Envision the day-to-day responsibilities of the typical mid-market private equity chief financial officer (CFO). Finance may be at the center of their title, but running waterfalls and closing the books are no longer the bulk of their responsibilities, as they were 10 years ago.
Now, CFOs are also managing IT, cybersecurity, marketing, tax, accounting – the list of functions goes on and on. And that’s not even taking into account the many CFOs who wear dual hats as chief compliance officers or chief operating officers of their firms as well.
“Gone are the days of the chief financial officers being the Excel mavens,” says Anne Anquillare, co-founder and chief executive at fund administrator PEF Services.
The statement sinks in around the conference table in midtown Manhattan, where pfm has gathered Anquillare along with another fund administrator and three CFOs of middle market firms. All have been discussing the new normal that has arisen in private equity fund administration in the past few years. Everyone agrees: running a fund is not as easy as it used to be.
The real challenge is that all firms are trying to scale up, increase their business and raise new funds to be even larger and better-performing than their last. But with that growth comes even more work for the CFO.
“Today’s CFO has to be a much more sophisticated individual who is more akin to a CFO of a larger operating company because of the greater realm of responsibilities they have under them,” agrees Christina Houghton, CFO at CapitalSpring.
In order to handle the increased burden of all those different functions, along with mounting scrutiny on fund operations from both regulators and investors, finance teams have to think about balancing their current personnel with possible staff augmentation or increased workloads, and whether or not to outsource functions to third-party vendors, a route more and more CFOs are taking.
“This struggle starts in trying to find all the right providers and being the manager of all those providers,” notes Blinn Cirella, CFO of Saw Mill Capital. “It begs the question: will CFOs end up being managers of vendors?”
Augmenting back-office staff
To answer Cirella’s question, the roundtable participants take a closer look at all the resources CFOs currently have available to them to manage their increased responsibilities, and how each of the three CFOs is managing their workloads.
At Blue Wolf Capital Partners, for example, CFO Joshua Cherry-Seto has been spending a lot of time thinking about how to leverage advisors in order to fill the increased workload of the maturing industry, which has created a variety of partial full-time employee (FTE) tasks. With only 15 to 20 professionals currently on staff at Blue Wolf, there’s plenty of finance, compliance and investor reporting work to go around, but not enough to justify creating a FTE analyst position or an FTE controller position.
“In a tight labor market, it’s hard to find quality folks – costly to get it wrong, expensive for mediocrity, and very hard to keep A-players, because if we did hire a controller, there isn’t a CFO opening for them to take on in a couple of years (I hope),” says Cherry-Seto.
Indeed, when coping with the need to scale, most private equity firms aren’t making new back and middle office hires, according to EY’s 2016 Global Private Equity Fund and Investor Survey. For functions like risk management, valuation and human resources, firms are much more likely to increase an employee’s current workload or expand a role rather than make a new hire (see Figure 1).
Cherry-Seto ultimately brought on a boutique fund administrator and consulting group to provide staff augmentation, not only assist with traditional administrator functions without system migration, but also valuations and portfolio company reporting support. But he’s now in the position that many CFOs are finding themselves in these days: onboarding the remote team and finding a balance of what’s outsourced versus what is kept in-house.
“I’ve been thinking about asking them to get days in the office because I’m struggling with making it work when they aren’t in our office to tackle tasks as they develop,” he says. “It’s hard to not just continue doing it all yourself.”
The comment receives a murmur of agreement from around the table, where everyone acknowledges that one of the biggest issues CFOs have when it comes to outsourcing: delegating. For the “jack of all trades” CFO used to accomplishing everything in their own way, letting go and putting responsibility in someone else’s hands can be a challenge.
“Continuing to keep the accounting function in-house is the path of least resistance, I know I can get it done, I might not sleep tonight, but I’ll get it done,” agrees Cirella.
The biggest argument Anquillare hears from CFOs is: “I don’t want to delegate it because it’s easier to get it done myself.”
“Two things are happening there. You’re robbing someone else of the opportunity to learn, and if you’re the one doing it and reviewing it, you’re leaving no trail. You become a single point of failure, which is totally unacceptable.”
Indeed, Houghton adds, “It may be quicker for you to do it now, but it uses even less of your time if you’re not doing it at all.”
Data, data, data
Another hurdle emerges when CFOs are responsible for hiring people in departments in which, as finance gurus, they may not have the proper expertise.
“I don’t have an IT background but I’m ultimately the one responsible for it, so I need to make sure I’m hiring the right people to oversee it,” says Houghton. “It highlights the importance of hiring the right vendors because ultimately, you need to be able to trust your vendors.”
Indeed, IT is an area commonly outsourced at smaller firms. And while CFOs are more than aware that good data management and technology can expedite any task, they are struggling with implementation. Nearly two-thirds (63 percent) of respondents in the EY survey said data is currently the most significant challenge they face.
