What Keeps a CFO Awake at Night?

Yearbook 2019 December 2019/January 2020 • privatefundscfo.com

What do I Will AI take need to know about GP-led over my job? secondaries?

Should I be How can I stop worried about a tech project data security? running out of control?

how do we sell a piece What keeps of our firm? a CFO awake at night? PEI Ad 10-19 - PRESS_bleed-marks.pdf 1 10/29/2019 12:08:42 PM

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Senior Editor, Private Equity Toby Mitchenall [email protected], +44 20 7566 5447 Editor Graham Bippart [email protected], +1 212 796 8332 2019 Yearbook Senior Special Projects Editor Graeme Kerr [email protected], +44 20 3862 7491 ISSN 2632-6418 • DECEMBER 2019/JANUARY 2020 Special Projects Editor Ben Payton [email protected], +44 203 862 7494 Reporters Brian Bonilla Everything you wanted to know [email protected], +1 212 633 1455 Insight about GP-led secondaries GP-led Connor Hussey processes are now part of the smart [email protected], +1 212 796 8321 manager’s tool kit 34 Researcher/writer 2 Philippa Kent Waterfalls: should you buy a car or [email protected], +44 203 944 7963 Eight things we learned this year Private equity has had to manage political and a driver? qashqade’s Oliver Freigang Contributors and Gregor Kreuzer explore options for Vicky Meek, Victoria Robson, Craig Savitzky regulatory pressures, as technology firms seeking to modernize their waterfall Managing Editor, Production: Mike Simlett becomes a preoccupation for CFOs calculations 38 Head of Production: Greg Russell EDITOR’S LETTER 6 Production Editors: Daniel Blackburn, Why you should be selling a piece of Adam Koppeser Ask the CFO Dimitri Koryakov, your firm There has never been a better Copy Editor: Eric Fish Sandton Capital Partners 8 time to sell a stake in your firm 40 Head of Design: Miriam Vysna SEC actions A year in compliance 10 Translating the TCJA EisnerAmper’s Senior Designer: Lee Southey Simcha David says there are still questions Designer: Denise Berjak Ask the CFO Thomas Mayrhofer, EJF Capital 12 over how private equity interprets Marketing Solutions Manager: changes in the 2017 tax reforms 44 Anthony Hackett Ask the CFO Sandra Kim-Suk, [email protected], +44 20 7566 4273 Norwest Equity Partners 14 Subscriptions and reprints [email protected] Customer Service [email protected] Analysis Editorial Director: Philip Borel Director, Digital Product Development: Amanda Janis 16 Director of Research and Analytics: Dan Gunner Private equity goes public Private funds Managing Director, Americas: Colm Gilmore have been in the political crosshairs Managing Director, Asia: Chris Petersen Group Managing Director, Brands and Markets: Passive competition puts pressure Paul McLean on private equity RSM’s Anthony Chief Executive: Tim McLoughlin DeCandido warns that hands-off investment offerings pose a real challenge for the industry 18

How robots are changing PE What does Lessons from the front line of tech automation and AI mean for your job? 20 implementation How you can stop a London calling for US managers JTC’s technology project chewing you up and Wouter Plantenga and Simon Gordon spitting you out 46 discuss why US investment managers are Can funds duck the TCJA’s punches? listing on the LSE 26 Withum’s Michael Oates argues that Prepare to do battle with data privacy landmark reforms have added further For subscription information visit New regulations around data governance twists to the tax labyrinth 52 privatefundscfo.com are coming to a state near you 28 The search for stability Managers are Tech shapes the future for private funds sticking with traditional domiciles and Rey Acosta of Allvue Systems looks at the outsourcing operational functions 54 factors motivating fund managers to move away from Excel 32 Last word Points of view on 2019 60

December 2019/January 2020 • 2019 Yearbook 1 2019 in review Private equity has had to manage political and regulatory pressures, as technology becomes a preoccupation for CFOs

SEC gets tough Wary of Warren The Securities and Exchange Commission Politics has not always been kind to private equity appeared to take a more lenient stance in 2019. Things could get more difficult in 2020, towards enforcement in the first years of especially if a more radical candidate such as Elizabeth the Trump administration. But the regulator Warren wins the Democratic nomination for president. swung back into action in fiscal year The Massachusetts senator has been at the forefront 2019, bringing 191 cases against of raising concerns about the way the industry investment advisors and operates, following a series of business failures at 1 investment companies. PE-owned companies. Her Stop Wall Street Looting This represents a 77 Act proposes reforms that would drastically alter the percent increase on regulatory ecosystem. Carried interest would count as Could we be the previous year, regular income for tax purposes and fund managers writes Ben Payton. would be financially liable for failed investments. targeted by The SEC is most The chances of the Warren bill becoming law are the SEC? likely to target effectively zero in 2020, given that Republicans control private funds over their both the Senate and the White House. Even if Warren misallocation of fees and (or another progressive candidate such as Bernie expenses. Several firms settled Sanders) wins the presidency, they are unlikely have enforcement actions in the past year, the votes to push the legislation through Congress. including two cases where firms paid close Even so, the danger of public opinion turning against to $3 million to the SEC. The need for firms to ensure proper the industry is a long-term concern for private compliance structures and procedures are in place has never equity. been greater, with the SEC particularly active in targeting firms where the chief compliance officer wears one or more hats. Meanwhile, the fallout from the Abraaj scandal continued in 2019. Founder Arif Naqvi is now facing criminal charges. And the enforcement landscape will get even more How likely is interesting if the SEC pursues its plans to open private markets to retail investors. For the plan to work, regulators will have Warren to to be ever more rigorous in scrutinizing managers to ensure get her way? individual retirement funds are adequately protected. 2

2 Private Funds CFO • December 2019/January 2020 The enforcement Don’t be afraid of AI – yet “ Many fear that the anticipated AI revolution will result in landscape will massive job losses. But artificial intelligence and robotic process automation are only just beginning to make an impact get even more in the private equity industry. And we found in our June issue that technologies that can be readily applied should allow interesting if the professionals to devote more time to creative and client-facing tasks. We heard from a PE firm that SEC pursues its 3 had automated its invoice processing function. plans to open How much This saved 2-3 hours a week – and far from making someone redundant, it freed up private markets to will it cost time consumed by a low-value task. Relatively few firms have seriously retail investors ” to join the AI engaged with AI. Our annual Private Funds CFO Insights Survey shows that 70 percent revolution? have not even reviewed its application. Part of the challenge is that AI requires a major investment in acquiring and restructuring data, when the payback may not be felt for years. $7,500 Maximum possible fine per violation of CCPA

Planning key to tech success Privacy privations The potential for private funds to The GDPR, the EU’s data protection reduce costs and improve processes behemoth, has become a notorious through automation means the CFO is compliance burden. Private funds increasingly focused on tech projects. (especially those headquartered Our case studies of three firms outside Europe) are still confused over that have implemented new whether they are subject to technologies reveal a the regulation and, if so, 4 number of common what they need to do 5 themes. While it is to comply. How do I ensure routine for firms to The looming Is the US the team buys in outsource technology introduction functions, a successful of data privacy headed to new tech? project relies on the firm measures in towards knowing what it wants to California, the achieve before turning to an CCPA, will further GDPR? external partner. Staying focused on complicate the picture. the problem and the solution is crucial if you It appears the US is heading are to avoid being distracted by fashionable technology. toward state-by-state data privacy CFOs also face dilemmas in how to strike a balance regulation, a model that is inconvenient to private funds between pushing projects forward while also achieving (and countless other industries) that have customers across widespread adoption throughout the firm. Restricting many states. In practice, complying with the strictest state a project team to a few individuals may help rapid requirements is the most viable strategy to ensure firms do implementation; but can come at the expense of not fall foul of regulatory standards. widespread buy-in. Although private equity firms do not typically collect huge amounts of customer data, protecting the data they do hold is of paramount importance. This is causing firms to focus intently on their cybersecurity infrastructure. Indeed, the CCPA imposes fines of up to $7,500 per 77% 70% violation – so if a database containing thousands of pieces of personal data was hacked, the firm could face fines Increase in enforcement actions Of firms have against investment advisors and not reviewed AI running into millions of dollars. investment companies application

December 2019/January 2020 • 2019 Yearbook 3 Insight

“ Artificial intelligence and Selling makes sense What do you do when your firm needs a capital robotic process automation injection to power the next phase of growth? Very few are now finding that the answer are only just beginning to lies in issuing shares on the public markets. make an impact It is far more common to enter into a private ” transaction, often with the biggest players in the industry. Typically, a firm will sell 7 Secondaries boom a minority stake of no GP-led secondaries deals are more than 20 percent. Should becoming increasingly popular. In some cases, the we sell a Out of $42 billion in secondaries founding partners transactions that closed in the look to monetize minority stake first half of 2019, GP-led deals their shares in the accounted for some firm, allowing a to generate 6 $14 billion. This leadership transition capital? might be to take place. But in the Will surprising to majority of these deals, the secondaries those who bulk of the capital is reinvested into remember the firm. This can often fuel new strategies generate the days and power expansion into new markets. when a Undertaking the transaction itself is far from straightforward. conflicts of GP-led Many industry insiders doubt there is a ‘typical’ way to structure interest? secondaries a deal. Methods of valuing private equity firms are shrouded in deal was opacity, although a best guess suggests that a firm may be worth normally a last-ditch around 10 percent of its AUM. attempt to resuscitate a fund that had gone badly wrong. But in recent years, as PE firms have looked for ways to efficiently manage an investment that still has Luxembourg rising room to grow beyond the 10-plus-two-years period, Our domicile survey revealed, unsurprisingly, they have found that a GP-led secondaries deal can that Delaware retains its status as the heartland be the ideal solution. of private equity. Some 45 percent of survey The biggest challenge is to manage conflicts of respondents said it was one of the jurisdictions interest. The SEC takes a dim view of firms that do they would select for their next fund launch. not adhere to the highest standards of transparency Next on the list, level with the Cayman Islands, when in the delicate position of being responsible is Luxembourg. Both jurisdictions were the choice for selling assets, managing a transaction and of 36 percent of respondents. The Grand Duchy is highly8 rated for possibly even buying a share in the same assets. its tax and regulatory frameworks and its business environment. Much of Luxembourg’s growth has come at the expense of the UK and Channel Islands, as investors seek a European domicile post-Brexit and LPs express concern over offshore funds. Luxembourg has also been proactive in establishing $14bn limited partnership Value of GP-led secondaries deals in H1 2019 regulations that mirror Will Brexit those in Delaware or the UK, thereby force us to offering reassurance “ Much of Luxembourg’s to investors. This has relocate our growth has come at the given it an edge in its quest to be a hub European expense of the UK and for funds seeking to domicile? comply with the AIFMD. Channel Islands ”

4 Private Funds CFO • December 2019/January 2020 charge the competition

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Hong Kong 19F On Hing Building, 1 On Hing Terrace Central, Hong Kong wo weeks into the new gig, and I’ve already been asked, jokingly, if my professional T: +852 2153 3240 jump from liquid capital markets to private funds journalism might have something Private Funds CFO Tto do with the direction public markets are headed. I certainly appear to have Published 10 times a year by come to Private Funds CFO at a particularly exciting, and crucial, point in its history. Net PEI Media. To find out more about PEI Media visit thisisPEI.com asset value in private equity alone has grown twice as fast as public markets since 2002, according McKinsey’s 2019 review. Ever since Dodd-Frank, the SEC has increasingly © PEI Media 2019 scrutinized large, private investment No statement in this magazine is to managers, and even with the purported be construed as a recommendation death of its ‘broken windows’ approach “ I certainly appear to buy or sell securities. Neither this publication nor any part of it to enforcement, there’s no sign it plans to have come to may be reproduced or transmitted to loosen up. in any form or by any means, The traditional image of private Private Funds CFO at electronic or mechanical, including photocopying, recording, or by equity as corporate raiders, à la any information storage or retrieval Barbarians at the Gate, somewhat a particularly exciting, system, without the prior permission subsided before coming back with of the publisher. and crucial, point in Whilst every effort has been a vengeance during the current made to ensure its accuracy, the presidential debate cycle. its history ” publisher and contributors accept no responsibility for the accuracy As this publication heads to of the content in this magazine. the printers, we are busy unpicking the punches thrown in a House Financial Services Readers should also be aware that Committee hearing on the industry, titled “America for sale? An Examination of external contributors may represent firms that may have an interest in the Practices of Private Funds.” It seems to have cemented private equity as a main companies and/or their securities battleground for a proxy war between the right and left over economic and financial policy mentioned in their contributions (that said, fears that the hearing would represent an all-out public thrashing of the industry herein. proved to be overblown). As the industry continues to grow, and potentially even open up Cancellation policy You can cancel to retail investors under the current SEC administration, increasing scrutiny and public your subscription at any time during the first three months of subscribing attention are all but inevitable, for better or worse. and you will receive a refund of This is a publication about best practices. That’s a rich topic, because, for all intents 70 percent of the total annual and purposes, ‘best practices’ are still being negotiated. LPs are pushing for more subscription fee. Thereafter, no refund is available. Any cancellation transparency and even greater interest alignment, the regulatory environment continues to request needs to be sent in writing evolve, and new technologies, structures and market segments – take ESG, for example – to the subscriptions departments provide additional challenges and opportunities. (subscriptionenquiries@peimedia. com) in either our London or That is to say, half a century into the life of the private equity market, in many ways, New York offices. it is yet in its nascency. We aim to help you navigate its growing pains and grasp its even Printed by Hobbs the Printers Ltd. brighter future. I hope our 2019 Yearbook will give you a taste of what’s to come. hobbs.uk.com

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Ask the CFO Give outsourcers ‘narrowly defined tasks or the project won’t work out’

+ Q A With Dimitri Korvyakov Sandton Capital Partners

Dimitri Korvyakov is CFO of Sandton $20 million on average – we haven’t Capital Partners, a mid-market firm found that the value of the work justifies with $900 million in assets under the cost. management, which raised its fourth fund in 2016 with committed capital of $600 What do you wish outsourcing million. Philippa Kent spoke to him about Qfirms would do better? the outsourcing lessons he’s learned, his You could call it a customer service issue, tips for fellow CFOs and his predictions but to go a step deeper; companies tend about the future of outsourcing. to spend less time on the client – with the desire to make a profit on the project. It What is your biggest outsourcing takes time for an outsourcing firm to get Qregret? and we know exactly what we will get as to know their clients and two or three We were looking into investing in a result. years to generate profit from a project. agriculture in France and we hired a Many outsourcing firms are trying to research company based in India to What three tips would you speed up this period in order to get into research the market to see whether the Qgive to other CFOs about the green by spending less time trying investment would be appropriate for us. outsourcing? to get to know who we are and what we They did produce a high-level review of Provide outsourcers with very specific, do. It seems to me, to ensure the quality the French agricultural market, but not to well-defined tasks and deliverables. Be of future projects, outsourcers must start the level for us to make any conclusions specific about the process you want them by spending a considerable amount of with regards to whether we could invest to carry out to achieve the results. Spend time getting to know their clients on a or not. Projects where you’re not giving time getting to know the outsourcing personal level, and as a business – what the outsourcer clearly defined tasks don’t team and explain to them what you do the investment strategy is, what the thesis usually work out that well. Because they and the role the outsourcing team will is and what previous investments they don’t know your internal culture, your play in your internal process. have made. internal dynamics and your constraints, the results of that are fine, but not What would you love to What do you predict for the necessarily useful. Qoutsource but can’t? Qfuture of outsourcing? The perception in the industry is that I’ve been in this industry for 15 years, What was your most important valuation has to be outsourced because and I do clearly see that the degree Qlesson learned? it requires a level of experience that you of outsourcing has been increasing, The most successful projects are those may not have in-house, but we haven’t and I believe that the future is in more when you do not leave much freedom found that experience to be helpful. With outsourcing. Eventually, a lot (maybe of interpretation to the outsourcing firm, small to mid-sized private companies, all) back-end activities, particularly on but give them very narrowly defined the use of standard valuation techniques the operations side, will be outsourced. tasks, clear instructions and very clear is necessary but not sufficient to provide Outsourcing as an industry has great expectations as to what you want them to a good valuation analysis. It probably potential, and the most successful deliver. It gives clarity to the outsourcing would work for a larger private equity outsourcing firms will be those that firm in terms of what needs to be done, firm, but for our size – and we are looking invest into getting to know their clients it enables them to staff the project better at investments between $10 million and better. ■

8 Private Funds CFO • December 2019/January 2020 We’re up to speed, so you can go full speed.

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PFM_20168-07x10-63_GR-NT-ALL-PEG-1115-PEI Yearbook.indd 46 Perspectives Ad.indd 1 11/12/1512/16/15 5:354:18 PM Insight

SEC actions Expensive fee fines A year in Topping the list by volume of private fund enforcement actions compliance (especially as regards private equity) were those taken against sanctions firms for misallocation of fees and expenses

