As back- and middle-office demands grow in volume and complexity, liftouts provide an alternative for private equity firms concerned about continuity
By Steven Millner, Managing Principal and Co-Founder, Gen II Fund Services, LLC
Two primary factors motivate private equity firms to outsource their fund administration function: either they want to scale their operations or they want to future-proof and de-risk their business. Sometimes the motivation is a combination of the two. The catch, however, is that many larger and longer-tenured PE firms have already invested so much time and capital into their back- and middle-office operations that nobody wants to admit these efforts have become a sunk cost.
Increasing back-office risk, for instance, can range from data protection and cyber security threats to the “key man” risk that has become more pronounced across the IT function. Many firms also desire a lighter, more agile operating structure, particularly given the challenges to recruit, retain, and upskill back-office professionals. Each of these considerations have only become more complicated by the increasing sophistication required for fund administration, as fund lives extend longer, co-investments become ubiquitous, and LPs request more information.
The transition from insourced fund administration to an outsourced model can seem overwhelming. It’s in these situations that a liftout can provide continuity as GPs leverage the benefits available through specialization and adapt a business model that better fits their current needs.
A Lighter Lift for Fund Operations
To be sure, the concept of a liftout can mean different things to different people. In some cases, it resembles a traditional outsourcing arrangement, although the fund administrator may take on certain in-house personnel. In other scenarios, a liftout may be more strategic to the administrator, whether it delivers new capabilities required for a specific asset class or represents an opportunity to extend their footprint geographically. In certain cases, a liftout resembles a true acquisition or carveout, in which GPs are paid by the fund administrator for their existing infrastructure.
In each scenario, the liftout offers an improved future state to better manage operational risk, create scalability, and keep pace as technologies and reporting systems evolve.
Accelerated Pace of Innovation
Consider just the increased data and technology demands that have become more acute across back-office operations.
Third-party fund administrators continue to raise the bar in this area. GPs still reliant on excel are already at a noticeable disadvantage, while those who have made investments in their back-office systems are today struggling to upgrade and maintain this technology to stay ahead of an accelerating innovation curve. A liftout provides an alternative for GPs to potentially monetize their earlier investments in this area and stay current as new technologies proliferate.
The expertise available through specialists is just as critical, particularly when entering foreign jurisdictions, interpreting new regulatory and accounting guidance, or adapting to evolving reporting standards. Gen II has serviced hundreds of funds and has recurring interactions with thousands of LPs across the world. Contrast this experience with a traditional in-house team who may only raise a new fund every few years, with little if any exposure as to how their peers are interacting with LPs day in and day out.
This expertise also translates into scalability, as third-party fund administrators can effectively “turn on” a new product within days or weeks versus the months typically required by an in-house team to ramp up new offerings.
Perhaps the biggest benefit for GPs is just the ability to focus on core competencies, which for most sponsors revolve around deal sourcing and value-creation initiatives. Beyond just minimizing administrative distractions, outsourcing will influence decisions around personnel and even strategic initiatives within the firm.
Moreover, fund administration is usually considered a tertiary activity within most general partnerships. For fund administrators, though, this is their focus. It’s the first thing they think about when their day begins and their day doesn’t end until they’ve tackled each and every deliverable.
Cues to Persistence
Not to be overlooked, LPs often prefer outsourced fund administration, a trend that gained momentum in the wake of the Bernie Madoff scandal and has only picked up steam since. In fact, most institutional investors will insist emerging managers outsource fund administration from the get-go. But for longer-tenured GPs, a liftout can offer supporting cues around succession planning and the ongoing “institutionalization” of the business. And post COVID, there is even more emphasis from LPs on business continuity and disaster-recovery plans, which again favors an outsourced model.
Many GPs may not realize the extent to which the fund-administration industry has evolved over the past decade.What began as an accounting role has transformed into an “information” engine and clearinghouse to provide transparency and substance to LP reporting, meet ever-changing compliance requirements, and support front-office decisions. In this sense, the back- and middle-office has become a complicated and high-performing hub that itself requires focus and ongoing investment to keep pace with the rigors of the job.
Most sponsors well know the value of specialization. And most also recognize the value proposition of third-party fund administrators, who can help GPs future proof their own business and position themselves for growth. Yet the inertia of “the way it has always been” can still stand in the way of better, more effective alternatives. It’s in these circumstances that a liftout represents a compelling compromise to access the advantages of specialization over continuing with the status quo.