“When we talk to folks about the implementation of technology, GPs tend to focus on the dollars out the door, but it’s more than that, it’s the cost of human capital too,” notes Mike Trinkaus, chief executive at private equity-focused fund administrator CARTA Fund Services.
This demand for better data management has become even more pressing as investor reporting demands have increased exponentially for GPs.
“I’ve spent a lot of time with different administrators to understand what technology platforms they have available for their clients, whether it be their dashboard reporting or understanding what systems they’re using” says Houghton. “I know I’m going to get detailed requests from investors that require a robust technology platform to easily answer. As a smaller asset manager, I’m not going to have the resources and appropriate technology to meet the needs of today’s LP and therefore I need to ensure my administrator is able to fill that void.”
“The overriding theme is that it’s all driven by technology,” agrees Trinkaus. “The solution is figuring out the right technology and platform so you’re drawing information from a single dataset and repurposing it for multiple uses throughout your organization.”
In contrast, Cirella recently went through the process of reviewing fund administrators, and decided to upgrade the firm software rather than moving to an administrator.
“If we choose to move to a fund administrator, we would have to let our fund accountant go. Given the complexity of the funds and need to shadow several calculations, I couldn’t see how, with only myself and a controller, we could keep up with the shadow calculations as well as issues like cybersecurity and compliance,” she notes.
For example, the conversation turns to calculating carry and the best way to run the waterfall model, and some around the table wonder if there’s a better way to do it. Cirella notes that the hardest part is not running the waterfall itself, but aggregating all of the data to be able to run it, including the cost basis, fee waivers, proratas and more. Moving to a new accounting system would mean recreating those tabs and tabs of data to satisfy the steps in the waterfall.
“In the mid-market space, you won’t spend the money to build something, it’s too expensive. The key is setting up your chart of accounts and ancillary data collection tools in the most granular way,” notes Trinkaus. “And it’s not just the waterfall, it’s one-off investor requests and regulatory reporting as well. Don’t think about what you need today, but five years from now, and put it into the system. There’s no harm in capturing that data now instead of having to go back and find a spreadsheet from years ago.”
Check-the-box or value-add
The mention of investor reporting shifts the conversation to an issue on the top of most fund managers’ minds of late: the Institutional Limited Partners Association (ILPA) fee template. Released in January, the template is just starting to be picked up by LPs, and has many GPs reaching out to service providers for help with the new demands.
“The insidious part of the template is the kitchen sink approach of asking for any possible piece of information. If we need to get that information for an investor, we’ll get it, but there’s no question that we’re trying to answer in the template – it’s just a data exercise,” says Cherry-Seto.
“When I first saw the [ILPA fee reporting] template, I thought, if we have to do this every quarter for every LP, I will have to hire a full-time person just for this, and who’s going to pay for that?” adds Cirella.
As a fund administrator rather than a CFO, Trinkaus had a different response to the release of the ILPA fee template.
“Based on what we have done with software and technology, 90 percent of what they are requesting is already built into our chart of accounts and the different memo fields that we use. Because of that, we have access to the data. We push it into our system and at that point we now have a template that works and is easy to replicate very quickly,” he notes.
But even if a GP hires a fund administrator to help out with the extra burden of the ILPA fee template, Cherry-Seto’s point still stands. It may be simpler to fill out the template and send it back with the help of a third party, but what are LPs doing with all the data they receive? Is it just a check-the-box exercise or a value-add?
“There’s so much data, but who’s actually analyzing all of it? And are prospective LPs really getting the intended value out of the process, which is that it should allow LPs to better evaluate the GPs they’re considering?” Trinkaus asks.
PEF also provides LP services, so Anquillare is able to provide insight into how LPs will use the fee template data.
“Fee management in private equity is about making sure you’re monitoring compliance and don’t have too many outliers,” notes Anquillare. “On the LP admin side, the analysis is more about if you have 300 positions, you need to hone in on the 10 positions that you need to investigate further. If they are outliers on the analysis, it is either because of performance or because of expenses. That’s what information is for, to get to decisions.”
For GPs who aren’t outliers when it comes to fees, the template will serve to aggregate and codify LPs’ manager information.
“The struggle is to make sure LPs are making the decisions based on the right data set and not just pulling things based on news reports, thinking that we’re off flying around in private jets,” Cirella notes.
But how do LPs feel about the rise in third-party oversight for private equity firms? According to the EY survey, most institutional LPs have been conditioned by the use of third-party administrators in other asset classes, and would be comfortable seeing it happen more often in private equity.
For Cherry-Seto, institutional LPs are thinking of the increase in outsourcing in private equity as a progression. They’ve seen it in the hedge fund space, and they want to see it happen in private equity as well.
“Investors are looking for us in the next generation to have more third-party oversight. It hasn’t been a make or break question yet, but in a year or two they’ll want to see more of it,” he says.