NB Alternatives Advisers ECP Manager LP he Securities and Exchange December 17, 2018 September 27 Commission’s Enforcement Disgorgement and prejudgment Disgorgement and prejudgment TDivision has had a very busy interest: interest: year, writes Graham Bippart. In total, the $2.36 million $122,304 agency levied $4.3 billion in monetary Civil penalty: Civil penalty: penalties in fiscal year 2019, with 191 $375,000 $75,000 Total: Total: cases brought against investment $2.74 million $197,656 advisors and investment companies – 36 percent of the total and a nearly 77 percent increase on FY 2018. Lightyear Capital Yucaipa Master Manager “The SEC basically is the Enforcement January 3 December 13 Division at this point,” says Todd Civil penalty: Disgorgement and prejudgment Cipperman, a compliance consultant. $400,000 interest: On the other hand, says Alma Angotti, a Total: $1.93 million former senior SEC enforcement official: $400,000 Civil penalty: “They are focusing on the basics… It’s $1 million Total: a direct shift from the ‘broken windows’ $2.93 million approach they had taken for a while that had gotten so much criticism.” Actions against private funds, and The SEC made claims against four PE firms for alleged misconduct regarding individuals associated with them, appear fees and expenses in FY 2019. It isn’t a new phenomenon. Some of the most to support that theory – most were for notable settlements with PE firms in recent years have been in this area. In 2017, fundamental compliance failures, along TPG partners was fined $13 million for taking accelerated monitoring fees with one for a major alleged fraud. coming from the sale, IPO and exit of portfolio companies. In 2016, it was Apollo stumping up $53 million and KKR paid out $30 million to the regulator for an 2020 looks complicated alleged $17 million in misallocated fees in 2015. Here, we give a timeline of major Lightyear became the most recent private equity firm to fall foul of rules enforcement actions against private protecting investors from unfair fees and expenses in December 2018, settling funds in FY 2019, and summarize some with the SEC in January over charges it misallocated expenses to its flagship key takeaways, but it’s going to get more funds. The firm settled without admitting wrongdoing and voluntarily agreed to complex in 2020. reimburse investors after a 2016 SEC exam found misconduct. Lightyear paid Industry players also noted actions $400,000 to the SEC, which accused the firm of allocating expenses associated against firms and individuals for with broken deals, legal, insurance, consulting and other fees to its flagship funds improper valuations, as well as a between 2000 and 2016. These should have been proportionally charged to co- high-level instance of a former SEC investors and funds that Lightyear’s employees invested in. All in, the SEC said enforcement agent getting caught in the flagship funds lost out on $1 million in management fee offsets as a result. the revolving door. He was federally Cipperman Compliance Services suggested that, with a reasonable indicted for allegedly leaking details of compliance program, the firm could have avoided overcharging altogether – or an ongoing SEC investigation into an discovered the problem and reimbursed investors before the SEC examination. alternative asset manager, in order to “C-suite executives should re-think the cowboy mentality that ignores obtain a job at that manager as… CCO. compliance until the SEC or a client makes them change,” wrote the firm’s With the increase in SEC actions, founder, Todd Cipperman. proposals to loosen restrictions on retail A month before Lightyear’s settlement, a unit of Neuberger Berman settled access to private investments and to for $2.74 million for allegedly misallocating compensation-related expenses to change marketing rules in the Investment three private equity funds it advised. The same month, Yucaipa settled for just Advisers Act, private fund managers under $3 million over claims it failed to disclose financial conflicts of fees to would do well to get their compliance funds it advised, as well as misallocation of fees and expenses. houses in order.

10 Private Funds CFO • December 2019/January 2020 Insight

Dubious claims

As far as compliance imperatives go, “don’t commit fraud” is the most straightforward

The SEC charged Dubai-based Abraaj Growth Markets Health Fund and its founder Arif Naqvi with misappropriating $230 million of money raised for Abraaj Investment investment in healthcare-related businesses in emerging markets. The SEC Management claimed the money was used to cover cash shortfalls at Abraaj IM and its holding April 11; company parent. Abraaj Group folded in 2018, before any charges were levied, Amended August 16 after investors complained about misuse of their funds, according to reports. Ongoing. SEC asking federal court Navqi was arrested in London in April. In June, a judge unsealed an updated for disgorgement, interest and civil indictment that included several other executives, laying out details of alleged monetary penalties. Abraaj Group deceit, bribery and personal enrichment. That indictment claimed the group collapsed in 2018; biggest private equity insolvency in history manipulated the valuation of another fund, prompting speculation that LPs may renew calls for LPAs to mandate external valuations and valuation reviews. And in July, Dubai’s financial regulator fined Abraaj IM and Abraaj Capital Limited a combined $315 million. Bluepoint Investment Abraaj wasn’t alone in being charged with fraud. Bluepoint Investment Counsel, et al. Council, its co-owner Michael Hull, his Greenpoint Asset Management, as well September 30 as Christopher J Nohl and his firm Chrysalis Financial were all charged with Ongoing. SEC asking federal court fraud in September for their operation of Wisconsin-based Greenpoint Tactical asking for disgorgement of any ill- Income Fund. The SEC claims the men and their entities were paid $6 million gotten gains, civil penalties and other in fees even as they told investors that the fund was illiquid and couldn’t meet appropriate relief. redemption requests.

Too many hats

Two cases illustrate that the SEC harbors a special distaste for failures in compliance at firms where the CCO also plays another executive role

“The SEC hates the dual-hat compliance officer model, where an executive Corinthian Capital Group assumes the CCO role but doesn’t really know what he or she is doing,” says May 6 Cipperman. It is also the kind of thing the SEC likes to fine both firms and individual executives for. Censured Corinthian settled with the SEC for $100,000 and chief executive officer Civil penalty: $100,000 Peter Van Raalte was ordered to pay $25,000 for not properly overseeing its Civil penalty (CEO): former CFO-CCO David Tahan, who agreed to pay $15,000. All settled without $25,000 admitting guilt. Civil penalty (former CFO-CCO): The case grew out of a 2014 exam by the Office of Compliance Inspections $15,000 and Examinations. In 2017, Corinthian’s auditor withdrew its unqualified Total: $140,000 opinion because the advisor had misclassified expenses (though “most of these expenses were misclassified before Tahan joined the firm,” the SEC said). That resulted in overcharging one of its funds. For three years, the firm also missed its ED Capital Management 120-day deadline to issue audited financials to investors, violating the custody September 13 rule. The list of alleged offenses went on: the SEC said Tahan arranged an improper Censured loan between the fund and the firm to meet a clean-up provision on a bank Civil penalty: $75,000 credit line. Civil penalty (managing member, In September, Elliot Daniloff (aka Ilya Olegovich Danilov), the Brooklyn-based sole owner and CCO): managing member, sole owner and CCO of ED Capital Manager, settled with the $25,000 SEC for allegedly failing to provide audited financial statements for four years. Total: $100,000 The firm, a small investment advisor and manager of private funds, was also fined and censured. Neither the firm nor its many-hatted CCO admitted guilt.

December 2019/January 2020 • 2019 Yearbook 11 Insight

Ask the CFO ‘Move from yes and no to see shades of gray’

+ Q A With Thomas Mayrhofer EJF Capital

homas Mayrhofer is CFO and the firm’s capital structure as it evolves – deputy COO of EJF Capital, which whether to raise debt or take in outsider Tmanages hedge funds, private investors. equity funds and structured products. He joined the firm in 2018 having previously How much of your work do you been a partner and managing director at Q feel could be automated? the Carlyle Group and CFO of Carlyle’s You have to distinguish between the corporate private equity segment. executive function, which is focused on culture, strategy and leadership structure, How has your day-to-day role CFO should lead the way in evaluating and the day-to-day financial operations Q changed in the last five years? where prudent belt-tightening is that a CFO is responsible for. In a highly The role of the CFO has evolved along possible. functioning organization, the CFO should with the growth in the industry. There spend as much of his or her time on the is an increased emphasis on the things As the CFO role becomes less judgment and leadership elements that needed to effectively manage larger Q focused on financials, how can’t be replaced by a machine. pools of capital. Firms are integrating exactly do you think CFOs can excel In the near to medium term, we will technology platforms, automating at what they do? see the industry move further along processes and enhancing data quality to First, I don’t agree that the role is less and the automation curve in terms of basic build seamless operating environments less focused on financial responsibilities. financial operations. Currently, only the across all functions within a company. Managing the firm’s financial operations largest managers have the size and Last year, I moved from a large firm and ensuring integrity in reporting is and volume to automate significant portions where I was principally focused on always should be at the core of the job. of their business processes the way a private equity to a mid-sized firm, EJF As the industry has evolved and grown, traditional operating company might. Capital, which manages hedge funds, the ability to put in place more robust Over time, I expect the technology and private equity funds and structured and automated control and reporting data quality initiatives throughout the finance products. My responsibilities infrastructures has required the CFO to industry to drive the automation bar are broader, but in many ways focused develop a broader set of skills to oversee lower and lower. on the same things: how do we run our technology and data initiatives. Simply funds and our firm so that we can report put, the modern CFO needs to be more What skills would you like to reliable and timely information to the involved in where the business is going Q develop to do your job better? investors in our funds and the partners in as opposed to just tracking where it has Most CFOs grow up in a binary world: the firm? been. yes and no, right and wrong. As CFOs However, with a strong financial progress in their careers, hopefully they How do you think the role of the infrastructure in place, CFOs are often learn that when someone else has a Q CFO will change if we’re faced able to take a broader role within the different opinion, it’s not necessarily with a recession in the coming years? executive leadership team managing that one is right and one is wrong, but It shouldn’t fundamentally change. CFOs the business. You see this as firms evolve that each has a different point of view. have the opportunity to get involved in a through leadership succession and a This perspective helps when a situation variety of elements of the business, but generation of executives emerge who are requires consensus building or change at heart the role must ensure that the firm more focused on using data and internal management. Over the years, I have operates with integrity and produces reporting to manage the business versus evolved along this path to see the shades high-quality financial information for founders who tend to be more intuitive of gray and other folks’ points of view, internal and external consumption, while decision makers since they have grown but like most people I could always do a ensuring that the firm spends money the business from inception. The CFO better job of walking a mile in someone prudently. That said, in a downturn, a also takes a leading role in managing else’s shoes before I make a decision. ■

12 Private Funds CFO • December 2019/January 2020 ey.com/lu/private-equity to create unexpected paths to value. Discover powerful new ways for private equity track? beaten the strayingabout from thought you Have

Ask the CFO It pays to get help upfront on tech implementation

+ Q A With Sandra Kim-Suk, Norwest Equity Partners

andra Kim-Suk is the new CFO What’s one piece of technology of Norwest Equity Partners, a Q you feel you couldn’t do your job SMinneapolis based mid-market without? investment firm. Prior to joining the firm Outlook, and my iPhone, are probably in April, Kim-Suk was the CFO, Americas, the most useful and both definitely for L Catterton, where she spent five something I can’t do my job without. years, writes Connor Hussey. Now, that being said, we are looking at The firm has also hired two partners other technological solutions to move in the firm’s Minneapolis office. NEP is the firm overall, so perhaps in some time currently investing NEP X, a $1.6 billion my answer may change. fund which began fundraising in 2015. We spoke with Kim-Suk about her Were you ever a party to a big new mandate as CFO, as well as her Q tech project that turned into a experiences dealing with outsourcing “ Now that there’s nightmare? teams, and some of the perils of At previous firms I have been involved technology implementation. an abundance of in technology projects which were challenging. What has been at the top of your technology, it’s trying One of the things I’ve learned Q agenda since arriving at NEP? after having experienced a few Given the evolution and maturity of to figure out how to implementations is that it sometimes private equity firms as an industry, there pays to get the help upfront and get help has been an increased focus on how harness information implementing. Your in-house teams may to manage data. We are no different – in a way that’s useful not have the skillset and/or the time to we have fund data, portfolio company undertake an implementation. data and deal pipeline data. In the past, for the firm overall everyone had stored that information in What’s the number one thing Excel. Now that there’s an abundance and consumable to Q that outsourcers do that of technology, it’s trying to figure out annoys you? how to harness that information in a our investors ” To really leverage the relationship with way that’s useful for the firm overall and an outsource provider, you have to bring consumable to our investors. There are them into the fold of the team and have a lot of great analyses that can be done, them understand and realize that their but trying to get to it is time-consuming work is being checked and reviewed. and manual. Outsourcers who assume that they know everything and that you are there What do you have direct to rubber stamp things will ultimately Q responsibility for? With NEP, it’s important to understand lead to misses in controls and process. Finance, accounting, technology. I also what we have currently, before we go But back to something that annoys me collaborate with our general counsel on down the path of outsourcing. It may about outsourcers: finding out that one compliance. make sense in certain areas, but it’s one of their team members who works on of those things where you don’t want your account is leaving and then being What parts of your firm do you to jump in too quickly until there is an surprised by an increase in time since Q outsource? understanding of what we have in place they had to train a new person… that’s on Currently, we do not outsource anything. today. the outsourcer. ■

14 Private Funds CFO • December 2019/January 2020 qashqade the digital waterfall & carried interest solution

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www.qashqade.com Analysis Private equity goes public

Private funds have been in the political crosshairs in 2019. Graham Bippart reports

t’s been a very public year for private Also in July, Senator Bernie Sanders of markets. As sectors like private equi- Vermont singled out Paladin Healthcare ty have become mainstream in recent Capital head Joel Freedman over the firm’s years, populist sentiment – with its sus- closing of Hahnemann University Hospital picion of globalization and corporate in Philadelphia. More recently, Sanders has greed – has spread its tentacles globally. attacked Great Hill Partners-owned G/O IRising inequality and the legacy of the Media as an example of the supposed threat Great Recession have generated debate on private capital represents to independent the impact of business and finance on voters’ media. Warren, Ocasio-Cortez and Rep- day-to-day lives – not just in the US, where resentative Mark Pocan of Wisconsin have anti-private equity political rhetoric has in- also written to five private equity firms ac- spond. The American Investment Council tensified ahead of the upcoming 2020 pres- cusing them of profiteering off privatized has been active in pointing out how private idential election, but also abroad. As one services to prison inmates. equity benefits the real economy, seeking to COO at a private equity firm said: “Realisti- The scope of the attack ranges from familiarize the public with the day-to-day cally, populist fervor is up around the world. mid-market firms to the biggest players. ways in which the industry has impacted That will impact private equity, whether in And not just in the US. In October, the new their lives for the better. the US, Europe or anywhere else.” left-wing parliament of Denmark indicated AIC president and chief executive Drew The public finger-pointing began ramp- it would tighten regulation on single-family Maloney penned an op-ed in Iowa’s Des ing up in 2017, when Toys ‘R’ Us filed for rentals, citing Blackstone as a cause of con- Moines Register, highlighting the $14 billion bankruptcy. Politicians cite the case as a cern in rising rental prices. in private equity investments in the state in manifestation of private equity avarice (de- And, of course, there’s the ‘Stop Wall recent years. In a piece published by Fox spite conditions in traditional retail being Street Looting Act’, the legislative proposal Business News, he praised the comeback of infamously difficult). Then in 2018, The from Warren, Pocan and three other Sen- Popeyes’ spicy chicken sandwich, noting the Washington Post alleged that the downfall of ators that aims to fundamentally alter the food chain was owned by Freeman Spogli care provider HCR ManorCare was caused economics of private equity. The bill counts before being sold to 3G Capital in 2017. the Carlyle Group saddling the company carried interest as regular income for tax AIC also released videos promoting with debt, adding further fuel to the fires of purposes, and holds funds and their manag- private equity’s impact on the economies public debate. ers financially liable for failed investments, of Texas, Michigan and Florida before the Since then, politicians – namely, Demo- among other things. primary debates in each state. And it part- crats in the US – have publicly taken the in- Industry groups have been quick to re- nered with EY for a report which, among dustry to task on other PE-backed failures. other things, points out that the industry Shopko’s bankruptcy filing in January led paid $174 billion in federal, state and local several party leaders to publicly denounce taxes last year. Sun Capital Partners. Senator Elizabeth Warren of Massachusetts and New York Unlimited liability Representative Alexandria Ocasio-Cortez $174bn Warren’s proposal represents the most con- sent a joint letter to Sun’s co-chief executive Federal, state and local taxes crete threat to private equity. “The Warren officers in July, demanding severance pay for paid by the industry in 2018 legislation would punish an industry that’s Shopko employees. an engine of growth,” the private equity firm

16 Private Funds CFO • December 2019/January 2020 Analysis

the very companies the industry often tries to turn around. “Companies who need capital the most, and therefore are already at a higher risk of failing, would not be able to access capital from private equity funds,” Hayes says, since they would present a higher personal risk for fund operators.

