Private funds service providers have good reason to swagger these days. The outsourcing boom continues, with plenty of GPs singing service providers’ praises for their high-quality products and cutting-edge technology.
Nobody is eager to build massive internal teams to cope with a firm’s growth or complexity. More often than not, outsourcing makes sense from a fiscal and strategic standpoint.
The growth of the outsourcing market is undeniable. As part of its latest proposals to dig deeper into outsourcing contracts, the US Securities and Exchange Commission found that over three quarters of private funds use at least one third-party administrator. This fact no doubt played a role in the regulator’s proposed rule that would require managers go through a six-step check of service providers before outsourcing any “covered functions” – a development that may strike managers as ironic, given that many are outsourced to cope with the burden of regulatory compliance.
But the reality of the GP-service provider relationship is a little more complicated when you dig beneath the surface. The bespoke nature of private fund managers – the very thing that makes universal LP reporting standards so difficult to establish – means operations look vastly different from firm to firm.
Some GPs have full faith in outsourcing, moving everything they can to an external provider to allow internal staff to focus on core competencies. However, even they are adamant about making sure that at least one in-house staff member is responsible for managing those service providers.
Other firms are early adopters that have expanded their outsourcing budgets as their AUM and compliance complexity increased, while some are still making their first foray into outsourcing, as much to address internal talent issues as workload increases.
“We’re outsourcing everything possible at the moment”
Monitor Clipper Partners
But outsourcing skeptics remain. Some of these naysayers are finding that the current crop of providers still aren’t worth the price as well as the difficulties of transitioning to an outsourced solution, while others have found a way to construct an internal team that can handle it all. They tend to be the exceptions to the rule, and the future remains bright for service providers even if they face serious competitive headwinds in the years to come.
Private funds don’t thrive by standing still, and they expect their providers to match them in their commitment to innovation.
Right now, service providers have the wind at their backs. “It makes sense [to outsource],” says Melissa Dickerson, CFO of Genstar Capital. “Outsourcers have simply gotten better, offering good value, services and solutions, with reliable internal controls and cutting-edge technological tools.”
CFOs cite the usual culprits as reasons for their increased outsourcing habits: impending regulatory requirements, LPs demanding greater speed and transparency for their information, the competition for capital and pressure on returns. Such challenges are being further compounded by the general market uncertainty that is currently dominating global economies, putting additional pressure on managers to remain economically sound.
“We’re outsourcing everything possible at the moment,” says longtime CFO April Evans, who is currently working with two recently launched firms. “We didn’t used to do this, but with these new funds, it makes sense for them to focus on their core competencies.”
Technology is a huge part of the value proposition for Evans. “By outsourcing, you can readily obtain quality IT services, with the security that the industry demands.”
But this penchant for outsourcing doesn’t translate to a ‘set it and forget it’ attitude. “Someone [internally] needs to be responsible for managing and maintaining the relationship with the service provider,” says Evans. “If not, the best efforts will be ineffective, either a waste of time or, at worst, a major mistake.”
Victory Park Capital has been outsourcing since its inception, but with the idea that service providers would truly be an extension of the internal team.
“We outsource to leverage expertise,” says the firm’s chief operating officer, Jeff Schneider. “That means when we registered with the SEC, we’d need a compliance program. We didn’t outsource our chief compliance officer, we appointed one. And when we tapped an outside compliance consultant for feedback and guidance, it was because they were closer to the regulatory trends underway.
“We have a fund administrator, but we also have fund accountants. Because nobody will truly understand the business as well as our employees do.”
There are limits to how much Victory Park is willing to delegate outside of its walls. “Connecting and communicating with our investors are the lifeblood of our business, and everything goes through our investor relations team before reaching our investors.”
Schneider also makes a point of encouraging internal staff to offer constructive feedback on service providers. “We make sure there are escalation points, so if anyone on the team feels that the level of service has declined below what’s acceptable, it’s raised to senior management as quickly as possible.”
The outsourcing experiment
Although several CFOs admit it may be easiest to outsource at a firm’s founding, “it can be daunting to outsource existing fund structures that have a lot of complexity, history and data to transfer over to an outsourcer,” says Genstar’s Dickerson.
“Any internal upgrade of software requires a similar amount of heavy work. If one is considering a software platform upgrade, one should consider outsourcing as an alternative – I find it’s the same amount of work for either.”
That burden hasn’t discouraged managers, with many looking to outsource for the first time in their firm’s history. Lisa Costello, who was CFO at HCI Equity Partners from 2004 to 2022, had resisted the urge to outsource until very recently.
