Emerging Managers Cannot Overlook the ‘Business of the Firm’

Authored by: Jeff Gendel, Principal, Business Development
Updated on: December 12, 2024

The past several years have seen a proliferation of new private equity managers. Whether spinouts from established firms by experienced dealmakers or new ventures by investment bankers, family office-backed groups or industry professionals, these emerging managers bring new ideas and are a welcome source of diversification for LPs eager to deploy funds.

At the same time, these managers are often unprepared for the challenges and obligations of firm operations that they were never responsible for previously. If not planned for appropriately, these functions can distract from dealmaking, undermine LP confidence and derail an otherwise promising fund.

Emerging managers should not be surprised when they are expected to provide reporting and transparency on par with larger competitors. When they walk into a meeting with an LP or adviser, they will be asked about things they have never had to respond to before. Someone on the other end of the table always dealt with those details at their predecessor firm, but now it’s their responsibility, and they need to take it seriously.

When GPs were asked about the factors they believe LPs prioritize when assessing the track record of emerging managers, only 16 percent named transparency and reporting. But when LPs were asked about issues that are most critical to their organization, 41 percent said GPs’ reporting format and standards. These two responses highlight the fundamental disconnect between perceptions of the importance of reporting by GPs and LPs, and GPs should take note.

In a challenging environment where economic uncertainty and greater competition have led to long fundraising periods and a slower dealmaking pace, it is critical for GPs to be aligned with LP priorities – especially so for emerging managers, which face greater hurdles. In 2024, 43 percent of emerging managers met with 150 or more prospective LPs in their fund raise, compared with just 27 percent in 2023. And 45 percent of emerging managers said it took five or more meetings for those LPs to commit, up from just 27 percent in 2023.

LPs are well aware of this dynamic. When asked about overall sentiment toward emerging managers, 75 percent of LPs strongly agreed or agreed with the statement that established managers get the bulk of the capital and LPs are much less enthusiastic about emerging managers. Similarly, 56 percent strongly disagreed or disagreed that LPs are willing to back new managers with compelling products.

This data and the operational due diligence questions that we get from institutional LPs investing in private equity make it clear that emerging managers’ focus on the ‘business of the firm’ is as important to their success as great dealmaking. Showing strength in the five areas highlighted below will build LPs confidence that your firm and its fund administration partners can deliver today and scale with them for the future.

1.Transparency & Reporting

As the survey results demonstrate, the quality of reporting and overall transparency may be more important than emerging managers think it is. LPs want more details, more frequent reporting, and greater clarity on every aspect of the fund and how performance is measured – the same clarity they receive from well-established PE firms.

This trend that built slowly over time was accelerated last year when the SEC was pushing for new regulations. While the new rules were never implemented, their invalidation by the courts did not change LPs’ minds about the information they want from their managers.

As this is being written, the Institutional Limited Partners Association (ILPA) is working to finalize a new Reporting Template and new Performance Template that will set a new bar for fee and expense reporting and compliance disclosures. Backed by more than 600 LPs – including some of the largest and most influential – these are likely to become the standard, despite not being enforced by the government. Gen II has been actively engaged with ILPA’s Quarterly Reporting Standards Initiative and assisting in the development of these new reporting templates.

While these new disclosure requirements may be somewhat onerous, they also present a rare opportunity for GPs to differentiate themselves. Being slow to enhance reporting, meeting only the bare minimum, or partnering with an administrator unable to support these new disclosure imperatives sends a clear signal that delivering the transparency LPs asked for is not a priority.

Similarly, the emerging manager that can deliver expanded analytics, is responsive to requests for new data and reporting, and can offer a ‘single pane of glass’ to easily view data, not only stands out from the pack, but demonstrates that they are thinking strategically about the next funds and long-term partnerships with LPs. LPs have told us that they are not willing to trust a crucial process such as fund administration to untested firms that haven’t been able to demonstrate proficiency in that side of the business – viewing it as an unacceptable risk.

2.Cybersecurity

With the continued growth of ransomware and data breaches globally, it’s no surprise that cybersecurity is a big focus for LPs these days. While moving to the cloud has dramatically improved industry security and made world-class security more accessible to emerging managers, it also raises new concerns for LPs. They want to know their managers are buttoned up with respect to data protection and have all of the layers of security that they require. Many LPs may be skeptical that emerging managers have the scale or resources to deliver.

The biggest risk when it comes to cybersecurity remains very low- tech: human error. With so many people working from home in the wake of the pandemic, the threat level has only increased. Even the most conscientious employees occasionally let down their guard.