Anquillare knows from her LP clients the thoroughness LPs tend to employ when it comes to fund administration due diligence.
“When we have them come to our office for due diligence reviews, it’s intense,” she says.
Houghton has witnessed first-hand the level of understanding LPs want to have regarding fund administrators. Her team has been receiving questions about the administrator’s controls around cash management, turnover, team structure, and the types of systems they use.
“The same questions that you expect to get asked about your organization, they’re asking about your administrator, and they expect you to know the answer. That’s why it’s so important to work closely with your administrator to understand what processes and controls they have in place,” she notes.
Masters of vendors
Outsourcing has become a viable resource for staff augmentation, a helpful tool for data management and an accepted solution in the eyes of investors. But how will an industry that has primarily conducted back-office work in-house shift to becoming an industry where CFOs are masters of their vendors? It’s all about selection and management, the roundtable says.
When it comes to selecting an administrator, private equity has many more options today than it used to. “There’s definitely a lot more choice in the industry to do specific functions aligned with us rather than just a vanilla administrator,” Cherry-Seto says.
With a boutique fund administrator focused on the private equity space, GPs gain greater flexibility, Anquillare notes. “Your administrator is basically a toolbox and they should be flexible enough to switch out the tools you need if you ask them to. That’s where the boutique fund administrators separate themselves from administrators that are part of a much larger organization that has many other avenues of profit and many other business lines. They might not be able to keep up with what’s needed in order to elevate the platform to service their clients and their clients’ clients, who are the investors, especially on the back-office side.”
On the other hand, it’s important to remember that weaknesses at your fund administrator could mean weaknesses in handling your firm’s data. Take cybersecurity, for example.
“If you have a strong cybersecurity platform but you outsource a number of functions and your vendor doesn’t have a strong cybersecurity plan in place, you’re still at risk despite all the good work you’ve done at your firm,” Trinkaus warns.
Cirella shares a view with the many private equity CFOs like her who have chosen not to outsource. The trend may not be ideal for the rhythm of some firms, where third-party oversight would mean changing the pace at which they do business. For shops that are used to getting in their quarterly reports just in the nick of time, it would require a big shift in the way financials are approved and checked.
“There would have to be a cultural shift in our office to go with a fund administrator,” says Cirella.
If a firm does make the move to an administrator, it’s important to remember that the balancing act isn’t over. CFOs need to keep working with their fund administrators, Houghton notes.
“I want to have oversight and be able to provide feedback, but also get their perspective because one of the benefits of having a fund admin is that they can tell you what’s market,” says Houghton.
A fund administrator may think of something when a firm is drafting an LPA that fund attorneys or management haven’t thought of, for example, or something the firm and fund attorneys think is feasible but in reality is not.
“You need to make sure you have a clear line of communication between your fund administrator and the investment team, because if you just send a four-page deal memo off to the administrator, they don’t have the context,” Houghton adds.
At the end of the day, the key to finding the right balance is not only securing the right fund administrator, but also engaging with them as a good client as well. And for an industry that isn’t as used to outsourcing, that process might take some time.
“Vendor management is so important. The best client for us is one where there’s a level of organization and discipline on the other side of the table,” says Anquillare.
Around the Table
Anne Anquillare is co-founder and chief executive of the fund administration firm, PEF Services, which she launched in 2002. Previously, she served as general partner of Walden Capital Partners and worked in the investment business unit for Prudential Insurance Company of America. From 1998 to 2000, she also served on the board of governors of the National Association of Small Business Investment Companies.
Joshua Cherry-Seto is the chief financial officer (CFO) at Blue Wolf Capital Partners. Cherry-Seto previously served as a portfolio and finance manager at Grove International Partners from 2008 to 2013 and earlier held a variety of positions within Citigroup, including responsibility for financial planning and analysis, tax structuring, Securities and Exchange Commission (SEC) registration, and systems implementation at various units.
Blinn Cirella is the CFO at Saw Mill Capital. Prior to joining Saw Mill in 2006, Cirella was a director at Bisys Private Equity Services, a fund administrator, where she was responsible for managing the accounting and administrative functions for a large institutional client. Earlier in her career, Cirella was the controller at Commonfund Capital.
Christina Houghton is the CFO at CapitalSpring, with more than 10 years of accounting and reporting experience in the financial services industry. Previously, she served as vice-president and controller of American Capital Senior Floating. Earlier in her career, she worked at Apollo Global Management, including as the controller for Apollo Investment Corporation, a publicly traded business development company.
Mike Trinkaus is the chief executive officer of CARTA Fund Services. Prior to forming CARTA, he served as CFO and of Portfolio Advisors for eight years. Earlier in his career, he was the director of finance and fund accounting for Moore Japan Restructuring Fund and an assistant controller in the merchant banking division of The Blackstone Group.