“It just didn’t make sense for us until now,” she says. “In-house administration worked well, and we couldn’t be sure which players would be around long term. Cost is also a factor.”
The lower mid-market firm continued to administer their own funds with an experienced team. HCI Equity Partners is, Costello explains, a fairly “straightforward operation” with US-based investments, $1 billion of AUM and traditional investment structures – factors that gave the team the ability to manage its funds in-house.
Costello and her team also periodically evaluated upgrading in-house software solutions like so many of her peers and found the options to be cost-prohibitive, with some platforms costing tens of thousands of dollars and requiring dedicated resources to learning and maintaining the system.
Over this same period, however, the private equity industry became increasingly complex and more competitive, with firms under more scrutiny from investors and regulators alike.
Costello started thinking of outsourcing as an additional resource as the firm grew and as a component of an eventual succession plan. HCI chose a service provider that had earned rave reviews from Costello’s industry peers and a long track record, reassuring her they would likely be around for years to come.
With additional resources to help administer fund accounting and reporting functions, HCI was able to promote Costello to the role of chief administrative and compliance officer and her colleague Amy Stremmel, who was responsible for the day-to-day accounting and tax function, to the role of CFO and director of compliance. These new roles served as a way to retain two veterans by engaging them in more challenging and rewarding work.
Outsourcing skeptics can be hard to dissuade, especially if they have a long history of successfully managing things in-house. Adam Weinstein, COO and CFO of New Mountain Capital, was one such skeptic. But when the staffer who handled their management company administration retired, Weinstein thought it was worth tapping a provider for the day-to-day processing of the management company’s accounts.
“That experience really opened my mind, especially as I saw their process at work,” says Weinstein. “With so many clients, service providers can invest, maintain and upgrade their technology in a way we never could alone.”
For Weinstein, outsourcing represents an upgrade in services, not a replacement.
Keeping it in-house
But some are still outsourcing skeptics. Jill Lampert, CFO and chief administrative officer of NGP, has kept her operations in-house to this day. When she started at NGP in 2007, everything was done in-house, but the firm was embarking on its biggest fundraising effort to date and decided to outsource.
“It was an utter disaster,” Lampert says. “There were so many errors in the calculations that we had to shadow the third-party administrator a hundred percent of the time.”
They brought administration back in-house, and since then, Lampert has explored outsourcing options. “Since we don’t charge our fund accounting to the funds, outsourcing never made financial sense,” says Lampert.
While Lampert may have avoided outsourcing, she has gone all-in on technology, having made it her mission to make the most of the systems and software already in use instead of searching for a new, shinier silver bullet solution.
“We are very focused on leveraging our current technology, with the ambition of automating as much as we can,” she says. Her internal team has stepped up on this front, with one staffer having taught herself computer programming. That staffer is now using code to pull together and deliver portfolio information.
Lampert credits her team for making outsourcing irrelevant. “We hire good people and pay them properly, which is key,” says Lampert. Noting that her outsourcing service providers struggle with turnover, Lampert says: “We give talent a reason to stay.”
Today’s administrators promise to make turnover irrelevant by having a whole team on hand for any given account, but if outsourced talent is an extension of the internal office, it can still be disruptive when that point of contact leaves a service provider.
There may, however, be no way to get around this disruption, as any worker worth having is a worker worth missing.
However, Lampert’s approach is an outlier in today’s market. Most firms are happily outsourcing administration and tapping expertise from all kinds of tax, compliance and tech consultants.
“It is always going to be hard in a high-performance culture to get anyone to do the lowest level work,” says Weinstein. “With a service provider tackling those duties, internal staff gets the chance to grow.”
No one expects their asset class to get simpler, less competitive or less regulated, so service providers can rest assured demand won’t dry up.
But expectations will continue to rise. Managers, even those happy with their outsourcing, are looking to a future that is even more streamlined and rigorous.
Several CFOs who currently outsource bemoan the limitations of the current tech offerings, which still can be labor intensive or hard to integrate into a single system. This does not, however, mean that any of them are looking to build their own tech internally instead.
Evans imagines that private fund services will soon consolidate in some form, so instead of having multiple vendors with multiple contacts to manage, there will instead be one or two key contacts to manage as one-stop providers emerge on the scene.
Others are looking to new technologies to address the pain points that remain. Victory Park’s Schneider says he is hoping to outsource legal entity management and tracking soon to avoid the high cost of leaving legal entity construction and compliance to the lawyers.
While service providers have earned the right to swagger some, they’d best not rest on their laurels, because their clients certainly aren’t.