If transparency and disclosure is what our industry needs, then it’s time to level the playing field, says Paula España.
Investors have come to expect unprecedented levels of operational data from their private equity GPs. In its 2015 survey of the global private equity industry, professional business services firm EY describes a new layer of criterion that investors have added as an essential part of their performance lexicon: operational excellence. What distinguishes private equity firms as best-in-class now goes beyond their investment returns to include the efficiency and effectiveness of their front, middle and back office.
Operational excellence is a differentiator that is defining the basis of PE firms’ long-term relationship with their investors. As such, funds that have the right levels of support, infrastructure and technology stand to gain the biggest advantage. As more LPs perform operational due diligence reviews, allocations will increasingly favour those firms that benchmark well against their peers. In essence, how fast and accurately a GP can deliver meaningful information to LPs will go a long way in maintaining and improving current relationships as well as enhancing a GP’s offering for prospective LPs.
The trend is acknowledged by PE firms themselves. The EY survey found that 66% of GPs respondents saw a need to enhance their reporting transparency, while 50% indentified timeliness in meeting investor demands as an important factor in their relationship with LPs. Around two-thirds of those surveyed reported that investors had demanded customised reporting from them within the past year.
Fund partners are turning to their finance departments to meet what are often requests for extremely detailed information at very short notice. To better cope, some firms have migrated to an automated portfolio company monitoring (PCM) solution that streamlines the way they collect, analyse and report portfolio company performance and valuations. In other cases, they have hired dedicated personnel to handle LP requests on an ongoing basis.
Either way, GPs stand to benefit by using a database-driven master repository of reliable and up-to-date information on the operational performance and valuation of their portfolio companies. These systems allow them to report at short notice, by reducing the need for human intervention and generally help to improve reporting accuracy, while reducing the scope for error.
The additional use of standardised templates and built-in data models within a PCM, such as AltExchange and ILPA’s templates, are a far more practical way of reporting through globally accepted reporting standards. Systems that can output globally accepted reports may even preclude the need for customised LP report templates. By contrast, firms that keep isolated files and spreadsheets, of which there may be several versions, are more likely to struggle when assembling ad-hoc reports.
Despite the obvious advantages in efficiency, consistency and transparency that a monitoring software package can provide, adoption levels remain relatively low. Another survey, this time by industry data company Preqin, found that nearly 65% of PE respondents are not using one, and many still rely on an entirely manual environment (Excel) to collect, analyse and report the performance of their investments, calculate valuations and aggregate cash flows to determine fund level investment metrics.
The same survey lays bare the reasons why. Over 30% of respondents cited costs as one of the most prohibitive features of the portfolio company monitoring software solutions. Indeed, some packages on the market can carry price tags well in excess of £100,000 for licensing and implementation. Total costs for these solutions are also notoriously difficult to budget, and greatly vary between firms. The migration process itself, can take anywhere between five and ten months to deliver, which constitutes another major hurdle.
These considerations make tailored software solutions a daunting prospect for those who can least afford them. Of the approximately 5,000 PE firms operating globally, an estimated 80% manage relatively small portfolios worth less than US$1 billion in assets, according to Preqin research. It is therefore those firms that constitute the largest portion of our industry, that are most likely to face constraints when developing their people, processes and technology.
To compete for the ‘big ticket’ allocations, and meet the information-sharing expectations of LPs, smaller funds require automated and standardised monitoring technology that is easy to employ, affordable and implemented at a fixed priced. Only by making operational excellence and best practice reporting accessible to the majority of PE funds, can we level the playing field for the benefit of the industry as a whole.
Paula España is a Director at Baxon Solutions