That’s why a Zero Trust strategy – a new high-water mark in cyber protection that requires validation for every digital interaction – is a must. It’s a shift from the strategy of ‘trust but verify’ to ‘never trust, always verify’, and is designed to remove the ability of bad actors from exploiting errors in judgment. And its why Gen II deploys state- of-the-art technology, best-in-class cyber-monitoring and protocols, regular network vulnerability testing, and constant staff training to stay one step ahead of bad actors. It’s also why we maintain robust SOC II Type I & II, ISO 27001, NIST-SEC Cybersecurity and NY SHIELD Compliance, among other industry-leading protocols.

By employing continual vigilance, carefully limiting data availability and cutting off avenues for data to ‘escape’ (no sending of attachments, no printing at home), emerging managers can assuage the concerns of LPs. With so much at stake, and a constantly evolving threat environment, it’s incumbent on GPs to choose partners that bring the best possible defenses to bear and relentlessly demonstrate their commitment to cybersecurity excellence through continuous investment in their people, processes and technology.

3.Data Accessibility

If quality reporting is job one for LPs, greater access to all aspects of their fund data and analytics is a quickly growing second priority. LPs today have more questions that demand greater data accessibility – we know because we hear from them directly. Even emerging managers are expected to provide transparency that enables investors to track their investments, projections, and returns to streamline communications.

Increasingly, that means on-demand access and visualization of fund data in aggregate and drill-down analysis for efficient performance reporting.

In some ways, emerging managers have an advantage as they are generally not burdened with legacy systems that house data in different formats and don’t speak to each other. However, every firm needs to plan for data transportability. A no-code solution that enables managers to effortlessly integrate fund administration data with both in-house and third-party platforms and optimizes data utilization, is required for operational efficiency.

 Similarly, a solution that automates data retrieval will ensure everyone on your team is working with current information and that they can deliver responses to ad hoc LP requests easily. Based on our decades of conversations with GPs – understanding their pain points and where they needed better solutions – Gen II developed the Sensr suite of technologies, which set a new standard in on-demand access, visualization, and drill-down analysis of fund data; integration with in- house and third-party platforms; and secure collaboration between attorneys, sponsors, and investors.

4.Technology Investment

Cloud platforms, advanced analytics and artificial intelligence are reinventing how business is done across the financial services sector, and the promise for transforming fund administration is no exception. While it’s early days for some of these technologies making a true impact, emerging managers must be investing in and incorporating them into their operations. While the core importance of talent and reporting rigor remains unchanged, technology is key to thinking critically about enhancing operations.

Gen II recently won an engagement with an emerging manager that reviewed 12 fund administrators. In their analysis, it was clear we had invested a significant amount in technology that enabled us to solve the major pain points that private equity firms and finance and operations teams have. More importantly, because of our investment in technology, they had confidence in our ability to solve in the future.

Forward-thinking emerging managers know that while they may not deploy a particular technology suite in their first fund, it will be beneficial for fund two, three or four as the reporting bar is raised and they rely more heavily on their fund administration team to efficiently navigate new demands. Gen II will continue investing in efficiencies in our market – prudently incorporating AI or other emerging technologies into our processes.

5.Integration & Scalability

With growing demands, and increased complexity due to issues like different terms for anchor investors, continuation funds and secondaries, and expansion into different asset classes and transaction types, the need for all firm operations to be tightly integrated has never been more evident. While the ‘core service’ may be capital calls and periodic disclosures, effectively executing on the mandate to do more often comes down to the scope of what your fund administration can do and how well your team and outsourced partners play well with others.

Does your fund admin compliance team work well with attorneys? How have they kept up with the sub doc review that is becoming a bigger portion of the work because it is expensive for lawyers to complete and manage the corresponding paperwork? Can your team do the investor onboarding that the legal team isn’t interested in? What about tax prep? The integration of these services into one tightly organized and cost-effective machine can make a huge difference in serving LPs and managing the business.

This is more than just technology and talent. Building a partner relationship with your fund administrator vs a mere vendor relationship is critical. True partners go above and beyond paperwork to educate, advise, help build expertise and think through difficult questions such as how much to disclose and which banks to use. Emerging managers recognize this, with 89 percent responding that the ability to provide strategic guidance and advice beyond core service was important. Good fund administrators go above and beyond and provide a competitive edge to their GPs.

When you walk into a due diligence meeting, being able to confidently say to LPs that not only the dealmaking, but the business of the firm is in good hands, is essential. While emerging managers will continue to navigate macroeconomic as well as competitive challenges, they can better meet LP expectations today and build for growth by partnering with the right fund administrator, which can not only equip them with the right platform to meet increased scrutiny, but with the knowledge, insights and best practices that can only come from having been there before.

Published on: December 12, 2024