Chief financial officer, Blue Wolf Capital Partners
Cherry-Seto is CFO at Blue Wolf Capital Partner, a mid-market control buyout firm focusing on challenging situations and complex relationships between business, customers, employees, unions and regulators to build value for stakeholders. Sectors include healthcare, forest and building products, energy services, and industrial and engineering services. The firm manages about $1.5 billion in assets.
Partner, chief financial officer, chief administrative officer, TZP Group
Michael is a partner, CFO and CAO of the TZP Group, which focuses on investment in consumer and business service companies. TZP, which has raised $1.4 billion since inception, invests in companies with EBITDA between $10 billion and $35 billion and up to $10 billion with their Small Cap fund. Michael joined 12 years ago. She was previously the chief executive of a family owned business and earlier served at Warner Publisher Services where she was a vice-president and treasurer.
Managing director and regional head of North America, SANNE
Steinberg is regional head of North America at SANNE, a company offering fund administration, corporate administration, investor relations, treasury and portfolio monitoring services. Listed on the London Stock Exchange, SANNE has about $300 billion in assets under administration. Steinberg joined SANNE in 2017 from Morgan Stanley, where he held the position of executive director in finance, overseeing and supporting closed-ended alternative asset funds.
Chief financial officer, Veritas Capital
Donner is the CFO of Veritas Capital, a private investment firm that invests in companies providing technology-enabled products and services primarily to government customers. The firm recently closed its sixth fund on $6.5 billion, bringing its assets under management to approximately $18 billion. Donner previously worked for a fund administrator where he co-managed the organization’s institutional private equity sponsor group. He also served as controller at Swiss Re’s PE division and started his career working in public accounting.
As limited partners have ramped up the intensity of their focus on private equity firms’ finance and operations functions in recent years, the role of CFOs has increased dramatically too, extending, for example, into fundraising and due diligence processes.
As a result, CFOs are surrounding themselves with bigger teams of experts and more are also now relying on outsourcing activities to third-party administrators and service providers to help relieve some of the pressure that comes with a broader, more visible and front-facing role within the firm.
According to the Private Funds CFO Insights 2019 survey, more than 70 percent of respondents report LP interest in operational functions has seen an increase over the past three years. Only 28 percent of respondents said LP interest has remained the same. In particular, US institutional investors, foreign investors and tax-exempt investors have conducted greater due diligence over the last three years, increasing demand on GP operations, according to the survey. “I spend more of my time on fundraising now because of the increased focus on operational due diligence than there had been for earlier fundraises,” says Sheera Michael, CFO and chief administrative officer at TZP Group. “Large investors and even some family offices have hired third parties to handle their operational due diligence.
“The due diligence questionnaires have become more complex over time and include more sections on finance and operations. This requires the CFO’s involvement.”
It’s not just the CFO but the whole operations team that has become more involved in the fundraising process. Mid-market firms have hired dedicated investor relations heads to lead efforts, and LPs often ask to meet the whole finance team during due diligence, including junior employees in addition to the C-suite. That’s true in LPs’ routine visits as well.
“In the past when they visited, they met with the deal teams to review the status of the portfolio companies,” says Michael. “Now, it’s common for them to also ask to meet with me at the end of the session for an update on the operational areas.”
LPs mostly ask questions around operations, and controls and processes at the firm. “The CFO’s role during fundraising has evolved from data gathering to a critical focal point,” says Jason Donner, CFO at Veritas Capital, which recently closed its sixth fund on $6.5 billion.
“During our latest raise, I had in excess of 60 meetings or calls with investors on a variety of topics including operations, internal controls, economics, work environment and culture of the organization. Our role has become front and center. Ten years ago, other than processing information, I was not meeting the majority of prospective investors.”
LPs and intermediaries’ inquiries are often more than just tick-the-box questions. They are specific and regularly follow up with GPs on action items, including cybersecurity preparedness or ESG policy, or whether the Securities and Exchange Commission has knocked on the door since they last spoke. As a result, LPs’ focus on GP operations has become more regular and doesn’t take place solely during fundraising but has become ongoing.