More scrutiny on the way As we went to press, the House Financial Services Committee was holding a hearing entitled “America for Sale? An Examination Political battle: of the Practices of Private Funds” – perhaps Senator Elizabeth Warren’s ‘Stop the first Congressional hearing on private Wall Street Looting funds since the Dodd-Frank Act, Hayes Act’ is increasing speculates. the scrutiny on the private equity While the hearing portends some of the industry inevitable political grandstanding private equity firms are wary of, Hayes welcomes the growing investor concerns in private equity. ILPA members are pushing for greater market transparency and raising their eye- brows at what they see as an ongoing ero- sion of fiduciary duties to LPs. “Given that some of these investor related issues are highlighted in the [Warren bill], we do expect that some of those issues will be raised and discussed at the hearing,” he says. COO said. It adds that the proposal to hold “Transparency and sunlight are gener- funds and fund managers financially liable ally bipartisan ideals that can be achieved.” “would violate a 300-year-old convention Those are issues that will need address- that when you put money into something, ing if the Securities and Exchange Commis- you can’t lose more than what you put in.” sion broadens access to private funds to re- That part of the bill even includes LPs tail investors – something the SEC has been in its scope; a fact not gone unnoticed by officially considering since June. This could the Institutional Limited Partners Associa- both produce another surge in private fund tion. The legislation would have holders of investment, as well as even more intense po- economic interest in a fund be held jointly litical scrutiny. and severally liable for all the liabilities of The paper, written by USC Marshall For the sponsors, the hearing underlines each portfolio company. “There doesn’t professor Charles Swenson, claims that the the unnerving potency of the Democrat- seem to be a carve-out for investors in the bill could result in the loss of up to 26.3 ic party’s recent campaign against private fund,” says Chris Hayes, senior policy coun- million jobs, and as much as $475 billion in equity: even if the bill is unlikely to pass, it sel at ILPA. “But even if we were carved out local, state and federal tax revenue, annually. has already impacted the broader political it would be problematic. This runs against In a modest-case scenario, Swenson wrote, debate, and parts of it could find their ways years of case law that establishes the princi- the proposed expansion of liability would into future legislation. But while the indus- pal of limited liability.” result in a 19 percent reduction of the PE try takes the threat seriously, few firms are A report published by the US Chamber industry. There would be up to a 19 percent ready to panic. of Commerce – the largest lobby group in failure rate for PE-backed companies and “People have their concerns with War- the US – on November 13 echoed that con- up to a 19 percent reduction in returns to ren’s rhetoric, but it’s relatively early,” says cern. It noted the provision “is the equiva- investors in PE. a CFO at a mid-market firm. “Around here, lent of requiring PE funds and their princi- Hayes suggests there is nothing stop- it’s a wait-and-see approach,” the executive pals to guarantee the performance of their ping GPs, if the legislation were passed as adds, noting that, even with a Democrat in portfolio companies to all of their creditors, written, from taking out large insurance the White House, Republicans have a good which would just end PE investing alto- policies to protect themselves and charging chance of retaining a majority in the Senate. gether and is contrary to the principle of them back to LPs as an expense – and by Such a result would significantly hamper a American business, which is to respect the extension, their end investors. But perhaps Democratic president’s ability to pass legis- corporate form.” even more fundamentally, it poses a risk to lation hostile to private equity. n

December 2019/January 2020 • 2019 Yearbook 17 Analysis

KEYNOTE INTERVIEW

Passive competition puts pressure on private equity

Hands-off investment offerings wouldn’t seem to be competing with the private equity funds, but RSM’s Anthony DeCandido suggests they pose a real challenge for the industry

No buyout firm touts their ‘hands-off’ Why should GPs pay attention SPONSOR approach to investing. On the contrary, to trends in passive investing RSM Q ‘hands-on value creation’ has become an vehicles? industry cliché that appears in virtually For investors of all types, whether they’re every private placement memorandum on and passive AUM at $4.8 trillion. As re- on Main Street investor or Wall Street, an LP’s desk. And GPs do plenty to sub- cently as 2004, passive investing represent- there are various options, and the cost point stantiate their claims that they pay atten- ed only $725 billion of AUM, while active for passive investing has the attention of tion to every line in every balance sheet of investing AUM was $3.2 trillion. many within the marketplace. As retail in- a given portfolio company – and do some- RSM partner and financial services sen- vestors and institutions get greater access to thing about them. After all, what are all ior analyst Anthony DeCandido suggests all kinds of strategies, this will inevitably be those generous management fees paying that private equity firms shouldn’t ignore another source of competition for private for? the surging popularity of these passive of- equity as an asset class. Given the record fundraising tallies of ferings. For now, private equity’s popularity is late, the pitch is still resonating. But else- On the contrary, they might put pres- high, mainly because the return profiles where, passive investment strategies have sure on management fees and force GPs have been so rich. Furthermore, when we been enjoying an even more dramatic to further substantiate the value they bring look at the period from 2000 until today, boom. According to Bloomberg, passive to their portfolios, especially as politicians the asset class has outperformed the S&P overtook active investors in AUM last year, and journalists become more vocal about index by a compound annual rate of around with actively managed assets at $4.7 trillion the industry’s size and influence. five percent. So for sophisticated investors, I

18 Private Funds CFO • December 2019/January 2020 Analysis

think it’s crystal clear that private equity is a a bit more cost conscious when the mar- preferred asset class. ket retreats, particularly when there’s not But it’ll be fascinating to watch as we “For sophisticated enough delta between the private equity and near the end of this business cycle, what passive strategies. That preference for the happens when those return profiles aren’t investors, I think cheaper option is just human nature. achievable anymore. Because, as we all know, any organization, regardless of indus- it’s crystal clear that So if a GP were take these try, will become much more cost conscious. Q passive strategies as a factor, And then there are broader societal trends. private equity is a how should they respond? How do they argue that they’re still worth Are we talking about the preferred asset class” those fees? Q criticism of private equity in the Their value proposition will always include press and on the campaign trail? some element of helping to drive a compa- We are in the midst of a US presidential ny’s operating agenda. When that GP shows election season and there’s still this stigma up to invest in that industrial business in around private equity managers. Elizabeth Iowa, there are relationship synergies that Warren has put forth the Wall Street Loot- are going to improve that enterprise and ing Act that puts private equity groups in the make it more valuable during that three- to regulatory spotlight when a portfolio com- seven-year period of ownership, a period pany goes through bankruptcy. Democrats that can allow them to weather a tough eco- are hoping to achieve better protections for nomic climate. some of the stakeholders, whether it’s health And GPs are already willing to reduce benefits, or reducing major windfalls to fees, though this is clearly isn’t ideal. The management and investors at the expense of traditional 2 and 20 percent model has now employees, or communities. become something closer to 1.6 and 16 per- But the conversation around this can eas- cent. Though it should be noted that it’s ily unnerve the public and lead to criticism debut funds where firms are looking to of- that causes large public pension plans like fer more favorable terms. I don’t think top CalPERS to review their allocations. That quartile firms are looking to compete on might further accelerate the commitment fees anytime soon. to passive strategies. However, this isn’t just But I do think private equity groups will about politics. People expect new levels of need to up their game on technology. Let’s transparency today regardless of who they face it, passive management strategies have elect. Look back to 2012, and the conver- benefited namely because of the technolo- sation around the Dodd-Frank legislation, gies they’ve implemented that deliver value where there was a real desire for investors er controls in place. And I think this grow- creation with near zero marginal fees. and all stakeholders to understand the me- ing trend of individuals wanting to allocate So private equity groups are also go- chanics of what these managers do. their money to places that they believe are ing to have to look for ways that they can This led to a focus on managers ade- aligned to their mission and values is only continue to drive their return profiles by quately reporting their investment thesis, going to continue. This might benefit these leveraging technology. So we see it in ways their strategies and their tactics. And people kinds of passive strategies at the expense of they’re using satellite imagery or geoloca- have only grown more interested in these private equity. tion, or other mechanisms to get an edge in kinds of details as they learn more about Some GPs might argue that they work evaluating the markets that they operate in. how managers work. They want to under- with sophisticated investors who may have A classic example would be if a GP were stand the mission and values of their man- their own ESG concerns, but these LPs will investing in a financial institution or a credit agers and ensure they align with their own, find the right solution within the asset class, union, and they pull the data on credit card especially in terms of social responsibility and not venture into some passive strategy usage for that institution. They could then and ESG. instead. scale that for thousands, even millions of The Vanguard ESG ETF has proven It’s not merely public criticism. This is people, and use that particular data point to quite popular with Main Street investors, about the business cycle, coupled with those improve the operating agenda for that credit as a passive strategy that delivers returns transparency issues. We’re monitoring the union. that investors can feel comfortable earning. middle market, which is the DNA of the cli- Today’s sophisticated technologies may However, such vehicles really need to stay ent base we serve. And while we’ve enjoyed allow these passive strategies to thrive with- true to these higher standards. One Van- a robust M&A and private equity climate of out that active manager. But they can also guard ESG offering mistakenly included late, there’s some telling signs that the busi- empower GPs to make even better decisions the gun manufacturer Ruger this past June, ness cycle is coming to an end, with some around value creation and maintain their and under investor pressure, had to sell the kind of slowdown on the way. status as an asset class worthy of those fees, shares in August and promise to put great- And then what? We’re all guilty of being and their investors’ goodwill. n

December 2019/January 2020 • 2019 Yearbook 19 Stories of the year

How robots are changing private equity forever

The revolution has begun. In June, we asked what the advent of robotic process automation and artificial intelligence means for your job

In our inaugural issue, we delved into the world of AI and robotic dustry – though it will certainly raise challenges. Automating routine process automation and shone a light on how these emerging tech- (and often mind-numbing) processes should in fact free-up profes- nologies will transform private equity. For many, the mere mention sionals to apply their human brainpower in more useful ways. Yet, of ‘AI’ sends a shiver down the spine, as they imagine clearing their for smaller firms in particular, it will not be straightforward to justify desk to make way for a super-efficient robot that can work more the costs of applying and scaling tech solutions. efficiently at a fraction of the cost. But, as we found in this story, the We can be certain that this topic will remain at the top of the reality of the AI rollout will be very different for the private funds in- CFO’s agenda, as firms find new ways to make use of AI.

20 Private Funds CFO • December 2019/January 2020 Stories of the year

loverlay is not your typical mid-market firm. It is young – founded in 2015 – and bills itself as an investor in “adjacent private markets” through Cco-invests, platforms, joint ventures, fund restructurings and secondaries. Like many private capital firms, however, Cloverlay is a “slim shop,” says principal and CFO Omar Hassan. The firm has 12 full-time staff managing approximately $360 million. It will soon raise Fund II with a $400 million cap, according to market sources. Processing invoices used to be a thank- less job that required a lot of human hours and “you really needed to get it right,” says Hassan. Thanks to robotic process automation, for the last two years this has not been the case. Supplier invoices are now sent to an email inbox at Cloverlay; the invoices are scanned, information extracted, and costs allocated to the appropriate funds or cost centers for sign-off. This was never a massive volume task for Cloverlay; the firm processes anywhere between five and 15 invoices per week. But the human intervention typically required to allocate the expenses with consistency meant headaches and human error. The robot, which has been taught how invoices from various suppliers should be coded, now takes the strain. Humans are not removed entirely from the process, but by the time a human is involved around 85 percent of the work is already done. It took Cloverley between four and six weeks to get it up and running and complete the necessary testing. The firm worked with a consultant; “in the grand scheme of things it was pretty painless,” says Hassan, who has discussed this with other CFOs at similarly sized firms, but has yet to come across a peer doing the same thing. A lack of volume is a commonly cited reason, he says. If you’ve not come across RPA before, it is – put simply – a way of getting a piece of software to undertake simple rules-based routine activities. Think of a program that can open emails, access databases (it has its own log-in, like a human), gather data, fill out forms and perform calculations. It is best suited to repetitive, rules-based tasks that involve structured data. Among the leading providers of RPA software are Blue Prism, Ui Path and Automation Anywhere. Giant financial services firms have

December 2019/January 2020 • 2019 Yearbook 21 Stories of the year

already caught on. In the space of 20 months, numerous calculations, which they spend “We have to test this and use robots to do it, Royal Bank of Canada’s wealth management hours producing. A bot can automate the which is quite standard I believe.” division used Blue Prism software to save spreadsheet and eliminate the manual inputs What would it take to make RPA more 153,000 hours of direct manual work, which and reconciliations to validate those investor relevant to Partners Group? “The heavily in turn equated to circa 170,000 hours calculations. rules-based RPA methods would have to be- “given back” to the bank (the extra 18,000 “Those tedious reconciliations can take come more intelligent, with more variable hours comes from not having to correct two or three days to complete,” says Wein- input and output handling; this could re- errors). One process that formerly took a stein. “And with the bot, the staff is freed up sult in coverage of more use cases,” he says. human around six hours is now completed to handle more interesting and productive “Then it might become more applicable to in around 10 minutes by Blue Prism’s bots. work, while also enhancing accuracy by lim- lower volume work.” Most private equity firms are not of the iting input errors.” Which leads us on to artificial intelli- same scale of RBC. This should not preclude These technologies allow firms to mi- gence. There is much excitement around them employing RPA within their opera- grate to an exception-based review and re- how AI will change private equity firm options, as the Cloverlay example illustrates. porting process, so that staff are not looking erations. A survey conducted in late 2018 by At the private equity coalface, however, at every number or calculation, only those fund administrator Intertrust found that 91 “many smaller PE houses operate on spread- that represent aberrations, say when a data percent of private equity professionals be- sheets rather than purpose built systems,” point communicates a loss, when the market lieve AI will disrupt their sector within the says Ben Booth, chief information officer for for a particular portfolio company is boom- next five years. fund administrator Ocorian. ing. So how does artificial intelligence differ We asked 15 CFOs of mid-market private from RPA? Definitions of these types of equity firms how many used an automated RP-nay tech can be slippery (and debated fiercely by waterfall calculation tool, and – in support RPA may not be for every firm. Partners technologists). Consulting firm CBF Bots of Booth’s assessment of the situation – only Group – a private markets firm with $83 puts it like this: “On the most fundamental three said they did, with respondents saying billion in assets under management across level, RPA is associated with ‘doing’ where- their waterfall was either too simple or too multiple asset classes – has a 90-strong tech- as AI and ML is concerned with ‘thinking’ complicated to automate. nology team. The firm recently worked with and ‘learning’ respectively. Or brawn versus But the industry is changing. What a consultant to analyze the firm’s operations brains, if you like.” could be called enterprise resource planning to see where RPA could drive efficiency. The Taking the invoice processing example: solutions for private equity – systems result came up negative. “Because we are RPA knows what steps to take, because it has provided by the likes of eFront, iLevel and quite tightly integrated from the front of- been told, but it may require AI to read the Investran among others – are starting to fice to our database, we did not find a single invoice and consider where to find each bit proliferate. place where we could get upside from RPA,” of the data it needs. Automation will pay a huge part in the Raymond Schnidrig, Partners Group’ chief By this definition, AI is already hard at next generation of improvements. Eisner- technology officer, tells Private Funds CFO. work in many private equity firms. Anyone Amper’s Jay Weinstein, managing partner “A typical application is when reconcil- using an expense system that scans pictures of markets and industries, explains how his iation is needed between two systems that of receipts taken with your phone and trans- firm is channelling resource into producing are not talking to each other. We don’t have forms these into a claim – such as SAP Con- ‘bots’ that are capable of automating major much of that.” cur – is already working with it. processes within PE firm operations. Partners Group does deploy software ro- AI is also more often characterized by its As an example, a fund may have month- bots to conduct regression testing when im- ability to take oceans of data and discover end reporting for thousands of investors plementing new software. “We have quite a patterns that humans cannot. And this is that they are currently recording on Excel big bank of internal developers either build- where private equity firms are starting to spreadsheets. These spreadsheets include ing or buying in software,” says Schnidrig, use their imagination. Returning to Partners Group: the firm worked with a niche provider to develop an A significant minority of private equity firms have begun implementing RPA; less so machine AI approach to identify negative news about learning its portfolio companies. This resulted in the Awareness raising Close to decision making Implementation creation of a bespoke tool used by its ESG team as part of its due diligence and portfo- 0% 20 40 60 80 100 lio monitoring activities. The firm has several thousand portfolio companies around Robotic Process the world, so to use conventional search en- Automation gine notifications would have produced too much “noise” for humans to sift through. Cognitive computing and The AI program does the sifting. machine learning Most private equity firms do not have many thousands of portfolio companies to Source: KPMG monitor. Indeed, most do not even have

