case in recent years as more GPs migrate their in-house IT systems into what some describe as untested (and relatively more risky) cloud-based platforms.

For the uninitiated, cloud computing can be described in a broad sense as files and applications that can be used over the internet. The most common form of cloud computing, and the one that has caught the eye of the private equity industry, is Software as a Service (SaaS). Users of SaaS systems use software and databases that are powered by machines run remotely by a service provider, meaning each of the firm’s computers would not need to be installed with specific software to run a certain application hosted somewhere in “the cloud”.

As alluded to earlier, the biggest advantage of the cloud is cost, according to Jeremy King, practice leader of SaaS service NetSuite for Hein & Associates. King argues traditional in-house IT systems are far more expensive when taking into account the costs of the “premise, licensing fees, applications and operating systems, database systems, hardware purchases, and maintenance”.

He adds that on the cloud computing side, “you have only really got two things: the subscription (so what you are actually paying for) and the implementation”.

The cost argument is indeed a fair one to make for cloud services, says Eric Feldman, director of IT at mid-market firm The Riverside Company. Feldman elaborates by saying another factor sometimes absent from GPs’ cost equations is the price of in-house staff. With an in-house IT system, Feldman argues that “private equity firms require highly skilled and well-paid professionals to manage complex CRMs, account systems and even HR management systems”. By utilising a Saas-based platform managed by an outside party, these costs can be mitigated, he concluded. 

AMORPHOUS CLOUDS

Even the way cloud providers charge for their services is advantageous for private equity firms, says Nigel Brooks, managing partner of IT solutions provider Capital Support. As cloud providers typically charge on a pay-per-use basis, it eases the pressure on smaller firms to spend large amounts of money upfront. Brooks explains that costs are proportional to the size of the firm, meaning firms with smaller headcount and in need of fewer applications pay a price proportional to that level of usage.

In comparison, traditional IT infrastructures require GPs to purchase a minimum level of equipment and services regardless if there would be three partners, or 30 partners, using the system, adds Brooks. Under this model, a firm wouldn't get “its full return on the equipment until you have all 30 people using it”.

Accordingly a cloud platform is more convenient when GPs need to scale up (or down) in response to changing markets, continues Brooks. Launching a new office, for example, would simply require an internet connection and some desk computers in implementing its IT services, he adds. “Compare that to the traditional model where you have to buy equipment, build servers in those locations, link them back to a main server, and then sort out if it’s a shared drive or separate.”

However Brooks, unlike Feldman and King, doesn't think that cloud services are necessarily cheaper overall. He argues that although cloud providers take the pressure off the initial outlay, the variable cost can be greater as headcount at the firm increases. In comparison an in-house IT system can be a large fixed cost, but cheaper on a month to month basis.

HOME SWEET HOME

Despite the trend of private equity firms transitioning to the cloud many remain hesitant to move their data out of sight. 

One London-based chief financial officer told PE Manager his firm has resisted the move to the cloud because they like to feel “closer” to their systems, which they feel an in-house system better provides.

His feeling was that greater control over the firm’s IT system could be achieved with a bespoke system tailored to their needs. Overseen by an in-house IT manager familiar with its design, he added this gave a greater sense of comfort over data quality, and more importantly, the system’s security. Moreover an in-house IT manager meant “having 24/7 service”, says the anonymous chief financial officer. “When the IT manager is on your payroll, he has a vested stake in being responsive and on constant call to manage the system. I’m not sure a cloud provider managing multiple clients has the same level of incentives.”

Sources indicate this isn’t an uncommon view in the industry, leading to the question of just what kinds of risks GPs take when moving into the cloud.

SAFETY FIRST

Alok Misra, the co-founder of Navatar Group, a cloud service provider which customised salesforce.com for private equity clients, argues cloud providers are in fact more secure than in-house IT systems. Misra says the level of resources a cloud provider has, in comparison to a private equity shop with maybe only a score of so of employees (and typically just one or two IT professionals) means greater dedication to security matters.

Hein & Associates’ King agrees that cloud providers are a safer option for private equity firms, who specialise not in IT security but dealmaking and portfolio management. “If you were to look at private equity firms’ IT security, data retention and back-up, and then compare that to the top cloud vendors, they couldn't hold a candle to them.”

King argues that cloud vendors spend millions of dollars on risk management and security measures whereas for private equity firms IT security is often just an afterthought.

But Brooks doesn't believe this issue to be all that black and white. By one interpretation, the cloud can be considered a public arena divided into millions of private cells. A private equity firm can purchase access to any number of cells, but “unfortunately there is a chance that data [between cells] can cross-contaminate”, says Brooks, who adds that he has witnessed password leaks, security breaches and innocuous human errors result in a loss of privacy.

For example a client could see, albeit for a brief period of time, someone else’s contacts and address books, and vice versa, their contacts could be seen by others, he adds. “That is a risk when you go with one of these big public multi-tenanted platforms, which may not be appropriate for private equity houses.”

This means vendor selection is of paramount importance, stress market sources, some of whom noted the decision to move into the cloud can also impact investor relations. Riverside’s Feldman says that investors are increasingly demanding more internal IT controls within the firm, and that it is the job of the GP to demonstrate what controls and security measures have been put in place to enhance data security. 

In order to mitigate its own security risk, Riverside has created a “hybrid-style” cloud for key systems, such as their email environment. “We use the cloud for data retention and replication, while at the same time we still have on-premise equipment,” says Feldman. “What that means is when you send me an email, a copy of it is retained for five or six years in a secure cloud environment, and a copy is sent to our onsite equipment.”

Another advocate of cloud computing has been private equity titan The Blackstone Group, which has rolled out cloud computing to its portfolio. Blackstone chief technology officer Bill Murphy says the firm makes use of a variety of SaaS solutions, including Coupa for its procurement efforts and Watchdox to secure its documents. 

However, Murphy is fully aware that teaming up with the right vendor is integral in making the cloud beneficial. “We have to be comfortable, and the cloud is not universally comfortable. It’s not that the cloud is secure or not secure, it’s secure sometimes if you go with a vendor who does it the right way and dangerous if they don’t.”

Murphy goes on to draw a parallel between cloud computing and exploring major cities: “It’s like walking around New York. There are neighbourhoods that are extremely safe and then there are neighbourhoods that maybe you don’t want to walk through at night.”

But like New York, which in recent times has significantly enhanced its reputation regarding safety, the cloud has undergone a similar progression. That is sure to capture the interest of even more private equity firms in the years to come.