Right sourcing is more important than outsourcing

So much about the current moment demands that GPs stay budget conscious, not only with their money, but their time as well. The SEC is cracking down on any fee that shouldn’t be charged to the fund, and the competition for capital and deals is only rising. The era of cheap money and swift, breezy fundraising drives is over, and GPs are left to up their game, lower their costs and automate or outsource any activity they can.

The good news is that service providers are stepping up with attentive service, great tech and increasingly sophisticated counsel. GPs who have enjoyed outsourced fund administration are now discovering the value of outsourcing the administration of their management company. And more emerging managers are launching firms where both funds and management company are outsourced from day one.

Outsourcing from the debut fund might be ideal, given there are no legacy systems, processes or staff. But even mature firms are finding pain points from their own AUM growth and regulatory complexity that argues for outsourcing that management company. But there is still need for an internal team or team member who can speak the language of the administrators and supervise the effort, because the one thing that no GP can outsource is their responsibility for the final deliverables.

For the first-time managers, service providers today offer a turnkey solution at precisely the moment when time and money are in short supply. “If you’re an emerging manager, don’t hire an accounting staff and commit to a financial system; focus on hiring your financial executive and we can deliver the support – the staff and the systems,” says Phil Bruno, head of management company services at Gen II Fund Services.

“The reality is that a lot of managers will spin out from larger firms where the financial administration was handled by the central financial organization, and now, out on their own, they’re left to figure the nuts and bolts of that, when they have more pressing issues requiring their attention.”

As part of that blind spot, emerging GPs might also underestimate the work involved in servicing the management company. “A lot of the time, management company accounting isn’t top of mind until tax season arrives,” says Luis Gutierrez, a managing director at Gen II Fund Services. “And then it’s a scramble to get all the financials together in time. That last-minute effort might work at first, but as the firm grows in size and complexity, the management company can’t be an afterthought.”

Gutierrez also notes that given the current regulatory climate, expenses warrant real attention. “New managers who wait until the end of the year to tackle their expenses might be in for a rude awakening as they realize that this or that item can’t be charged to the fund, so while the GP assumed the management company was only fronting the money for fund expenses, they’ll actually have to eat those costs.”

But with that service provider on hand, no such nasty surprises arrive. Broader compliance matters also argue that small, new teams would be best tapping outside help. “Nowadays, no GP can afford to slip up on compliance issues, but every time a partner is wondering if they can credit this or debit that, that activity runs up against a regulation. That’s time and attention taken away from their core business,” says Dautanya Strachan, a director at Gen II Fund Services.

Some new managers won’t have to bother deciding whether to outsource or not. “More and more emerging GPs are tapping anchor investors to serve as the foundation of their first fundraising drives, and those investors are demanding that the GP brings aboard an administrator,” says Bruno. This might be the strongest evidence that service providers have convinced the industry of their value.

Larger, more established players who might have handled their management company activities in-house will often find the workload too much as they reach certain levels of size and complexity. “For larger, veteran firms, it’s about pain points,” says Bruno. “Maybe they’re spending too much time managing staff and wrestling with accounting processes when they should be servicing the business.” So, that GP decides to outsource their management company as well.

Most frequently, GPs will outsource the management company administration to the same firm that they outsource their fund administration. “They see the benefit of having the administration of both the funds and the management company in the same platform,” says Gutierrez. “At Gen II, the management company servicers are in constant contact with the team servicing the funds so we’re always on the same page.”

This says nothing of the value of sharing the same technological solutions for both. Onboarding remains the biggest pain point of outsourcing, and it’s a major undertaking for funds with the long histories of data to upload, although service providers do all they can to minimize that burden.

Yet, even as these administrators are eager to take more and more off their clients’ plate, there’s no avoiding the fact that the buck still needs to stop with the GP. This means that there needs to be an internal liaison with the service provider. That may be one of the partners for the first few funds, and then shift to an in-house CFO or controller. “The founders are busy investing, as they should be, but there still needs to be a point person, even if they don’t have an accounting background,” says Gutierrez. “Our best relationships are where we educate the client about our work, and the client educates us about their work and needs.”

Rising to the challenge

Eventually, GPs may grow out of relying exclusively on their service providers. “Our clients should view our services as the base on which they build their financial function allowing them to focus on hiring the strategic financial roles – a CFO or controller,” says Bruno. “The value we bring here is the higher-level hire can join and focus on thinking strategically about the business because we are handling the day-to-day financial operations of the management company.”

One of the most common selling points for industry outsourcing is making sure that senior staff gets to focus on matters that only senior staff can tackle.

This is not to say that service providers don’t have their own ambitions. Bruno stressed that given the depth and breadth of their experience with so many different GPs of so many sizes and vintages, they can offer higher-level counsel as well. “From what we see, we can be of tremendous help in sharing various industry benchmarks, such as profitability metrics, and even suggesting other vendors for needs not addressed by us, and that’s simply because of the everyday expertise and experience of serving our clients,” says Bruno.

No one can be surprised that administrators would eventually aspire to more sophisticated services, as the overall culture of private markets is one devoted to growth and innovation. And in a climate that demands GPs up their game, service providers have little choice but to rise to the challenges of the day.