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ESG teams. What all private equity firms Finding and executing deals was the most Such a program is not cheap to build. have, though, is a need to source deals. commonly cited motivation for VC firms to Schmitt does not give a figure for the in- increase or improve their technology stack, A million analysts to look at a million according to a 2017 survey vestment, but the project has been the work companies? How about one investor to look of three full time engineers reporting into 0% 20 40 60 at a million companies? This is the vision chief technology officer Philippe Laval and presented by Paris-based growth equity in- Improve ability four analysts since work began on it in 2016. vestor Jolt Capital. to find and Exciting as it is, has it been worth it? If execute deals Jolt is a relatively new firm, having been Jolt were to remain a small player – rais- established in 2012 with backing from Te- ing less than €100 million per fund – then Helps in masek subsidiary Vertex Ventures among managing the answer would be no, says Schmitt, but other investors. It has a team of 11 and right the portfolio this is about scalability: “We formed Jolt in now it is raising its fourth fund for which and internal 2012 and are growing fast. We asked our- processes it is seeking around €200 million, according selves what firm we wanted to be when we to market sources. It is not a private equity reached €1 billion in AUM. We are now Helps in giant, but the expectation of its partners is marketing the more scalable.” Ten percent of Jolt’s reve- that one day it will be. firm to LPs nue will continually be invested in Ninja. Jolt’s ability to scale should be greatly Side note: the existence of Ninja has, enhanced by its investment in a proprietary Helps in says Schmitt, has had a deep impact on the marketing the AI-driven software platform, Jolt Ninja. firm to founders partners investing behavior; they feel they Ninja monitors a vast array of open can negotiate on a different footing. “Most

source and third-party information ser- LPs had specific people are worried about losing an oppor- vices to find suitable investment targets. requirements tunity. We are less worried about losing a Since starting development in 2016 and which we need deal because our dealflow is so robust.” to fulfill going “live” in 2018 it has led to two bolt- on acquisitions for portfolio companies and Robots finding deals one new investment for the firm. Another Source: Blue Future Partners’ survey of 137 VC The ability to find and assess investment Ninja-sourced deal is due to be announced funds, 2017 targets is clearly where many firms see the imminently, managing partner Schmitt tells future. While a young firm like Jolt Cap- Private Funds CFO. This is impressive for a ital is looking outward at what data it can firm that is not a volume player. absorb, firms with decades of their own Jolt’s target investment universe is data are looking inward. One is Riverside, a opaque and not easy to map; at least not for global firm focusing on businesses with en- the human brain. Ninja, however, ingests terprise values of less than $400 million. In data from open web sources, like company private equity terms – certainly in the lower websites, as well as closed ones like sub- mid-market – Riverside is a volume player, scription databases. It takes in datapoints with more than 90 companies in its port- from LinkedIn, news sources, patent filings, folio. The firm has made more than 600 events and other data sources numbering in “To be effective, investments since it was founded in 1988, the hundreds of thousands. It uses natural so within its vaults is an ocean of data to language processing software to extract rel- machine learning analyse. evant information and build graphs of peo- Before this dream becomes a reality, ple, companies, revenue numbers and distri- needs millions, if not Riverside must overcome an obstacle that bution agreements with resellers. will be familiar to many of its peers: organ- It has ingested and processed informa- billions, of data points. izing and structuring data that is currently tion on over 300,000 companies. Now half “scattered around a dozen or so” different of all Jolt Capital’s outbound deal sourcing And many firms are internal systems. is led by Ninja’s recommendations. Chief information officer Eric Feldman Ninja even tailors its recommendation still in the process of tells Private Funds CFO that the firm’s depending on the preferences shown by each leadership dreams of being able to look at member of the investment team. What’s it structuring all their a small manufacturing company in Omaha like working with this type of robot? Much and immediately analyze hundreds of thou- like working with a rookie human who re- data into a ‘single sands of comparable businesses around the sponds well to training. “Every week I get an world in a way that none of the humans email saying that here are the companies that source of truth’” around the table could. have been matched by Ninja,” says Schmitt. Implementing the AI technology is the “At the start, probably only one in 20 leads JASON BINGHAM easy part, experts say. What’s difficult and would be interesting, but the more I tell it Sanne can turn firms off the whole idea is the cre- what I like, the better it gets.” ation of one data source. Before firms can

24 Private Funds CFO • December 2019/January 2020 Stories of the year

A survey by a fund administrator in 2018 asked where private equity firms believe digital Luddites will be proved wrong innovation was having the greatest impact currently, and five years from now So we are all agreed: robots are great. But how afraid should members of the knowl- Now In 5 years edge workforce be as automation eats into 0% 20 40 60 their workload? A recurring theme among CFOs and service providers is that this next More efficient back-office wave of technology is about maximizing systems what current staff can do. The asset class tends to staff leanly as a rule and every firm aims to do more with less. Quicker due diligence “We are looking for how many hours au- process in completing tomation can save, not just now, but during a transaction future growth as well,” says HarbourVest’s CFO Karin Lagerlund. Screening potential “So, we fully expect to be able to in- investment opportunities crease efficiency, without necessarily increasing our accounting staff.” Cloverlay provides a case in point. Pro- Client interfacing cessing invoices was never a full-time job – two or three hours a week typically. Instead, the hours “given back” allow operations professionals room for creativity. Improved risk management “It allows us to step back and say, ‘What in a transaction do we want to spend our time on?’” says Hassan. For many it is difficult to imagine a Improved investment world in which robots take on human tasks decisions and the result is not human job losses. But as ever, the picture is more complicated Improved accuracy of than that. decision-making For small, young, lean firms with am- bition, automation provides tools to scale quickly. In the case of giant firms with legacy systems, we are more likely to see repet- No noticable impact itive finance jobs replaced with technology positions. We have grown used to the idea that the Increased returns role of the private fund CFO transcends finance to encompass wider operations and projects. In the automated world this will be more so than ever. The future-proof CFO Source: Intertrust will be adept at managing IT projects… or hire someone else who is. ■ take advantage of AI technology, automa- something that we should be looking at.’” tion processing and robotics, they have to In other words, AI requires an enor- go back into their data and create a data mous amount of data to learn from, says warehouse. Jason Bingham, managing director of prod- June 2019 • privatefundscfo.com “Surprisingly, the single ‘source of uct development for the fund administrator truth’ approach to deal-management ena- Sanne. “To be effective, machine learn- bled by effective data warehousing was not ing needs millions, if not billions, of data adopted by a large margin of funds until points,” says Bingham. “And many firms are very recently,” says Michael Asher, chief in- still in the process of structuring all their formation officer of RFA, a service provider data into a ‘single source of truth.’ Much of How robots are changing private equity forever with a focus on technology. the ‘big data’ captured in the past five years “By doing so, GPs can build algorithms does not as yet have a long enough time This is an edited version of the cover that look at portfolio data from all phases of series to be properly validated and may be story from the June issue of Private the cycle holistically and say, ‘Well, this is a more commonly used by firms five years Funds CFO. For the full article, go to great deal’ or ‘Our research indicates this is from now.” privatefundscfo.com

December 2019/January 2020 • 2019 Yearbook 25 Analysis

KEYNOTE INTERVIEW

London calling for US managers

More and more US investment managers are listing funds on the London Stock Exchange. JTC’s Wouter Plantenga and Simon Gordon discuss why it makes sense

What attracts US managers There are also tax laws in the US that SPONSOR towards a UK listing? force listed managers to distribute a certain Q JTC Wouter Plantenga: Currently there is a amount each year, resulting in less flexibil- lot of competition for capital in their home ity around the ability to roll up capital for market, which gives US managers an in- offers more flexibility in terms of fund struc- reinvestment. centive to try to find a new pool of capital. tures than the US. That’s a driver towards the UK, where they What type of US manager is can get access to a relatively sophisticated Simon Gordon: Often investment trusts Q most likely to be interested in institutional investor base and a financial that are listed on US exchanges go to IPO a UK listing? Does it appeal to some system and equity capital market that offers and end up trading at a discount, which asset classes or types of funds more the level of infrastructure that US managers is not good news for the US manager. In than others? are comfortable with. the UK, by contrast, closed ended invest- WP: If you look at the US funds that have British investors are also often looking to ment trusts have this ability to grow from listed vehicles over the past few years, diversify portfolios away from Europe, and a relatively low IPO size through just issu- there have been various asset classes, in- so there is an appetite there for US investing shares in secondary issues. In the UK, cluding energy, renewables, private equity ment funds. Since 2017, over $5 billion has a manager can do an IPO at £150 million and hedge, so it’s hard to pinpoint a trend. been listed by US-based managers on Lon- and grow that. Over five years it is not un- There is certainly an argument that more don investment fund markets. common to grow to £1 billion-plus through energy and renewables managers are going The other element is the fact that the more and more secondary raises and issuing in that direction, in part because the Lon- UK is a less regulated environment, which more shares. don Stock Exchange offers a more stable

26 Private Funds CFO • December 2019/January 2020 Analysis

financing proposition and the investor base possible. There are lots of great brokers and is more interested in sustainable finance and legal advisors in London, and my advice ESG-type investments. would be to speak to two or three brokers “There is a danger early on in the process. They will be able to SG: The underlying theme over the last few offer first-class advice on how attractive the that US managers years has been yield cos, so anything that proposed strategy is going to be for Lon- can generate income is attractive to the in- don’s institutional investors. over-egg the AIFMD stitutional investor market via the LSE. The It is quite a small community of people, LSE is open to alternatives beyond equities so the brokers will know who they are going pudding by thinking and bonds, and the type of manager looking to market the opportunity to. They will also at the UK is a manager who either is already be able to work with a manager to tweak the that they need to investing in an asset class that generates a proposition and make it as attractive as pos- reasonable level of yield, or one who wants sible to those investors. The pre-marketing go for full AIFMD to open up a new sub-investment strategy is very important to make sure that manag- that they have not done before. ers meet the numbers they are looking to passporting” For example, maybe they have been do- achieve in an IPO. ing straightforward private equity investing There is also a cultural difference be- SIMON GORDON in the energy sector and they want to start tween the US and the UK when it comes investing in renewable energy infrastructure to lawyers and other service providers. They projects. They can diversify that strategy will all bill on an hourly rate basis in the US, and it is popular with investors as long as whereas in the UK a manager will be given there is that underlying theme of yield. a fixed fee quote. Often, US managers will Whether there is going to be a clamour come here with a fear of running up bills for a greater element of growth in those very quickly, but that is not how advisors est from US managers looking to list on funds remains to be seen – at the moment, operate in the London market. the London exchanges. This year, there has yield and income are the attractions. probably been a bit less activity, and there WP: For US managers going abroad, there have not been many IPOs of funds general- From your experience, are there is often a fear of the unknown. London ly. The two that we have dealt with for US Q any top tips or common pitfalls offers an Anglo-Saxon framework, which managers this year have both been in the re- that US managers considering a is helpful, but it is also critical to connect newable energy space, but it has been slower listing in London should know about? with the right providers from a professional for new listings. SG: The number one rule for US managers standpoint. The income-generating funds that are coming into this market for the first time already in the market, whether they are RE- is to speak to a London advisor as early as SG: In the UK, it can take months to IPO ITs or renewables, have done extremely well and you need to deal with regulations like on the secondary raising market and have AIFMD, which US managers are not famil- been oversubscribed a lot of the time. So iar with. There is a danger that US managers that is a clear sign that there is a lot of cash “The LSE offers a over-egg the AIFMD pudding by thinking out there looking for the right products. that they need to go for full AIFMD pass- At the moment, due to Brexit and polit- more stable financing porting, when actually that is rarely the case. ical uncertainty, the exchange rate for the There is a lot of flexibility in the process pound against the dollar has been extreme- proposition and and the team at the LSE is really helpful, so ly volatile and investors are a little nervous advisors can run a prospectus past the listing about investing into new products. Once we the investor base is authorities and there is quite a collaborative have got this out of the way, hopefully early process that goes on. next year, then sterling should be a little less more interested in volatile and I think by the second quarter of How do you expect the next year we will see an uptick in the num- sustainable finance Q attractions of the London ber of IPOs coming to market. market to develop? What are your I believe we will continue to see a lot of and ESG-type predictions for activity in 2020? activity around renewables, but we will also WP: It is obviously difficult to make predic- see more innovative products come through, investments” tions at the moment, but the Brexit uncer- like the music royalties fund that listed earli- tainty will eventually pass and I think we will er this year and was very successful. ■ see a very attractive environment, potentially WOUTER PLANTENGA supported by the government as it seeks to Wouter Plantenga is the US-based head of attract capital into the market again. group client services at JTC. Simon Gordon is the London-based director SG: In 2018, there was quite a lot of inter- for fund and corporate services.

December 2019/January 2020 • 2019 Yearbook 27 Stories of the year

DATA PROTECTION DATA PROTECTION DATA PROTECTION

Prepare to do battle with data privacy

In our July/August edition, we looked at how new regulations around data governance are coming to a state near you

So far, the GDPR’s bark has been worse than its bite. European reg- it is unclear how widely the CCPA will be enforced. Could any firm ulators have tended to hand out only minor fines for breaching the with investors in the Golden State be exposed to fines for data priva- DATA PROTECTION DATA PROTECTION DATA PROTECTION data privacy directive. But multiple experts told us that enforcement cy breaches? Our prediction that many firms will opt to play it safe is about to get harsher – and we found widespread confusion among and comply with the strictest privacy standards looks like it is being private equity firms on what they need to do to stay compliant. We borne out. Microsoft, for example, has promised to conform with are now just weeks away from the rollout of the California Con- the CCPA across all its US operations. Even if private funds tend not sumer Privacy Act (although last-minute amendments have now to harvest customer data on a vast scale, compliance teams certainly pushed back some aspects of the law). Much like with the GDPR, have plenty to do as we brace for more onerous data regulations.

28 Private Funds CFO • December 2019/January 2020 Stories of the year

56 million: that’s how much still difficult to know if they are fully com- European authorities had im- pliant, the CCO says, stating that GDPR as posed in fines on companies a whole is “overly complicated” and based that breached the EU Gen- on an “ambiguous set of rules.” eral Data Protection Regu- lation by February this year, Complying in the US €nine months after the law’s introduction. Chances are that you have already consid- Admittedly, that amount has been spread ered the implications of GDPR and either across more than 200,000 cases – equating enacted a compliance program or decided it to an average penalty of €280 – but experts does not apply. It is a European law but ap- predict regulators are just getting started. plies to those outside of the EU, Dan Silver, Alex Scheinman, a director at ACA a partner at law firm Clifford Chance tells Compliance, warns that since GDPR has Private Funds CFO. been around for a year, regulators will be A US-based fund manager must comply DATA PROTECTION DATA PROTECTION DATA PROTECTION handing out more fines. with GDPR if it has a physical establishment “The supervisory authorities in the EU or operations in the EU and processes data are indicating that we should see a signifi- in connection with that physical location or cant increase of firms that are subject to if it offers goods or services into the EU. monetary penalties,” he tells Private Funds “It’s not crystal clear what the latter CFO. means in the fund context, but we usually “We should expect to see more and more interpret that as actively marketing a fund to of these fines beginning sometime later this EU investors and, in particular, to individual summer and this should serve as a wake-up investors,” says Silver. call for many private equity firms that have If you are in the decided-it-did-not-ap- not been paying attention or have taken ply camp, it may be time to think again. a wait-and-see approach with respect to The California Consumer Privacy Act GDPR enforcement.” comes into force on January 1, 2020 with a If you are having doubts over whether one-year lookback provision, so it is essen- your firm is compliant – or even needs to be tial private fund managers understand how – you are not alone. “I don’t think anybody it affects their data operations now. is compliant,” says one Europe-based chief The law requires companies to inform compliance officer of a US private equity California residents: which of their person- firm. “I regularly meet with other compli- al data the company collects or holds; the ance officers and have observed a wide range purpose for which it was collected; where of GDPR implementations. It’s difficult to the company got that information; how know how to comply without unnecessarily the information is being used; whether the going too far.” information is being disclosed or sold; and Even after putting in place what they to whom the information is being disclosed consider to be a best practice program, it’s or sold. Under the law consumers have the

DATA PROTECTION DATA PROTECTION DATA PROTECTION

December 2019/January 2020 • 2019 Yearbook 29 Stories of the year

right to request to opt out of a business sell- sonal data – for example the bank account ing their information, to access any personal numbers of a million Californians – and a information the business has stored and to hacker got in and stole that database, there the deletion of any personal information the would be potentially a class action filed business has stored. Businesses will also be against you for $750 million, even if the obligated to provide an opt-out page or link hackers didn’t do anything with that data- on their websites’ homepage that notifies base,” says Ed McNicholas, a partner at law consumers of their right to not have their firm Ropes & Gray. personal data sold. Both data privacy laws allow individuals The CCPA was inspired by the GDPR, or customers to request access to any per- but while they share some similarities there sonal information that a business may have are key differences to keep in mind with collected about them. GDPR requests must geographic scope being the most obvious. be complied within 30 days (with a possible That said, for the CCPA, it is less than clear 60-day extension), while CCPA requests what “doing business in California” means, must be dealt with in 45 days. says Silver. “It will likely apply if you have a physical presence in California or have Cali- Personal data: what counts fornia-domiciled investors.” Private equity firms are not – for the most Those businesses complying with that part – in the business of vacuuming up hazy definition are required to comply with oceans of personal data and monetizing it. CCPA if they have revenues over $25 mil- For some, particularly those with only in- lion or data on 50,000 or more residents, stitutional investors, this is enough to feel households or devices, or if 50 percent of the compliant with either GDPR or CCPA. “In business’s revenues are coming from selling my view, the only way a private equity firm personal information. would be directly responsible for that data The two regimes are also subtly different is if you have multiple portfolio companies in how they define personal data. In broad that are consumer facing,” says Sanjay Sang- terms, both include any information that hoee, CFO and COO of Delos Capital, a could identify a person, including name, lower mid-market private equity firm based email address, date of birth and phone num- in New York. ber. The CCPA goes a little further in terms For Sanghoee, the robustness of the of including data that identifies either person firm’s cybersecurity is the most relevant part or household, says Silver. of data governance. Delos has a compliance Penalties for transgressions differ. A consultant that comes in quarterly to review breach of GDPR could be as much as 4 the results from its IT consultants and secu- percent of global revenues or €20 million, rity tests. They also express opinion about whichever is greater. For the CCPA it’s best practices seen at firms that can be im- $7,500 per violation, and the violating com- plemented.“From the perspective of HR or pany will be subject to an injunction. The protect ing the information of our investors, CCPA also allows fines for statutory dam- which is obviously a huge focus for us, our ages of between $100 and $750 per person. cybersecurity set-up is very robust,” Sang- “If you have a database with covered per- hoee adds. “Our default position is that we