“Many of our existing investors have dedicated operational due diligence professionals who perform ongoing operational due diligence every 12 to 18 months,” Donner explains. “They typically want to speak with different teams, including finance, compliance, investor relations and technology.”
Michael adds: “In the past, institutional investors would only conduct operational due diligence before they made an investment in the fund, and now some of them reach out on annual basis. Their follow-up questions include areas such as cyber security, IT and the status of any SEC exams.”
By extension, consultants and fund administrators like SANNE are also an intrinsic part of the due diligence process and of the ongoing touch points between fundraises.
“There has been additional focus on controls and processes,” says Michael. “If you use outsourced vendors, they often will reach out directly to the third-party firms.”
“They want to understand what our controls are and how we operate,” adds Fred Steinberg, regional head of North America at SANNE.
“What we keep hearing is the need for independence. They want to know we’re not just acting as bookkeepers for our clients but that we’re making sure things make sense, that we have a direct relationship with the firm’s auditors, that we’re always in touch with our clients, and that we have the right checks in place.”
Fund administrators often help their clients fill out due diligence questionnaires from prospective investors. “We also help support or attend annual meetings with our clients where they report back on a full array of questions to their current investors,” says Steinberg.
LPs are also focusing their questions on valuations and how fund managers are handling them, according to the survey, as more than 70 percent of respondents say LPs’ questions on valuation during due diligence are the most detailed, above compliance, IT and business continuity.
At the demand of LPs, but also to alleviate the pressure, CFOs have increased their reliance on outsourcing especially in complex areas where they might not be experts.
According to the Private Funds CFO Insights Survey, the most outsourced function is tax, with more than 97 percent of respondents relying on external third-party support, followed by technology (73 percent) and fund accounting. The experience of the CFOs around the table confirms the data.
“In private equity, it’s been a more recent push,” says Joshua Cherry-Seto, CFO of Blue Wolf Capital Partners. “It feels like the market is moving a little bit where investors are just more comfortable that you’re using somebody as a third-party review on some level. LPs in our last fundraise seemed to appreciate that we used a third-party firm, and I do feel that the market is moving towards a preference of having a third-party look like most of the alternative asset class already.”
When to outsource
Outsourcing makes sense for smaller funds that may not have the capacity to administrate their fund in-house, while LPs may have more confidence that the larger managers have the means to build the necessary processes in-house.
“In my opinion, institutional investors are more comfortable investing in small funds if they have a third-party fund administrator reviewing the financials,” Michael says. Steinberg explains that SANNE has both large and small clients, and that he sees growth coming from the small new funds.
“It’s those guys that are first coming to the market,” he says. “They came from established institutions and they’re used to having a fund administrator. The other prospective clients are those with first- or second-time funds. Their first fund wasn’t so big, so they took care of it in-house, but once they reach a certain scale, they see the potential to build efficiencies with us.”
The topic of utilizing a fund administrator was discussed during Veritas’ latest fundraise. Donner sees a couple of benefits for contemplating the move.
“One is the added benefit of institutionalized processes and controls,” he says. “Investors want to know there’s an independent third party checking the data. In addition, it is important for our team. By eliminating some of the processing from their responsibilities, their jobs are more challenging and rewarding.”
Cherry-Seto adds that Blue Wolf’s fund administrator has allowed his firm to provided assistance on the tax front as well. This has been meaningful considering the firm does a lot of flow-through structuring in its transactions, which brings complexity and lots of entities for reporting from a tax perspective.
However, Cherry-Seto points to the fact there used to be a lot of turnover at fund administrators, which forced GPs to reteach the specifics of their firm to the administrators every year. This is changing.
“I think over the last few years, it has become more relationship-driven in private equity, where there are more CFOs coming out of our space and working on the administrator side, where you feel like it’s somebody who understands the business and is almost virtually in the room,” he notes. “They are thinking about the challenges we are facing, as opposed to just processing transactions. That continuity and partnership is important, and I think the market is doing a better job.”
Another deciding factor in outsourcing to a fund administrator is their increased capacity to invest in technology over the past few years, offering greater options to firms, especially in the mid-market.
“It is critical to us to keep a finger on the pulse on all technological changes to assess their likelihood and/or importance,” says Steinberg.
