Three misconceptions about management company administration

Certain beliefs – like in-house staff will be sufficient in the long run – may have been true in the past, but no longer are the case.

Common wisdom – by its intrinsic ubiquity – can be rather convincing. But common wisdom will not stay wise if it ignores new evidence that disproves the assumption. GPs appreciate this, given how often they stress test the assumptions made in an investment case. Indeed, that institutional skepticism is often a point of pride for fund managers who are busy building proprietary dealflow by questioning that which “common wisdom” has rejected.

But there are only so many hours in the day, and today’s GPs are already trying to cram a 25th hour into their schedules. With so little excess capacity, the (seemingly rudimentary) administration of the management company plows along unexamined. This can leave managers assuming it can be easily handled by the in-house finance staff; that if they outsource that administration, the service provider is there to provide an extra pair of hands and nothing else; and that there’s no cost in delaying upgrades. But these three assumptions are largely incorrect.

What complicates matters is that these misconceptions have some semblance of truth. The in-house staff can indeed handle it – many have done so for decades. Service providers do offer manpower. And the saving made for delaying an upgrade may be worth it, if there simply isn’t the budget to tap a third party or some sophisticated platform – especially for those managing a debut fund, when the firm might be held together with shoestring and one wheezing printer for pitch books.

But these assumptions do obscure the reality of administering the management company today. In-house staff can get overwhelmed as the firm’s AUM swells. Saving money on the management company at the launch of a firm can eventually cost plenty in time and money when it’s time for an upgrade. And today’s service providers aren’t just offering a pair of hands, but expertise, given that GPs often don’t have the spare time to master the nuances of the management company themselves. Here are three common misconceptions:

In-house staff will be sufficient in the long run

The firm can tackle the management company administration in-house when it’s a matter of a couple of funds, with a small staff. But even at the launch there’s a lot to be done. The problem is that it can be hard to discern when the size or complexity of a fund begins to tax the internal staff, until it’s already overtaxing them. They may be working through the weekends to prep that quarterly report. They might miss a filing deadline, which may not be a serious error, but it’s indicative of a sloppiness that might produce more grievous mistakes. They might misallocate fees or expenses, which the Securities and Exchange Commission doesn’t look too kindly on these days.

And this burden courts other downstream consequences, as the internal finance team neglects other duties to keep up with management company demands. The trickiest part of this is that these crunch times might not be constant, but it’s important to pay attention when they arrive. Hiring more people might not make sense either, as there isn’t always a steady volume of work to warrant another person to manage.

Then there’s the matter of in-house tech, which at the launch of a fund could be an updated version of QuickBooks. That might do the trick to start, but that consumer grade software likely won’t be compatible with what a fund administrator is using. And a firm that’s using QuickBooks for the management company will likely be outsourcing their fund administration, precisely because they don’t have the resources to do that internally.
That incompatibility requires many more manual processes when exchanging data between the funds and the management company, which slow things down and risks more human error. There’s no easy flow of data between the funds and management company, and that doesn’t get any easier with additional volume or new asset classes.

Outsourcing only solves the labor problem

As much as this makes the case for outsourcing the management company administration, it’s not quite that simple. Yes, the internal staff will be freed up to focus on higher level work, and someone else will be left to sweat maintaining and upgrading the technology in play. But GPs should expect service providers to offer far more than an extra pair of hands. A service provider for the management company should be a collaborator, advising on best practices they’ve cultivated over years with other clients, and helping clients to plan their future, and not just service the present.

The best service providers are thinking two or three steps ahead and working with the internal staff on any tax or regulatory change on the way. The GP shouldn’t be aiming to merely get the work off their desk but finding the best way to manage these tasks. It’s true that a lot of management company work is straightforward, but in the event of a question, GPs should be able to trust that their vendor will offer an informed answer. After all, how else will they avoid the kind of “common wisdom” that’s already out of date?

There’s no cost to delaying institutional grade servicing for the management company

All that QuickBooks data adds up over time. It might not seem too much of a burden, until of course, there’s an audit, which often will review the firm’s activity all the way back to day one. Suddenly, the team’s frugal approach doesn’t seem like such a bargain. A recurring theme among private equity CFOs we spoke with on the matter was the value in starting out with the best processes, protocols and systems possible, because it will always be a pain to upgrade later, specifically due to training staff and executing a massive data migration project. Service providers will be happy to take on that onboarding, but they won’t do such a thing for free.

For more mature firms, they might have invested in a powerful tech system early, only to discover that it was expensive or difficult to upgrade. Switching systems still requires a laborious onboarding process, not to mention additional training for staff, which even if it means less work in the long term, will be one more thing they have to find time to do. And as with the question of in-house staffing, it’s hard to predict when that tech solution will be overwhelmed by the task at hand. These issues drove the popularity of outsourcing fund administration, and it looks to be doing the same at the management company level.