4 considerations for outsourcing private equity fund administration

Synergy between internal and external teams is perhaps the biggest determinant of success.

Finding the right match depends on several key factors

Outsourcing of fund administration in the private equity industry has experienced a dramatic upward trend in recent years. In less than a decade, the percentage of U.S. middle market private equity firms using a third-party fund administration solution has increased from around 25% to nearly 60%.

The factors driving this trend are well documented and numerous. With the limited partner community fully embracing the outsourcing of fund administration, and with so many fund managers and chief financial officers having now adopted outsourcing in some capacity, there is a growing realization that handling everything in-house can be a waste of precious resources. This belief has gained further traction in light of the growing talent shortage, rising costs of technology, and overall economic and human capital commitment required to maintain an in-house accounting and administration team.

Fund administrators invest considerable time and money into implementing sophisticated technology, refining their reporting and business processes, building dynamic investor dashboards, incorporating tax-related functionality, and developing career paths for everyone on the fund accounting team. When taking these costs into consideration, outsourcing can make good business sense, particularly for emerging managers.

There are many benefits to outsourcing—such as access to industry best practices (e.g., Institutional Limited Partners Association principles), innovative technology solutions, and experienced talent—which together can work to lower a private equity firm’s operating expenses. However, synergy between internal and external teams is perhaps the biggest determinant of success. This article explores four areas that private equity fund managers and CFOs should consider before hiring a third-party provider to handle fund administration and any additional advisory responsibilities.

1.    Depth of experience and industry focus

While the market is flooded with fund administration vendors, the list narrows if limited to providers with substantial experience in private equity. Given how important this function is to a fund’s long-term success, selecting the right provider is vital.

Finding a good fit starts with getting to know the potential provider’s engagement team, including each team member’s level of industry experience and technical knowledge. In addition, the provider should demonstrate that it has the depth and breadth of resources needed to support fund administration in the private equity space.

Key questions:

• Is the provider’s engagement team forward-thinking on issues affecting private equity—including environmental, social, and governance concerns; pending regulations from the Securities and Exchange Commission; considerations related to tax/generally accepted accounting principles; and new developments and trends involving the ILPA?
• Does the team understand the investment structures of the private equity firm, and are team members confident in building these structures, in all their complexities, into the firm’s technology platform?
• Does the team understand the critical nature of investor reporting?
• Who will handle the onboarding of funds, and has the team previously onboarded clients with similar structures and levels of complexity?
• Would the provider’s team members qualify to work in the private equity firm’s back office?

2.    Corporate culture and talent management

A strong bench of talent is usually the product of a healthy corporate culture, which breeds happier employees who foster customer loyalty. To better understand a potential service provider’s values, it is worth inquiring how the company engages and supports its people and clients.

A private equity firm should also consider its need for short- and long-term strategic planning and how a potential provider would support these goals. Understanding the provider’s organizational structure and who performs what (and from where) will provide valuable insight into the level of service it can provide.

Key questions:

• What is the provider’s employee turnover and client retention rate?
• How does the provider promote, compensate, motivate and cultivate the success of its employees?
• How many clients will the engagement team serve concurrently?
• Does the provider leverage remote work strategies for its employees?
• Is the provider a regular or potential participant in mergers and acquisitions, and how does that affect its approach to strategic planning?

3.     Technology innovation and competitive advantage

The future of all back-office functions is digital. Fund administrators that have previously relied on manual processes are now embracing technology to automate workflows, reduce costs and free up their time to focus on higher-level tasks.

It pays to work with an innovative provider that leverages technology and other strategies to deliver tailored fund administration services and scalable processes. Getting a complete picture of a provider’s technology setup will show the potential competitive advantages that a technology-minded fund administrator can offer.

Key questions:

• Does the provider use a leading private equity technology platform, a proprietary system, or a combination of both? If multiple platforms are used, are they integrated or do they need to be reconciled?
• How comprehensive is the provider’s technology solution—e.g., is it front-to-back or is there a single point of data entry?
• Can the engagement team produce an extensive list of customized reports?
• How does the team perform waterfall calculations and prepare working papers?
• What tasks are automated versus Excel-based?
• Do the team members leverage work collaboration tools and document-sharing technology, or do they still rely heavily on email to facilitate processes and workflows?

4.     Commitment to quality assurance

Even the best people and technology are not foolproof, which is why effective oversight is necessary. Fund managers and CFOs should ask a potential provider about the resources it dedicates to quality assurance and the system controls and processes it has in place.

Key questions:

• How does the provider’s engagement team review capital calls before they are executed?
• How are system-generated limited partner emails reviewed before they are released?
• How are distributions calculated and signed off by the private equity firm and the potential provider?
• How are financial statements reviewed and approved?
• Can the team produce an example of a recent security operations center report?

While not a definitive list, these four considerations will help steer the decision process for outsourcing the critical function of private equity fund administration. With the right people, processes, and technology, fund managers can build a virtual advisory dream team to best position the firm for continued success.