30 Private Funds CFO • December 2019/January 2020 Stories of the year

a side note, job applicant data will likely other states don’t allow for that exemption be taken out of the CCPA definition; an you could have a fight over pre-emption,” “The SEC is putting amendment approved by the California As- he says. sembly on May 29 saw collection of personal Pre-emption is when a state and feder- some teeth behind that information from job applicants, employees, al law contradict, and the federal law su- contractors or agents removed from the leg- persedes the state law because it is ranked rule and the industry islation. higher under the Supremacy Clause in the constitution. Reg S-P and CCPA overlap needs to pay attention” The SEC’s warning shot because they both enforce the idea of keep- So if you haven’t been caught by GDPR, ing data safe by having proper policies and GUY TALARICO you may have to comply with CCPA… and procedures in place to ensure security. CEO of Alaric Compliance then there is good old Regulation S-P. “The CCPA goes beyond that by im- Services, on Regulation S-P The Securities and Exchange Commis- posing additional restrictions on what you sion’s rules on safeguarding customer and can do with personal data,” Silver says. “For client data have been around for nearly two example, it requires that you give consum- decades, but a risk alert released by the com- ers the right to opt out of the sale of their mission in April is a signal that examiners data and also provide a detailed disclosure are going to be paying closer attention to as to how you plan to use that data. This this. “It’s an old rule being looked at in a new is far more aligned with the GDPR ap- cyber world. The SEC is putting some teeth proach.” “We could easily see litigation behind that rule and the industry needs to over pre-emption or litigation over the pay attention,” says Guy Talarico, CEO and constitutionality of the CCPA,” McNicho- founder of consulting firm Alaric Compli- las adds. “For instance, when California put ance Services. out a financial privacy law years ago there Greg MacCordy, a former SEC indus- was a long-running battle about whether or try expert who now works alongside Talar- not it was pre-empted by the Fair Credit ico, rams the point home: “Every Office of Reporting Act. After many court battles it Compliance Inspections and Examinations was decided that it was partially pre-empt- do not share data with anyone, unless ei- team that is going out, even if they didn’t ed.” ther legally required to do so, with explicit participate in this set of risk exams, will be After the CCPA was passed, a number permission to do so from an employee or looking for this in a firm’s policies and proof US states started to push for their own investor, or with a prior understanding of cedures.” privacy laws similar to California’s. If the what information we need to share in the Regulation S-P “requires a registrant US adopts a state-by-state model, then ordinary course of business.” to provide a clear and conspicuous” priva- private equity firms have to start coming up So exactly what personal data does a cy notice to customers or clients when the with a plan now to get ahead of the wave. typical firm gather? “We have mainly three initial customer relationship is established, “We’re providing guidance to our pri- kinds of personal data that we process,” annually and opt-out privacy notices if a vate equity clients. The first thing they need says the Europe-based compliance officer. customer or client doesn’t want personal to do is to really figure out if the law applies “First is investor data. All our investors are information shared with third parties. Reg- to them, and if it does, what kind of data are required under local KYC and anti-mon- istrants must also have adequate written pol- they collecting that they would have to wor- ey-laundering regulations to provide cer- icies and procedures that address “adminis- ry about,” Bonnie Yeomans, special privacy tain information to us. Second is the infor- trative, technical, and physical safeguards counsel at Proskauer, says.n mation of our employees. We also handle for the protection of customer records and third-party personal data, which can be information,” according to the April risk related to service providers, portfolio com- alert. This regulation only concerns private panies and current employees.” equity firms with individual investors.

July/August 2019 • privatefundscfo.com EXTRA How the fund finance game The same CCO also mentions having SEC-registered firms will certainly have is changing Data privacy CFOs prepare to keep track of data regarding individuals considered and made some effort to comply for battle on multiple fronts interested in working for the firm. with S-P (although the aforementioned risk Job applicants’ résumés are also noted alert highlights some common compliance by Fredrick Shaw, chief compliance officer shortcomings). of NASDAQ-listed private equity inves- In general, federal privacy regulator and advisor Hamilton Lane, as data tion will have a complicated relationship that needs to be considered PII (personal with the state privacy laws, says Ropes & identity information). “It was apparent to Gray’s McNicholas. “Right now, anything This is an edited version of the cover us that we have obligations to these people processed pursuant to GLBA (Gramm– story from the July/August issue of now, even if we never speak to them, even Leach–Bliley Act), which was the source Private Funds CFO. For the full article, if their résumé is completely off-base.” As of Reg S-P, is exempt from the CCPA. If go to privatefundscfo.com

December 2019/January 2020 • 2019 Yearbook 31 Analysis

EXPERT COMMENTARY

The use of more sophisticated, integrated technology by GPs is gaining steam. Rey Acosta, CEO of Allvue Systems, looks at four factors motivating fund managers to move away from Excel

Tech shapes the future for private funds

Over the past 20-plus years, I have seen be deployed, you can bet investors will be SPONSOR private equity evolve from what was once a doing deeper dives into portfolios. Insights ALLVUE SYSTEMS small cottage industry to become an impor- into ESG management practices and adop- tant component in capital markets and the tion only complicates reporting needs. economy. LPs are driving GPs to adopt Technology – particularly systems where As we enter a new decade and with pri- 1new technology portfolio monitoring, fund accounting and vate equity assets under management at an In Allvue’s 2019 Private Capital CFO Sur- front office technologies such as the CRM all-time high, it’s worth looking at how fund vey, portfolio monitoring was the number and investor portals are integrated – will managers’ own technology, operations and one functional process that GPs were look- play a pivotal role in getting LPs what they infrastructure are evolving as well. ing to improve over the next year (75 per- need on a timely basis. Once the domain of spreadsheets, ad- cent of respondents). This is not surprising vances in technology, particularly around given the manual and tedious work involved The era of Excel running the cloud computing and system integration, in using spreadsheets to collect and analyze 2back office is over have provided GPs with the tools they need portfolio company metrics and KPIs. Everyone loves Excel. And why not? It’s to efficiently scale their operations. The use As LPs want more insight into their fund easy to use, most people are familiar with of spreadsheets to run fund and manage- manager’s investments, both the back office it and it’s fairly cost efficient. That is, un- ment company accounting, not to mention and IR teams are actively seeking solutions til mistakes begin to happen, employees get keeping track of investors and deal flow, is to bring better and quicker information frustrated and, in the worst case, LPs either finally becoming a distant memory. The about their portfolio holdings to their inves- get incorrect information or capital account drivers governing these transitions are both tors. If we see a turn in the cycle, and with statements and notices start to get delayed. market-orientated and idiosyncratic. the amount of dry powder still looking to Private equity and venture capital strat-

32 Private Funds CFO • December 2019/January 2020 Analysis

What operational areas are you looking to improve over the next 12-18 months? (%) Are your fund structures becoming more/ same/less complex? 0 20 40 60 80 Less complex Portfolio monitoring 3% Investor reporting

Management accounting/ internal accounting

Data privacy/cybersecurity

Same More complex Fund accounting 31% 66% Source: 2019 Private Capital CFO Survey Source: 2019 Private Capital CFO Survey

egies have seen a remarkable increase in as- freely, and accurately, from the back office to come portfolios must be taken into account, sets under management in the last five years. the front office, and ultimately out to stake- as any multi-asset class CFO can attest to. GPs are growing, not only in assets, but in holders such as investors, operating partners When private equity and private debt personnel and the number and types of in- and regulators. come under the same roof, the technology vestors as well (think co-investing as well to support both types of strategies changes as bringing on new investors from various Credit strategies create new the required infrastructure of the GP. This domiciles). This ultimately results in a sub- 3operational challenges is one of the reasons why AltaReturn and stantial increase in the number of entities The private debt market is growing – and Black Mountain, private equity and private that need to be created, managed, allocated fast. Current assets are approximately $650 debt technology specialists respectively, have to and reported on. Again, referencing our billion but are expected to grow to $1 tril- joined forces to address the continued evolu- 2019 CFO survey, 66 percent of respond- lion by the end of 2020, according to the tion of the capital markets and the operation- ents stated their fund structures are becom- Alternative Credit Council. What’s driving al challenges that will have to be addressed. ing more complex. this growth? On the fundraising side, insti- We have seen many GPs come to us say- tutional investors continue to be challenged Data ownership and reverse ing, “We’re growing, and Excel is just not a by low interest rates in the traditional fixed 4outsourcing viable option for us anymore.” These man- income markets, driving allocations to pri- As GPs grow and look to scale their busi- agers ultimately hit a breaking point where vate credit managers. Healthy returns, low nesses, they will inevitably face the decision the familiarity of Excel as a fund accounting correlations to other strategies and further as to what functions to keep in-house and and reporting system is not enough keep up diversification in their portfolios are driving what to outsource. Both have their advan- with the complex entity relationships and the attractiveness of private debt. tages and disadvantages, particularly when it LP reporting communication requirements On the GP side, the retrenchment of comes to working with a third-party admin- they are facing. traditional lenders after the financial crisis istrator. While many managers understand Another trend we have seen is that GPs (due to asset/liability management and Ba- the benefits a TPA can bring in helping to that have moved away from an Excel-based sel III requirements in Europe) has created scale their businesses, many don’t want to ‘platform’ have installed various pieces of a sizable opportunity set for credit manag- give up ownership of their data or processes disparate technologies to run different parts ers to provide needed financing. Distressed to an outside vendor. of their operations and processes. They fund managers, who have long waited for A new model we have seen gaining trac- might have installed some type of generic default rates to start ticking up, may finally tion with fund managers – and we believe accounting software, like QuickBooks, or be seeing the light of day as the global econ- will continue to grow in popularity – is a standalone VDR to function as their in- omy slows down. Private equity managers, ‘reverse-outsourcing.’ In this GP-adminis- vestor portal. A non-PE specific CRM like for their part, have become acutely aware trator working arrangement, the GP ‘hosts’ Salesforce might also be used. of these dynamics and are ramping up their or owns the accounting and external report- While an improvement over Excel-based private debt capabilities. ing data and technology. The administrator processes, these systems lack the true inte- However, a private equity manager look- utilizes, not their own software, but the gration capabilities that GPs will need to ing to step into the private debt market or GP’s in-house system to assist in the fund scale their firms successfully in the future, even one that already has lending capabilities accounting and investor reporting function. particularly as they grow in assets and inves- and is looking to expand its assets must face For GPs looking to capture the efficiencies tors. To address what will ultimately entail an inevitable challenge. From an operational of the outsourced model while maintaining more complex processes and workflows, perspective, managing a portfolio of credits is control over their underlying information, GPs will look to a more unified platform very different from a portfolio of equity in- reverse outsourcing can provide an optimal where the various pieces of software are tru- vestments. Significantly different data points balance between the insourced and out- ly integrated, allowing information to flow and metrics between the equity and fixed insourced models. n

December 2019/January 2020 • 2019 Yearbook 33 Stories of the year

Everything you wanted to know about GP-led secondaries

Once associated with problem funds, we found in September that GP-led processes are now part of the smart manager’s tool kit. Should you be doing one?

Not so long ago, we would only have written about GP-led second- long-term. Not that secondaries deals are without complications and aries if we were covering a fund that was lurching into crisis and controversy. For fund managers not wishing to receive a knock on desperately trying to keep its investments on life support. But, as the door from the SEC, transparency throughout every stage of the we found in September, such stigma is misplaced and outdated. The process is crucial. Indeed, it is not easy for GPs to avoid a conflict of market for GP-led secondaries is thriving. And such deals can make interest, when it has a fiduciary duty to get the best price for existing perfect sense. When the lifecycle of an investment doesn’t fit neatly LPs at the same time that it is designing the transaction and might into private equity’s 10-plus-two-years model, then a GP-led buyout even be a buyer of the assets. As the market continues to grow, we can be the most rational option for delivering value creation over the hope that this article proves instructive.

34 Private Funds CFO • December 2019/January 2020 Stories of the year

rownRock Minerals came processes have emerged to solve one of the to running an auction,” says lawyer Andrew into being in February major structural shortcomings of the private Ahern of Debevoise, who has worked on 2007 when private equity equity model: that a 10-plus-two-years fund GP-led deals for a number of general part- firm Lime Rock Partners life does not always fit with the trajectory of ners and advised HarbourVest on its invest- struck a deal to provide up the underlying portfolio companies. ment in Lime Rock’s restructuring. “A good to $100 million in growth Such deals were once considered a fix for quality advisor can lend a credentialization Ccapital to a joint venture with oil and gas a broken fund, in which GPs and LPs had to the process that it will happen and be business CrownQuest Operating. The in- become misaligned and something drastic done well.” vestment came from Lime Rock’s fourth was required to reset the economics. This The process from the GP’s perspective fund, which closed on $750 million in Sep- stigma has now been consigned to history broke down into three strands, Sernovitz tember 2006. and GPs have grown to see the secondar- adds: finding the right secondaries buyer; Fast forward to 2018 and Lime Rock ies market as a tool for efficient fund man- working through the legal documentation Partners IV was all but liquidated, save one agement. In-demand managers such as and structuring; and the process around the asset and a few residual holdings. Howev- Warburg Pincus, TPG, Blackstone and the limited partners. er, that one asset – CrownRock – had a net owner of PEI Media Bridgepoint have un- The first of these – finding the right asset value of close to $1.9 billion and still dertaken processes. secondaries buyer – involved pitching the had room to grow in value, in Lime Rock’s With investors consulted on an informal opportunity to a roster of established sec- estimate, by a significant amount. The sit- basis, Lime Rock selected an advisory team. ondaries investors. “We basically spent uation, an end of life fund and a remaining “We spoke to our existing LPs who have three days in Evercore’s New York confer- asset with a future of continued growth, was secondaries programs and asked them which ence room giving the same presentation 12 ripe for a GP-led secondaries process. “We intermediaries they work with who bring times,” says Sernovitz. After a competitive had been talking about the potential for a them the best product,” says Sernovitz. process, the firm lined up HarbourVest longer holding vehicle with investors in the Evercore’s private funds group was selected. Partners, a private markets investor whose course of our regular site visits for several secondaries program ranks in the top 10 in years before launching a process,” Gary Ser- Good advice the world, according to our sister publica- novitz, a Lime Rock managing director, tells It is technically possible to run a process tion Secondaries Investor. Private Funds CFO. without an advisor – EQT ran a stapled While prices are presented as a discount In pursuing a GP-led secondaries pro- tender offer in 2017 without one – but nor- or premium to net asset value, sophisticated cess, Lime Rock was to join a wave of private mal procedure is to hire one. “These are secondaries investors will reach their own fund managers doing similar deals. These time-intensive processes and there is an art conclusions as to the value of the assets, par-

December 2019/January 2020 • 2019 Yearbook 35 Stories of the year

ticularly because reference dates for pricing tend to lag the deal by months. In the first The VSS case and the path toward half of the year, the average high bid across all secondaries deals for buyout funds was 95 best practice percent of NAV, according to advisory firm Greenhill, but “certain high-quality GPs or When the SEC released details of its settlement with Veronis funds continue to price at significant premi- Suhler Stevenson, the secondaries community took note ums (eg, 120 percent of NAV).” For the second strand – the structur- Amid a fast-growing GP-led secondaries market, the SEC case that came out in ing – Lime Rock opted to create an acqui- September 2018 only confirmed that information asymmetry and potential conflicts sition fund that would buy the assets from of interest in GP-led deals need to be addressed promptly. the old fund. Those investors who wanted The sanction related to stakes in the New York firm’s Fund III, which was raised to roll into the new fund, rather than cash in 1999 and VSS was looking to dissolve in late 2014. The fund had two remaining out, would receive a distribution in kind of portfolio companies at the time VSS offered a deal to LPs: a cash distribution-in- an interest in the newly minted Lime Rock kind payout at a price based on 100 percent of the fund’s December 2014 net asset Partners IV AF, so that no tax liability was value. The SEC says the NAV of the fund at the time was $33.9 million, and VSS incurred. The original Fund IV would be used this as the basis for the offer to LPs. marked as fully realized. However, at the beginning of May 2015, before the deal went through, VSS Fund terms are not standardized across failed to inform limited partners that it had received information indicating the NAV continuation vehicles, says Debevoise’s of the fund had “increased significantly” on the amount previously stated, to the tune of approximately $1.74 million, the SEC said. The regulator said the “omission of this information regarding the potential increase in the value of Fund III’s portfolio companies resulted in certain statements in VSS’s May letter being misleading. In addition, after the offer was made, VSS did not provide the remaining Fund III limited partners with the first quarter 2015 financial information, which, according to VSS’s calculations, still showed an increase in Fund III’s NAV.” The SEC said that the offer letter made it appear the limited partners would receive the full value for their interests. VSS and one of its managing partners, Jeffrey Stevenson, settled for $200,000 with the SEC. The essence of the case wasn’t a complete surprise. The SEC has focused on potential conflicts of interest in the private fund management world for years and had already expressed concerns – coincidentally starting back in May 2015 – about those arising in fund restructurings. Add to that the growth of the secondaries market and of GP-led secondaries in recent years, it didn’t come as a surprise that the SEC started paying closer attention. “In certain of these transactions, the net benefit may be geared towards the GP rather than the LPs,” says Brian Mooney, a managing director at secondaries advisor Greenhill. “What the SEC is saying is that GPs need to be very clear and specific about how they are managing the inherent conflicts.” In many GP-led secondaries transactions, the GP, which has a fiduciary duty to its funds’ LPs, finds itself on both sides of the table. It is representing the existing LPs, but also designing the transaction, running the process, picking the advisor and the buyer, negotiating the terms, and as in cases like VSS’s, it is also a buyer of the assets. That position, combined with the fact it is the party that knows the most about the assets, puts it in a highly conflicted position.