“Given our size and the systems we use, we look to invest in the changes that can disrupt our industry. We can offer more client support via portals as an example, where we can white list the portal for them. We’re constantly looking ahead to what’s next coming down the road.”
In a galaxy five years away
New technologies, including artificial intelligence, robotics and automation, could revolutionize the world of private equity, facilitating deal sourcing and assisting portfolio management.
But they are still far into the future for the majority of private equity asset managers, according to the Private Funds CFO Insights Survey.
Asked how close they are to adopting these cutting-edge technologies, a vast majority of respondents – 70 percent for AI, 76 percent for machine learning tools, and 79 percent for robotic process automation – say they have yet to review them. Between 16.5 percent and 28 percent of respondents are evaluating these technologies, while very few – under 5 percent in each of the three categories – are already implementing them.
Based on the survey, 53 percent of respondents believe the greatest impact of AI on private equity will be seen in five years, while 43 percent believe it will be in 10 years.
Those currently implementing it are mainly some of the largest players dealing with multi-asset strategies and portfolios.
“It depends on the size of your firm and what you are willing to do,” Steinberg says. “AI and robotics have more potential for the larger players and in the fund of funds space, where the sheer volume of paperwork makes it more critical. It’s more on the asset manager side, where the volume can be overwhelming.”
Through the portal
Steinberg stresses the added value of portals, particularly for GPs. “Portals are growing in importance. People always talk about what you give to your investors. What we’ve found interesting is that when GPs offer investors all these bells and whistles, they don’t use it as much you’d think they use it. What we see becoming much more important are portals for the general partners to supply them with all of their data at their fingertips. That’s what we’re working on now as that’s where we see the industry going.”
Donner agrees there is a need for easily accessible data for GPs.
“That’s very important to us, especially when we’re self-administrating existing funds and fund administrating a newer fund, as we want to be able to report consolidated across all of our funds and we need to have that information,” he says. “Leveraging technology is a top priority for the organization. We collect a lot of data and now are looking for opportunities to use this data to support our investment process and streamline internal procedures.”
Veritas has a number of projects in the pipeline including building a collaboration and workflow tool to interact with its portfolio companies, and an upgrade to its CRM and deal pipeline systems. It also hired a director of IT in early 2019 to support these efforts.
“Our fund administrator prepares quarterly IRR reports and waterfalls for our review. A software that could produce these reports quickly on demand is on my wish list,” concurs Michael.
It’s clear that small but targeted improvements in technology could enhance the work of CFOs even further. For now, most GPs continue to rely on existing software and Excel spreadsheets, but the tech revolution in private equity could change the game in the next five to 10 years.
Courting new LPs
With funds getting larger with each vintage, GPs have only a few options to find the additional needed capital
According to our CFO survey, nearly 65 percent of respondents think their firm’s next fund will be larger than the current vehicle, while only 27 percent believe it will be the same size and 8 percent predict it will be smaller.
One option in the hands of private equity firms is to have existing LPs reup and increase their commitment. That’s not always a possibility or might not always constitute enough capital. Another way is to bring in new LPs, but this can be tricky. Survey respondents report that finding new investors to back the fund is one of the biggest challenges associated with raising a larger fund.
“It takes years to build these relationships,” says Michael. “Most large investors would like to see a track record over time before they commit.”
“That was a big change for us, to actually figure out how to programmatically onboard prospective LPs,” says Cherry-Seto. “Just in this last fundraising round we got to a size where we can talk about how we are onboarding people to track and watch us. That wasn’t really a reality when we had a $300 million fund and half a billion under management. But once over $1 billion people want to follow you.”
GPs need to forge ongoing communication with prospective LPs, and often invite them to attend annual general meetings, which allows LPs to follow them. But it can be even more challenging if the GP is looking to geographically diversify its investor base and to bring in new LPs from overseas.
“As organizations grow, they need to develop investor relationships outside of the traditional investor base,” Donner adds. “You need to build these relationships over multiple years and fund cycles.”
It can take several years before investors invest in a fund, particularly those in Asia, which stresses the need to cultivate relationships with prospective LPs.