36 Private Funds CFO • December 2019/January 2020 Stories of the year

Ahern. “I generally see pretty bespoke wa- Skin in the game terfalls with varying carry points and return One of the keys in terms of getting existing points. Unlike commingled funds, where “A good quality investors comfortable with the deal was be- you have no idea what you are going to in- ing clear about how the GP would benefit vest in and a lot of different investors, here advisor can lend a from the deal; the GPs’ carry from the orig- we know exactly what the portfolio is going inal fund became an LP interest in the new to be, you can better project what the re- credentialization to fund and the GP became the largest investor turns are going to be and you are negotiat- in the new vehicle. ing with one counterparty: it is a platform to the process that it will “When you sit across from investors say- design something bespoke.” ing that management, the senior manage- Returning to Lime Rock, the LP part of happen and be done ment of Lime Rock and others on the team the process began with seeking the approv- are rolling their entire stake over, given their al of the LPAC. There was no specific lan- well” conviction in the opportunity, they appreci- guage in the limited partnership agreement ate it and understand it,” says Sernovitz. that warranted this (there never is for a 2006 ANDREW AHERN A fund restructuring is not the always fund), but Lime Rock judged this to be a Debevoise the answer and should not be undertaken reasonable interpretation of the spirit of the lightly. agreement. “We have talked clients out of doing GP-led secondaries deals are rife with these,” says Ahern. “You could do a term conflicts of interest. There are four stake- extension if it is just about time. Need more holder groups with different priorities: ex- capital? Raising a side car is probably easier. isting investors looking for an exit, existing Some investors want out but there’s nothing investors looking to roll, new investors else that needs to be changed? A tender offer backing the deal and the financial sponsor. can solve that.” “It’s always good to go to the adviso- This market is booming. Advisory firms ry board first, explain why you’re doing predict that secondaries deal volume will a transaction, what you’re doing, provide once again break records this year after a maximum transparency, listen to your LPs The important thing for Lime Rock was busy first half. Greenhill found that $42 bil- and ask them for their opinion,” says a man- to be open about the fact this is a process lion in secondaries transactions closed in H1 aging partner at a secondaries firm active in that can pose potential conflicts, Sernovitz 2019, of which GP-led transactions – as op- GP-led deals. says. Each of the variables needs to be ad- posed to LP-initiated stake sales – accounted “Every LP has an opinion and a pre- dressed, including the price being offered as for a $14 billion. If anything is to slow this ferred outcome, so you need to figure out a percentage of NAV, the terms of the new trend down, it will not be a lack of available what makes sense, and then create a level capital and whether there is a stapled com- capital to back the deals. Secondaries Inves- playing field.” ponent to the deal (which in this case there tor research suggests that five of the largest was not). managers of secondaries capital will hold When the data room was opened to all final closes in the second half of the year rais- the existing investors, it contained the same ing nearly $50 billion between them. ■ information that had been made available to prospective new investors. In the end around 40 percent of Fund IV investors either held or upped their stake, 30 percent chose to partially liquidate and September 2019 • privatefundscfo.com another 30 percent sold out entirely. As lead Everything buyers, HarbourVest accounted for around you must half of the $741 million in new capital and a know about book was built around that cornerstone that including familiar names from the investor GP-led community. secondaries According to news reports at the time, CrownRock ended up making 24x invested This is an edited version of the cover capital for investors in Lime Rock’s 2006 story from the September issue of Fund IV, and the whole fund ended up at Private Funds CFO. For the full article, 2.9x. go to privatefundscfo.com

December 2019/January 2020 • 2019 Yearbook 37 Analysis

EXPERT COMMENTARY

qashqade’s Oliver Freigang and Gregor Kreuzer explore different options for firms seeking to modernize their approach to calculating waterfalls

Waterfalls: should you buy a car or a driver?

Building a waterfall model in today’s most of custom in the highly competitive funds SPONSOR used application – Excel – is a bit like build- market. QASHQADE ing your own car. When you imagine your But then, there is no need to build a car car as a chair with four wheels and a steering by yourself. There are experts out there, who wheel, building it yourself might seem doa- that come from LPs. With all these balls to do that every day. They learn from the past ble. But then, would you risk driving it on juggle, it would be a minor miracle if you and make the car better every time. a highway? Not to mention that you forgot didn’t make some mistakes along the way. They ensure that every new model has the engine… And did you think about the possibility features that improve the driving experience. Comparing a waterfall model to building that maybe over the life cycle of the fund, And you feel rather safer driving the car on a car is not that far-fetched. Like a car, the somebody else might be responsible for a highway. waterfall model tends to have more moving using your waterfall model in Excel? This The same is true for waterfall calcula- parts than meets the eye. When you set up inevitably leads to (overly-)complex work- tions. There is no need any more to create a waterfall calculation in Excel, you might books, workarounds like creating a file per them in a tool not built for the purpose. not think about all the cases the calculation version, hand-over issues with multiple lay- There are services out there which allow needs to cover, what sort of transactions may ers of logic within the same file, undetected you to buy the solution, instead of trying to come along, the side letters that add further errors, delays in response and the looming find it yourself. complexity or the requests for transparency possibility of reputational damage and loss Essentially there are two different types

38 Private Funds CFO • December 2019/January 2020 Analysis

of offerings available in the market: a car cision-makers can easily create specific with a driver, or a car you drive yourself. “The skill set to scenarios for their waterfall calculations and can therefore address key business The ‘full service’ model correctly calculate very challenges quickly and effectively; Outsourcing the waterfall calculation to – Speed of decision-making should im- experts who possess specialized tools (but complex waterfalls is prove, since you can model and simulate often use Excel as well) is not a new idea. with the right software in real-time and Plenty of fund administrators or technology not readily available do not need to rely on someone else first companies have been established to provide having to make those calculations or per- services with and around carry calculations. and can usually be form the analysis; This ‘full service’ model allows firms to – Costs: in general, a self-service mod- profit from service providers’ experience in found only at a high el should be more cost effective than a setting up waterfall models. It has the addi- full-service model since you do not have tional advantage that the fund manager can price” to pay for the ‘driver’. insist the service provider works according to their requirements, in order to avoid ob- The disadvantage is that whoever uses stacles and to understand and solve issues. the self-service tool must be open to new But if the car is just a chair with four technology and digitization. The fund man- wheels, then the driver can only do so much. ager then needs to trust the software and In addition, it requires significant experi- the outcome. While this is easier said than ence and expertise to correctly calculate very done, the fund manager also needs that trust complex waterfalls. if they outsource to an external provider. This skill set is not readily available and can usually be found only at a high price. Verdict Fund managers therefore often end up cal- Whatever model you might choose, be it the culating the waterfall again using their in- full-service model or the self-service mod- ternal models, just to ensure that the service el, you should decide beforehand what you provider’s calculations are correct (which would like to get out of it. often they are not). If you are looking to outsource An additional disadvantage of the ‘full everything, and are willing to trust the out- service’ model for calculating waterfalls put from a service provider that comes with is the need for regular communication. A a high price tag, then the full-service model fund manager has no direct access to the might work best for you. Just consider as wheel and must communicate anything it well what your investors might say if the cal- wants changed to the outsourcing partner. culations are erroneous and how you might But there is always the risk that informa- handle complaints if you have outsourced tion gets lost in translation and the fund everything but are ultimately still held re- manager might have to endure frustrating sponsible. delays as they wait for the service provider If you are looking to keep full control to respond. and are interested in maintaining the highest flexibility for your calculations, then a The ‘self-service’ model self-service tool might work better. The Using new technology to calculate the wa- self-service tool should provide you with terfall is a rather new trend. Often it is labe- easy-to-use software that can be used with- led as self-service. Here, the product carries out any major training. It should be able to all the experience and knowhow. And there- reduce the time you spend on these waterfall fore, the product needs to be able to handle “The self-service calculations significantly, while increasing all the complexities currently found in the the transparency of your calculations. alternatives industry. There is no driver to tool should provide As you move away from Excel and all its cover up for weaknesses in the product. The weaknesses to explore new technology, ul- fund manager is in the driver’s seat and de- you with easy-to-use timately it is up to you to choose the right cides what to do. Any data entry, modeling model for yourself and your firm. or calculation that the fund manager needs software that can Some changes need courage, time, mon- can be done immediately. ey and effort, but it will be worth it all!n Using self-service software has many ad- be used without any vantages, including: Oliver Freigang is the chief executive and – Increased flexibility: when utilized major training” co-founder of qashqade. Gregor Kreuzer is properly, with new or existing data, de- chief product officer and co-founder.

December 2019/January 2020 • 2019 Yearbook 39 Stories of the year

Why you should be selling a piece of your firm

There has never been a better time to raise capital by selling a stake in your firm. In our October edition, we told you what you need to know

Do you want to turbocharge the growth of your firm, resolve suc- are driven by the need for an infusion of primary capital, allowing cession and develop new strategies? If so, selling equity might be firms to grow in size and expand into new areas. Of course, selling a an exciting option. In October, we explored the growing trend for stake in a private equity firm is not simple or straightforward. There private equity firms to look to outsiders for a capital injection. Most is no clearly accepted formula for valuing a firm and transactions firms sell a relatively small stake (usually no more than 20 percent); typically involve an army of lawyers and advisors. But, much like any in some cases, the founding partners are bought out, allowing lead- other industry, selling an equity stake is becoming common practice ership to pass to the next generation. But the majority of transactions for GPs. It’s an issue we’re sure to return to in future editions.

40 Private Funds CFO • December 2019/January 2020 Stories of the year

ver the summer, two storied European private equity houses were putting the finishing touches on milestone deals. Partners at EQT Oin Stockholm and BC Partners in London were both lining up an infusion of capital aimed at supercharging growth in their already sizeable private equity franchises. While the two deals were set to raise similar amounts – both around the €500 million mark – the two firms were pursuing different paths. In what has become an increasingly rare move in modern private equity, EQT confirmed plans to list on the public markets, joining its long-time shareholder Investor AB on NASDAQ Stockholm. BC Partners, on the other hand, was busy inking a private transaction to sell a minority interest to Blackstone’s Strate- gic Capital Group. In doing so, BC joined a fast-growing list of firms to have raised permanent capital from specialist investors. The three largest buyers – Dyal Capital Partners, Blackstone and Goldman Sachs’ Petershill Funds – have been linked to at least 32 deals with private capital firms, most of which have happened in the last 18 months, according to research by our sister publication Private Equity International. Ad- visors in this area say the number of such deals is closer to 40 in the last two years. While these three investors account for a large share of the market, other investors are also active. Wafra, which is backed by the Public Institution for Social Security of Kuwait and partners with other global asset owners, has invested in 16 GPs, according to senior managing director Daniel Adam- son, with most of these deals coming in the last three years. Advisors also point to RDV Corporation, the DeVos family office, as being an active participant in this market. New entrants are currently raising capital to invest in this market: Aberdeen Stand- $ ard Investments is raising $1 billion for its GP interests program, Bonaccord Capital Partners, while StonyRock – launched by former Blackstone and Carlyle AlpInvest execs – is partnering with Jeffries Financial Group also seeking $1 billion.

What’s the money for? Typically, these deals involve combinations of both primary capital going back into the business and secondary capital going into

December 2019/January 2020 • 2019 Yearbook 41 Stories of the year

the pockets of the selling shareholders. Better call Saul “Most of the time the majority of capital Few people are better qualified than Good- being raised is primary capital to grow the man to opine on the shape of these deals. He firm, not secondary capital,” says Herald has advised on transactions involving New Ritch, the founder of DC Advisory US, who Mountain Capital, Lexington Partners, advised lower mid-market firm MSouth on Providence Equity Partners, Vista Equity a minority stake sale to Aberdeen’s Bonac- Partners, Silver Lake Partners, Platinum cord in June this year. Equity, Leonard Green Partners, Starwood There are plenty of uses for the primary Capital and Bridgepoint, the owner of PEI capital. As fund sizes grow, for example, the Media, as well as many others. The firm need to commit more to one’s own funds has been part of 35 minority interest deals – both in relative and absolute terms – be- in recent years. This summer he added BC’s comes more pressing. Research from law investment from Blackstone to his creden- firm MJ Hudson this year found that 35 tials. Evercore is the 800-pound gorilla in percent of all funds had a GP commitment this space. of 3 percent or more, which is an increase The headline percentage of the stake on each of the prior three years. sold in these deals is often less than 20 per- Then there is the question of transi- cent, because it might comprise a 20 percent tioning ownership of the firm’s economics stake in the management company, “but to the next generation. As a GP stake sale half of these deals are done with a non-con- allows senior partners to monetize a portion gruent stake of the performance fees,” says of their equity, it allows the next generation Goodman. “When you blend it all together, of leadership to participate in the transac- it might only be 12-13 percent of the overall tion – either in the form of loans from the economics, with many even lower.” balance or a simple allocation of capital – to The percentage stake is not really of buy out the senior partners or increase their paramount importance to either the in- participation in subsequent GP commit- vestor or the seller, Goodman adds. “The ments. investors aren’t solving for a minimum per- The other reasons for raising external centage ownership, because they are getting capital are all about growth, like funding the same limited governance protections expansion into new locations and hiring anyway; they are focused on the strip of talent. “It brings an extraordinary ability economics they are purchasing. The sellers to grow the business,” says Daniel Lav- aren’t solving for a percentage either; they on-Krein, a senior partner in law firm Kirk- are looking at their business plan needs and land & Ellis’ investment funds group. any secondary proceeds, if desired.” “If you look at the deals that have been Advisory sources differ as to how tem- done, after every deal the sponsor pours plated these deals have become, but a “typ- money into new strategies, new offices, new ical” deal, if such a thing exists, will involve products and they bring in extra operational the acquisition of a percentage of the man- resource to, for example, raise capital in a agement company – and the management new market.” fee income that comes with it – plus imme- Lavon-Krein’s team advised on Black- diate participation in the carry vehicles, as if stone’s investment in BC Partners and is they had been an investor on day one. These understood to have worked on most major are permanent capital deals, so investors are GP interest transactions this year. buying into these income streams in perpe- According to sources, Kirkland is one of tuity. Existing GP commitments can also be a handful of law firms to have developed a thrown into the deal. In some instances, the deep track record in this type of transaction. incoming investor can also pledge to corner- Other firms cited by market sources include $ stone future funds as a limited partner. Fried Frank, Simpson Thacher, Wilkie Farr & Gallagher, Debevoise and Holland & How much is my firm worth? Knight. “If you are only selling 10-15 percent of the In terms of what gets sold, “the vast ma- economics and some of that might be going jority of these deals have been 20 percent back into the firm, then valuation is not the or less at the outset,” says Saul Goodman, most important piece of the puzzle,” says head of the alternative asset management Goodman. “This market focuses on long- practice at investment bank Evercore. term cashflow and franchise value; not just

42 Private Funds CFO • December 2019/January 2020 Stories of the year

putting a multiple on current earnings,” he managers,” says Adamson. The majority of notes, adding that the management compa- its GP investments have been in younger ny and carry vehicles are valued differently. firms. What Wafra is looking for is “defen- Goodman stresses that these private sible franchises in asset classes and strategies markets investors do not look to the public- that have enduring value for asset owners ly listed firms for comparables. “The private around the world,” adds Adamson. In oth- market is separate and people are looking at er words, if you have proven your ability to a much longer time horizon – not just the invest well in a segment that is in favor with next year or two.” global investors (with which Wafra boasts Most advisors are, understandably, reluc- intimate knowledge), you may be of inter- tant to outline any sort of “back-of-the-nap- est regardless of size. There needs to be a kin” approach to valuing a PE firm. For one clear rationale for the transaction in terms thing, they don’t want to publicize commer- of what the GP will be doing with the pro- cially sensitive information. “No, no, no,” ceeds and what they are looking for from chides one banker when asked if there is a a partner. Wafra, for example, will avoid ready way a CFO can put a valuation on their GPs who are “purely looking for a financial own firm. “They are valued on a DCF basis transaction,” says Adamson. – very complicated models – but I don’t want These deals are, ironically, about more to get into it for competitive reasons. Given than just capital. When BC Partners an- the long-life nature of these investments – nounced its transaction with Blackstone this not just one fund, but multiple fund cycles summer, partner and chairman Raymond – these tend to be long-dated models.” $ Svider said, “We look forward to leverag- Another advisory source breaks it down ing Blackstone’s best-in-class resources and more willingly: “Assuming a typical 2-and- exceptional talent.” Those resources were 20 structure, we would advise that the firm not specifically identified, but likely refer to is worth around 10 percent of its AUM, and portfolio company cost savings, back office maybe you would look to sell 5 to 10 per- perks, new platform advice and introduc- cent of the firm.” tions. GPs considering a deal should know “It is a small set of financial and legal what they want to achieve and what capital advisors who know the deal pricing, deal and resources they need to do it. structures, terms, fit and preferences of These deals are sensitive subjects. None the buyers,” says Ted Gooden, head of pri- of the GPs contacted for this article were vate markets advisory practice at Berkshire willing to discuss their own transactions. Global Advisers, “so you need to go to Speculating on why, most contacts attribute someone with multiple reference points of it to the optics of what their LPs might be competed deals.” Gooden has advised on a thinking. “It is not as commonly accepted as number of GP interest transactions, includ- it should be,” says one banker. ing Clearlake Capital and Siris Capital. Looking at the names that have undertaken these transactions – and their subse- Am I big enough? quent fundraising success – there is certainly There is no litmus test in terms of AUM or no evidence to suggest investors are being maturity to tell whether a transaction like put off. ■ this will work for you, says Goodman. “Ob- “Most of the time viously it works better the bigger you are, Private Funds the longer you have been in business and the majority of CFO

October 2019 • privatefundscfo.com EXTRA How do credit lines really affect the more profitable, but it’s not like there IRRs? is a checklist covering certain metrics which capital being raised have to cross a certain threshold.” One restriction on whether your firm is primary capital to will be a suitable target is the size of check

grow the firm, not Why you should sell a piece of your firm that investors are looking to cut. Advisors (and how to do it) say that the largest investors in the market will want to deploy circa $150 million to secondary capital” $200 million at a minimum. This is an edited version of the cover Wafra, however, invests across the en- HERALD RITCH story from the October issue of Private tire GP lifecycle: “We’ll be the first dollar DC Advisory US Funds CFO. For the full article, go to in, catalyze growth or partner with mature privatefundscfo.com

December 2019/January 2020 • 2019 Yearbook 43 Analysis

KEYNOTE INTERVIEW

Translating the TCJA

As the 2017 tax reforms take effect, there are still questions over how private equity interprets the landmark changes, according to Simcha David of EisnerAmper

The Tax Cuts and Job Act of 2017 was one for the fund of funds so that the GP of the SPONSOR of the most significant pieces of tax legisla- fund of funds is entitled to carry. The long- EISNERAMPER tion in decades. Headline reforms like the term capital gains rate clearly applies to the drop in the corporate tax rate from 35 per- limited partners of the fund of funds. But cent to 21 percent earned cheers from Wall standards in the case of carried does it apply to that GP of the fund of funds, Street, despite many deductions and credits interest? whose fund of funds has only been around vanishing. The TCJA states that if someone holds an for a year? Practitioners currently assume Even the densest passages of legislative applicable partnership interest, they need to the three-year holding period pertains to language still leave room for interpreta- hold that asset for greater than three years the underlying assets, but there hasn’t been tion, much to the delight of tax attorneys before selling it in order to qualify for the guidance that fully resolves that question. everywhere. The inherent complexity of long-term capital gains rate. Previously, the And for funds of funds which may face how private equity funds are structured and minimum holding period was greater than this situation quite frequently, some clarity how firms invest means that the industry is one year. Private equity frequently holds would be welcome. bound to discover unintended consequences assets for longer than three years, so there within the TCJA. So we spoke with Sim- shouldn’t be too much of an issue, although GPs don’t time an exit solely by cha David, a tax partner with EisnerAmper, this new standard may cause a wrinkle for Q tax considerations, so what are about some of the thornier questions the law some funds. firms doing when they’re fortunate raises for GPs. However, this rule is not entirely clear enough to sell that portfolio company in certain respects. Suppose a new fund of after only two years? There is plenty of tax relief funds invests in an underlying fund. A year What does not work is utilizing the gener- Q contained in the TCJA, but not later, the underlying fund sells a portfolio al GP waiver provision that is currently in all of it applies to the private equity company that it has held for more three many fund operating agreements. That was industry. In fact, doesn’t it tighten years. This sale generated enough income put into operating agreements for situations

44 Private Funds CFO • December 2019/January 2020 Analysis

where the GP will waive the carry because What other deductions have the GP believes that it will eventually be Q been eliminated that might subject to clawback. That is a real waiver. “The new tax adversely impact the private equity Simply waiving the carry on the early deal industry? just to take it on the next deal is not a waiver, law ended a lot of One worth discussing is Internal Revenue especially if the value is already inherent in Code Section 461(l). This is part of the new the subsequent deals. deductions, including law that limits the use of trade or business Instead some attorneys are drafting losses to offset investment income. Section waiver provisions that mimic a manage- the one for investment 461(l) states that losses from a trade or busi- ment fee waiver for carry. Historically, some ness can only offset investment income up funds had a management fee waiver in place. expenses” to $500,000 (married filing joint). For exam- Practically this means that the management ple, if the general partner of a private equity company has the right to waive a portion firm gets $1 million in investment income of its management fee in exchange for the from the fund, but operates the manage- GP entity receiving a deemed capital con- ment company at a loss of $1 million, the tribution into the fund. The GP will have liability is not zero, as it would be before the priority in the cash waterfall for this amount TCJA. Instead, now they can only use up to for a future realization event. As long as the $500,000 (married filing joint) of those loss- deemed capital is subject to the entrepre- es to offset the investment income. neurial risk of the fund, this arrangement But questions remain around the defini- should be respected. tion of trade or business. Does the sale of an Under the current law, should the fund operating partnership, which is common in sell an asset in the first two years of own- private equity, give rise to trade or business ership, the GP can’t simply waive that car- income or investment income? There’s no ry and say they’ll take that amount on the guidance on that. next deal. In that case, the GP hasn’t really waived the carry income and the IRS would Are there any other not respect such a waiver. Instead, the GP Q uncertainties? needs to waive the carry on the current deal, We also don’t know what to do with the and only take the waived amount from the losses that exceed the $500,000 limit. Say a profits or increased value in the future, pre- private equity partner has earned $5 million cisely because that value doesn’t exist yet. in capital gains income and suffers $10 mil- There is no guarantee of getting that waived lion loss at the management company. Since carry in the future. It would require that in- that $10 million loss is considered from a vestments increase in value enough to trig- trade or business, the partner can only offset ger the payment of traditional carry, and the $500,000 of that loss against the $5 million waived carry as well. of income, and that leaves $9,500,000 of company) could end up with long-term cap- losses that were not utilized in the current What has been the effect on the ital gain. year. Which means on the partner’s personal Q private equity industry? So the fees are waived, and in lieu of that, tax return, they have $9,500,000 losses they The new tax law ended a lot of deductions, the GP gets a phantom stake in the partner- couldn’t use. including the one for investment expenses. ship equivalent to the fee they waived. The Practitioners have been assuming that LPs would use this deduction for manage- interest from the future appreciation of the the $9,500,000 rolls over to next year, and ment fees. Private equity firms will often fund will arrive sooner in a standard water- is no longer subject to the limitation, as it take a management fee based on the com- fall calculation than the GP’s usual carry, would be treated as a normal net operating mitted capital. This could be a rather large and those monies may arrive at the lower loss deduction, and offset up to 80 percent amount of income in the early years of the tax rate of long term capital gains. Such of the subsequent year’s income with it. management company. So, as mentioned waivers are a win-win proposition, but the So the partner could use 80 percent of the above, the management company will retain IRS is sensitive to a GP’s abuse of it. They $9,500,000 in a subsequent year to offset the right to waive a portion of their manage- need to see the GP face real ‘entrepreneurial investment income and not be subject any- ment fee. Without waiver the investor ends risk’ that the fees they’ve waived might not more to the $500,000 limitation. up with an expense they can’t deduct and the arrive. Most practitioners are interpreting Sec- manager has ordinary income. And that’s the thinking behind the carry tion 461(l) as a one-year deal, and next year Under a fee waiver arrangement, the waiver being rooted in the increased val- it’s a normal NOL. But we don’t have guid- management company has less current ordi- ue of assets in the future. However, while ance on that either. That doesn’t mean guid- nary income, the limited partners have less they’re using the management fee waiver as ance won’t be forthcoming on any of these of a non-deductible expense and ultimately a model, there is no guidance that the IRS issues, but the industry should tread carefully the GP (same ownership as the management approves of the practice. as there aren’t definitive answers just yet.n

December 2019/January 2020 • 2019 Yearbook 45 Stories of the year

Lessons from the front line of tech implementation

In November, we asked how you can stop a technology project chewing you up and spitting you out

We all know that a tech project, which promises to streamline our vember issue. For answers, we turned to three firms – Insight Part- processes and eliminate inefficiencies, can soon leave us tearing our ners, Adams Street and Riverside – that have recently carried out hair out and screaming in frustration as budgets spiral, delays mount major projects. As a starting point, the case studies showed us the and design flaws become apparent. So how do we avoid the common crucial importance of stepping back and deciding what we want to pitfalls of tech implementation – and make sure that our colleagues achieve with tech improvements before we turn to service providers. actually use the gleaming new systems that we invest so much time And we learned how getting buy-in throughout the firm is a vital to and effort developing? That was the question we asked in our No- a project’s success.

46 Private Funds CFO • December 2019/January 2020 Stories of the year

Tech tales

Lessons from the front line of tech implementation

Insight Partners
Riverside
Adams Street Partners

hat is the secret we ask about successful projects. “Some- There are many other ingredients that go to a successful times it is easy to get caught up in the ex- into a successful implementation. “Whoever technology imple- citement around a given type of technolo- is using the software needs to be properly mentation? “First gy, such as artificial intelligence,” says Ned trained, and that training needs to be ongo- and foremost, we Gannon, president of eBrevia an artificial ing,” says Oliver Freigang, chief executive of want to be clear intelligence software business. “In our expe- waterfall software business qashqade. Won the problem we are solving,” says James rience, the most successful implementations “The business” needs to be onside from Fung, chief technology officer at global of a given technology start with the user’s the get-go, meaning both the senior man- private markets firm Northleaf Capital. “If pain points.” agement and end users. we decide to explore a technology solution, Clearly defined goals are common to the “The business users are critical in provid- we want to be laser-focused on the prima- three case studies we look at in this issue. In- ing details regarding the business need and ry objective for the solution, so we are not sight Partners required a better way of gath- feedback during the design and implemen- distracted by the ‘bells and whistles’ of the ering, analyzing and disseminating data from tation phase,” says John Manganiello, head solutions of the day.” a growing stable of portfolio companies. Riv- of business development at asset manage- That sentiment – that you need to know erside needed a neater and safer way to sign ment-focused tech firm RFA. These themes your goal before you go out and buy some off wire transfers. Adams Street Partners and others emerge from our three case stud- shiny tech – is echoed by every technologist needed to centralize 40 years of fund data. ies. We hope they are instructive.

December 2019/January 2020 • 2019 Yearbook 47 Stories of the year

mined, however, to move away from the

Tech tales

biblically-proportioned Excel spreadsheet. He kept his eyes open for an outsourced provider and accepted every meeting invita-

Insight Partners’ tions. He was struck: “This is what I had built,” he remembers thinking to himself. But it was too expensive and not much of an
10-year improvement, he decided at the time. But as Insight grew, the need for a so- quest for phisticated portfolio management team grew with it. “Within a few years, we were projecting to have well over 100 active port- portfolio folio companies and in over 350 businesses since our inception. So we had an immense management amount of data on private software com-
Tech tales ensure we could effectively mine and utilize h3> it,” says Lessing. Throughout that process of searching

for a portfolio management platform Less-
ing said he met with any service provider he could and recommends the same approach
for any company looking to invest in soft-
Insight ware. It was iLevel that Lessing eventually
CFO
returned to. At the time Lessing’s team was considering a cheaper software option, but the final decision came down to a conversa- Insight Partners’ 10-year quest for tion between Lessing and his VP of finance about cost. “I said, ‘We don’t want to be cheap on this. Spending a few thousand dol- portfolio management software lars more a year is well worth it because if we use it the way I expect we’ll use it, it will pay off in a big way.’” Insight Partners’ CFO Mark Lessing discusses his Lessing estimated it would take a year to properly implement the new platform, but firm’s move away from Excel in the end, it took only three months. Insight Partners now has nearly 200 in- hen Mark Lessing joined Insight the system himself with some tech support vestments to track. Switching to a third-par- WPartners in 2000, the iPhone had yet from India. It took him about two years to ty software has allowed the firm to dissemi- to be invented. Facebook and Twitter did finesse the platform, which allowed portfo- nate information to all employees within the not exist. And Lessing found himself gather- lio company CFOs to log-in and input their firm. Roughly two-thirds of those employing financial data from roughly 40 portfolio financial data directly. “The system was re- ees log in to the portfolio tracking software companies and inputting it into a monolith- ally good,” says Lessing. But regardless of weekly, at minimum, to look up information ic spreadsheet nicknamed ‘the Bible.’ Near- how well a system functions, if it doesn’t on a portfolio company. ly two decades later and things look very get used, it isn’t much use. Lessing had an There is benefit, he notes, from using different in Insight’s finance function, but issue with buy-in: portfolio company CFOs third-party rather than self-built software. the road to operational efficiency has been were not logging in to upload and, crucially, The vendor’s access to other clients, for far from simple. Insight’s senior deal team was not pushing example, gives them a wider perspective on He knew what was needed: a platform to them to do so since there were other prior- potential upgrades and technology features gather and collate portfolio company data ities at portfolio companies. Lessing found available to private equity firms. efficiently and consistently, that could be himself pretty much back at square one. “I Return on investment from a technology interrogated in real-time by the investment was the only one using it,” he says. upgrade is hard to measure. Lessing knows team. At that time – in the early 2000s – such Having got the self-built platform up CFOs are cost-minded, but says eventually a platform did not exist. Lessing, a techno- and running, after about two years Less- they have to take risk that fits their firm’s logically-minded CFO, set about building ing decided to shelve it. He was still deter- situation and size.
48 Private Funds CFO • December 2019/January 2020
Private Funds CFO_ADVERT_102019.indd 1 31/10/2019 17:23:20 Private Funds CFO_ADVERT_102019.indd 1 31/10/2019 17:23:20 Analysis
Tech tales
“We believe our portfolio company
data is among the
Adams Street Partners largest in the private market space”

Centralizing ALICIA PANDO Adams Street Partners 40 years of data
sits above all these systems” known as a data
mart. The creation of this hub was therefore to become Pando’s first priority, as it would

then pave the way for the introduction of
Alicia PandoAliciab>
Pando
which the hub was the starting point – was signed off by the Adams Street leadership by the end of 2017 and after scoping the project and hiring the team, implementation could begin from Q2 2018. It would take four full-time developers around a year to have the hub – built on Microsoft SQL Adams Street on centralizing Server – operational. Pando also built a data management 40 years of data team – something new to Adams Street. “We have established a team that is fully responsible for the quality and timeliness Alicia Pando, CTO at Adams Street Partners, discusses of the firm’s operational data,” says Pando. “In addition, our data management team normalizing and centralizing its data oversees a large offshore group that is responsible for the ongoing digitization of our hen Alicia Pando joined Adams master data but also needed to be synchro- portfolio company data.” WStreet Partners as its first chief tech- nized with data hosted in other systems,” Overall the firm has just over 30 in the nology officer in 2017, she was tasked with says Pando. technology team, broken up into the infra- modernizing the venerable firm’s systems: “The architecture presented a number structure team, which consists of help desk no mean feat for an organization that has of problems. Firstly, the number of syn- and engineering and the largest group – de- been collecting fund and portfolio company chronization points grew rapidly with each velopers – of which there are around 15. data from GPs since the 1970s. additional system. Secondly, implementing The benefits of the hub are now being “We believe our portfolio company data applications or reports that required data reaped by Pando’s developers in the speed is among the largest in the private market from multiple systems was challenging as with which they can create new applications space. We collect data for hundreds of active developers had to mine data in multiple da- on top of it. GP funds on a quarterly basis,” Pando tells tabases. This severely hampered the deliv- “We are in the process of replacing our Private Funds CFO. ery time of applications and reports.” data mining and reporting modules and our In a scenario that may be familiar to In other words, if Adams Street wanted client portal with more powerful applica- many PE executives, Adams Street had ac- to keep making full use of new and exciting tions that source their data from the hub,” quired various third-party tools and built third-party products as they became avail- says Pando. proprietary systems over the years to tackle able – as well as develop its own applica- “The time to delivery for these user-fac- changing business needs and growing com- tions – its data needed to be “normalized ing tools is significantly faster than without plexity. “Each system hosted its own set of and centralized” into one hub: “a layer that the hub.”
50 Private Funds CFO • December 2019/January 2020 Stories of the year
oving large sums of money around: it Mis part and parcel of a private equity firm’s operations. It is also a process that can be vulnerable to error and fraud.
Tech tales
Riverside, a firm whose international private equity and structured capital portfolios include more than 100 companies,
and which operates from 16 offices, knows this as well as anyone. The company is averaging nearly four new transactions
Riverside a month in 2019. With investment professionals spread across most time zones, there came a point last year when it deemed
A wire system it was no longer appropriate to handle the request for, and sign-off, for wiring funds by email. fit for purpose
“We were concerned about not having easily identifiable and documented records of appropriate approvals for investing in portfolio companies,” chief financial of-
ficer Béla Schwartz tells Private Funds CFO. The old transfer protocol involved an
Béla Schwartz
email chain requesting sign off from rele-
Béla Schwartz
vant parties, and the information included in each email would often differ, Schwartz
CFO
says. “Each fund family sent an email their
CFO
own way with their own comments.”
a little shoddy; we really don’t know if the Riverside on building a wire money being asked for has been approved.’” Riverside’s director of project management, Russell Leupold, explains how the service fit for purpose new sign-off works: “Each time we need to kick off a new workflow, a member of the deal team goes into the platform to fill out Riverside’s Béla Schwartz and Russell Leupold talk a simple form. They enter a description of the transaction, the amount to be approved about creating a safer way to send money at this funding, along with other support- ing details. The system left Schwartz and others “When they then click save, a number unsure as to who had been involved in of notifications are sent. Initial alerts go the approval process. “It was not neces- out to the fund administration team, to the sarily clear who began the wire process,” CFO, to the deal team and to the partner Private Funds Schwartz says. “It could have been a very CFO on the deal related to the approval request.
November 2019 • privatefundscfo.com EXTRA Keeping a Is your operational lid on legal junior person. It wasn’t clear whether costs The partner will then log in, click ‘yes’ to technology holding you back?
the fund manager had signed off on it, or Tech tales confirm. That then routes another notifi-
Back to front office ▸ Real Estate ▸ Private Equity whether it was just the senior folks. Somesolu-tions for: ▸ Infrastructure ▸ Venture Capital cation to our fund manager. When that is
Take your operations to the next
level with AltaReturn’s front-to- times the fund admin team would get binack office- solutions. Lessons from the confirmed, another notification is sent to Built specifically for private front line of tech capital funds, our integrated volved. It was hazardous.” suite of Accounting, CRM, implementation the co-CEOs, who then give the final ap- Business Intelligence and Portal Solutions ensures you’re never
The system’s shortcomings led to a lelotft behind. proval. At that point, a ‘funds approval is Learn more at: Contact us at: of time expended on verification, and whilewww.altareturn.com [email protected] completed’ notification is sent to the entire there were no known instances where Riv- audience.” erside made an errant transfer, one of the As is ever the case, buy-in from the top firm’s CEOs saw the need to improve the was paramount. “After we went live anyone This is an edited version of the cover system to avoid a potential mistake being story from the November issue of who tried to sidestep the process would made. “There was a request made by one Private Funds CFO. For the full article, be identified and forced to go through the of our CEOs saying, ‘This email thing is go to privatefundscfo.com proper channels,” Leupold says. ■
December 2019/January 2020 • 2019 Yearbook 51 Analysis
EXPERT COMMENTARY
Landmark reforms have added further twists to the tax labyrinth for private funds, writes Withum’s Michael Oates
Can funds duck the TCJA’s punches?
The 2016 campaign trail introduced the Trader fund versus investor fund SPONSOR nation to then-candidate Donald Trump’s It is absolutely crucial to understand and dif- WITHUM promised tax cuts, which gave way in 2017 ferentiate between these two types of funds. to sweeping reality in the form of the Tax Quite simply, the distinction significantly Cuts and Jobs Act. as well as new limitations of others influences the tax treatment of the partner- In the almost two years since, the exten- and changes in various tax rates have ship and its investors. As a result, it is es- sive repercussions of the TCJA have become significantly altered the taxation landscape sential to determine the fund’s classification increasingly apparent within the private eq- in the immediate future – and will do until each year. uity, hedge fund and venture capital space. at least 2025. On one side of the ring is the trader fund While IRS clarifications are typically in- Most prominently, the TCJA has raised – typically high-risk, high-reward endeav- tended to clear up ambiguity, on the TCJA the limits of standard deductions to nearly ors designed to capitalize on micro-market front they also have created muddied waters twice their previous amount while severely trends and short-term swings with a high for individual, fiduciary and business taxa- curbing itemized deductions. According to level of portfolio turnover. And in the other tion. the Tax Foundation, the aim was to sim- corner is the investor fund: notable for buy- Across industries and fund types, the plify tax returns by discouraging the heading and holding assets over the long term to TCJA has created a wave of uncertainties ache-inducing technicalities of itemized generate income from interest, dividends and challenges as finance departments at- calculations. and capital appreciation. tempt to understand the new provisions. So, how has the TCJA altered the alter- Despite the differences, the proverbi- Expansions of certain deductions, native investment fund landscape? al fence between the status of trader and
52 Private Funds CFO • December 2019/January 2020 Analysis
investor funds is not as rigid as one might undermining potential with taxation at a imagine. In fact, the area between the two higher rate. However, regardless of fair- is quite grey and has been developed by “The TCJA presents ness or utility, trader funds could bene- case law over the years. Hence the TCJA fit from calculating business losses under presents deep nuances and occasional loop- deep nuances and the $250,000 ceiling (which is raised to holes. $500,000 for married couples filing jointly). Since the impact of the trader versus in- occasional loopholes” vestor debate has longevity on its side, funds QBI’s minimal impact on funds need to carefully evaluate their investment The qualified business income deduction strategies in order to achieve intended re- was heralded as providing substantial tax turns. This is due to the TCJA’s shift of the savings for eligible pass-through entities. trader/investor fund landscape with pro- But these benefits have not yet materialized found effects on both investors and manag- on the trading fund front. Under Section ers. Some important highlights include: 199(a), a deduction claim can be made if (1) Suspension of itemized deductions for which we will address later). This greatly there is income from a trade or business op- miscellaneous expenses (including man- reduces the extent to which investor fund erated as a pass-through other than a speci- agement fees and other investment ex- expenses can benefit taxpayers. In fact, the fied service trade or business. This includes penses) new Section 11045 stipulates that tax-relat- the activity of trading securities in a partner- (2) A new limit on business interest deduc- ed expenses – such as investment advisory ship. There are limited benefits for the de- tions fees – are no longer deductible. duction for fund investors for the following (3) Limits on excess business loss from a But (there’s always a but) if these fees types of income: partnership are tagged as business expenses and fall into (1) 20 percent of ordinary dividends from a the same category as trader funds, there is a real estate investment trust Non-deductible Section 212 possibility they can be deducted. This minor (2) 20 percent of ordinary income from a expenses wrinkle in the system is a perfect representa- master limited partnership with QBI. The trend from itemized to standardized tion of the complex and often-convoluted deductions favors trader funds – primarily implications of applying the TCJA’s provi- The pass-through to C-corp because funds with the ‘trader’ designation sions on funds’ above-the-line/below-the- reality are categorized under the umbrella of busi- line expenses. The expectation that a tidal wave of pass- ness expenses, according to IRC Section through entities would soon be converting 162. Thus, business expenses can be deduct- Business interest expense their status to C-corps has proven to be mis- ed as standard expenses. limitations placed. In reality, few have made the jump, The same, however, cannot be said for But when are they limited? It should be not- despite the new corporate income tax rate investor funds. Under the TCJA, itemized ed that new Article 163(j) has introduced of 21 percent. expenses under Section 212 are no longer a limit on deductions to business interest C-corps still retain the double layer of deductible by investors (apart from C-corps, expenses. According to the IRS, relevant taxation – the first associated with the cor- taxpayers must ensure the total of such de- porate tax rate on profits and the second at ductions comes in lower than three different the shareholder level on dividends. Rath- criteria – business interest income for that er than being an incentive, this has been year; 30 percent of adjusted taxable income; a deterrent as pass-throughs have taken a and floorplan financing interest expense. ‘wait and see’ approach that appears to be Any excess is carried over to future tax years. working in their favor. And why not? Pass- Article 163(j) does not apply to investor throughs are taxed on the individual rate, funds, since they do not qualify as business not the corporate rate. expenses. But both investor funds and trader The TCJA – at its initial roll out – was funds are restricted by other limits tied to comprised of 400+ pages of twisting tax annual investment income. reform, and its volume has since expanded with the ensuing clarifications, regulations “Across industries and Excess business losses in trader and final rules. While the TCJA is neither funds heads nor tails, black nor white, one thing is fund types, the TCJA Perhaps one of the most puzzling compo- certain: it is a complex, turbulent ocean best nents of TCJA is Section 461, the excess navigated with experienced financial servic- has created a wave business losses provision. Under the guide- es industry tax advisors at the helm. ■ lines, there is a cap of $250,000 on non-cor- of uncertainties and porate business losses. Any amount beyond this limit is subject to a net operating loss Michael Oates is a CPA with Withum’s challenges” Financial and Investment Services Group that passes over to the next tax year. and the practice leader for the firm’s financial What makes this a head scratcher is its service tax practice.
December 2019/January 2020 • 2019 Yearbook 53 Analysis
The search for stability in a shifting environment
In an increasingly complex investment market, managers are sticking with traditional fund domiciles and outsourcing more of their operational functions, survey findings reveal. By Vicky Meek
rivate fund managers are in- center has largely been to their detriment. creasingly opting to domicile It has been a key beneficiary of substance funds in Luxembourg, our requirements under BEPS, the Paradise Pa- exclusive survey carried out in pers and Brexit, while also introducing the conjunction with RBC Investor SCSp, which has made structuring much & Treasury Services revealed more straightforward.” Pin June. While the top three jurisdictions Luxembourg has increasingly become a remain consistent with a similar survey we hub for AIFMD compliance among those conducted last year – in which we polled seeking capital from European investors. only private equity real estate fund manag- The launch of the SCSp, or special limited ers – with Delaware, Luxembourg and the partnership, in 2013 – a limited partnership Cayman Islands well ahead of rivals else- agreement that is effectively a copy and where, this year’s survey, which includes the paste of Delaware and UK limited partner- views of private equity real estate, private ship documents – was the start of Luxem- equity and private debt funds managers, bourg’s rise. suggests the popularity of Luxembourg has But developments since have boosted its risen over the past year to match Cayman. popularity, including the UK’s vote to leave the European Union, the implementation Delaware retains top of BEPS and increasing LP concerns about domicile status using offshore structures following the Pan- When asked which domicile private fund ama Papers and Paradise Papers leaks, and managers would choose for their next pri- the marketing passport available for AIF- vate fund launch, Delaware emerges as a “If you rolled back a MD-compliant private funds. clear leader, with 45 percent of respond- A large part of Luxembourg’s growing ents choosing this as a jurisdiction, 36 per- few years, the UK and allure is down to the parallel structures be- cent opting for Luxembourg, and the same ing established by US managers. Proskauer proportion selecting Cayman. All three are Channel Islands would partner Edward Lee points out: “In our own highly rated for their optimal conditions for analysis of European funds, we’ve seen a big doing business and for their regulatory and have appeared among shift in Luxembourg’s favor over the past 12 tax framework. months, in particular among UK funds, a This is quite a turnaround in a relatively the top jurisdictions for move that is clearly Brexit-related. However, short space of time. “If you rolled back a few we are also seeing a number of US managers years, the UK and Channel Islands would private funds” establish parallel structures in Luxembourg, have appeared among the top jurisdictions where they either establish their own AIFM for private funds,” says Leith Moghli, part- LEITH MOGHLI or use third-party AIFM service providers ner at Reed Smith. “While they are still rel- Reed Smith and delegate back to the US.” evant, Luxembourg’s development as a fund “Luxembourg is a relatively easy place
54 Private Funds CFO • December 2019/January 2020 Analysis
for US fund managers to do business,” adds How do you expect your investor base to change in the next five years, by type of investor? Stephen Meli, partner at Proskauer. “In key Increase Decrease Remain the same N/A ways it’s becoming the Delaware of Europe 0% 20 40 60 80 100 for US managers. The entities Luxembourg offers are similar to those available in Del- Pensions aware and the Cayman Islands for fund structures and the documentation is similar, SWF/Government even down to the way the documents read. Other Institutional Investor There’s also a network effect, where every additional US manager that establishes a Corporate parallel vehicle there helps attract others.” Investors are also gaining comfort that Retail Luxembourg’s regulatory regime and re- quirement for depositary services under AIF- MD offer added protection, a trend noted by Nicolas Fermaud, head of the New York How do you expect your investor base to change, in the next five years, by location of investor? office at Elvinger Hoss. “Where firms have Increase Decrease Remain the same had parallel structures for two to three years, 0% 20 40 60 80 100 we have noticed a disproportionate increase of the commitments collected through the UK Luxembourg structure,” he says. “In part, managers are raising more capital from Eu- Europe (ex UK) ropean investors, but it’s also because investors globally are becoming increasingly com- Asia (ex China) fortable with Luxembourg as a jurisdiction. China For firms that equalize costs across their platforms, the Luxembourg set-up with its Middle East depositary and regulatory regime is clearly more attractive for many investors.” Americas (North) Private fund managers are also eyeing fairly significant growth in assets under man- Americas (Central and South) agement. Over a quarter see an increase of 10-20 percent growth in the next year and over half expect over 20 percent in the com- Which domicile will you choose for your next private fund launch/reallocation? ing decade. 0% 10 20 30 40 50 This increase will come from a wider variety of investors from a broader range of Delaware geographies. The majority of respondents Cayman Islands (88 percent) expect to increase the proportion of investors from Asia (excluding Chi- Luxembourg na), 81 percent anticipate a rise in North American investors and 53 percent predict Other US that capital from Central and South Ameri- can investors will make up a higher propor- Jersey tion of their AUM. All this adds up to increased complexity when it comes to managing private fund How important are the following data management strategies to your firm? businesses. Many respondents are looking to outsource parts of their operations: 51 per- Extremely important Important Moderately important Not important at all cent of respondents are seeking to outsource 0% 20 40 60 80 100 at least half of the fund administration part Humanizing big data of their business and one-third of respondents want to outsource at least 50 percent Regulatory data services of their technology function, with 28 percent and 20 percent saying the same about Benchmarking services legal and regulatory services, respectively. “Outsourcing among fund managers is Risk and analytical services
December 2019/January 2020 • 2019 Yearbook 55 Analysis
clearly being driven by a desire to optimize How will you approach outsourcing of the following areas over the next 12 months? their operations and focus on what they do Increase Remain the same Decrease best,” says Holz. “It’s also a way for them to 0% 20 40 60 80 100 manage certain risks, such as regulatory risk, given that it’s challenging to keep up with Data management regulations across the different markets they are operating in.” Distribution
Disruptive concerns Fund administration Big data, automation and artificial intelligence rank top among respondents for Fund management their potential to disrupt private capital investment in the next three years, yet over a Legal quarter are not planning on implementing these technologies, and many report having Procurement little expertise in this area. Less disruptive technologies could, how- Technology ever, help private funds streamline their processes without the need for high levels of investment. Priya Nair, managing direc- What is your target outsourcing level for the following areas? tor and global head of product management 0% Up to 25% 25-50% 51-75% More than 75% for private capital services at RBC, says: 0% 20 40 60 80 100 “Smart contracts, for example, can help create base templates where there are a lot Technology of similarities, such as liability frameworks, without the need to have a large element of Procurement involvement from lawyers. Regtech has a lot of potential for helping firms monitor reg- Legal ulatory developments globally and ensuring firms can stay ahead of the game – it could Fund administration streamline passporting, for example, and be applied to AML and KYC compliance.” Data management For those that invest in deploying technologies like big data, the prize could be bet- Regulatory services ter dealflow. “Firms are looking at how they digitize their internal processes at a time Fundraising when there is a lot of dry powder in the private markets space,” says Nair. “They need to differentiate themselves around how they What is the potential for the following to disrupt the private capital investment and service space in the next three years? originate and how they create value in their 1 2 3 4 5 portfolio.” Low potential High potential And being able to differentiate from the competition is uppermost in respondents’ minds. While the biggest barrier to achiev- Artificial Intelligence 2.60 ing their objectives in 2019 is the econom-
ic environment (mentioned by 72 percent), Automation / Robotics 2.60 competition is second for 42 percent. n
Big data 3.38
Methodology Blockchain 2.34
PEI Media surveyed 82 private Crowdfunding 1.90 fund managers about a range of fund domicile and regulatory issues. Regtech 2.33 Answers were given on a strictly anonymous basis and the results Smart contracts 2.32 aggregated.
56 Private Funds CFO • December 2019/January 2020 Analysis
If your organization is not planning to implement any of the following, what is the biggest reason? Do you intend to make use of any capital call facilities over the next 12 months? Too expensive No expertise Offers no value 0% 20 40 60 80 100 No Don’t know Artificial Intelligence 16% 11% Automation / Robotics
Big data
Blockchain
Crowdfunding
Regtech
Yes Smart contracts 73%
Do you use a capital call facility to bridge between an investment and the capital Tapping new demand for private equity contributions?
With 74 percent of private equity funds in our survey expecting an increase in AUM No of at least 20 percent over the next decade, including more than two-thirds expecting to achieve this within half that time, investor relations and fundraising teams in this 11% part of the alternative assets space are set for a busy time. There is clearly demand from institutional investors as fund sizes have increasingly crept up over the years since the 2007-08 global financial crisis. Yet private equity funds also have their eye on the retail market, our survey shows. Nearly half of respondents expect to increase retail investors in their investor base mix, including 19 percent predicting a large increase. There has been some movement in this space, according to Reed Smith’s Moghli. “Over the past 12 months, I’ve seen the launch of a handful of fully fledged private equity operating platforms aimed at retail investors that provide fully automated administration processes,” he says. “However, they aren’t targeting the average person on the street – they generally Yes require minimum income levels of around £100,000 and assume a certain amount of investment sophistication.” 89% Yet major developments look some way off, especially in Europe where regulations are currently not well tailored to the needs of private equity.
What will be the main barriers to meeting your objectives in 2019? Do you use fund financing loans?
0% 10 20 30 40 50 Yes Geo-political events 44%
Economic environment
Regulation
Technology
Competition No Other 56%
December 2019/January 2020 • 2019 Yearbook 57 Analysis
Canada Bermuda Regime Will you choose for next fund? Will you choose for next fund? ratings 4% 3%
Delaware, the Cayman Islands and Luxembourg are the top jurisdictions,
according to our survey 0 20 40 60 80 100 120 0 20 40 60 80 100 120 of 82 private funds managers. All three domiciles rank highly Delaware Will you choose for next fund? in terms of regulatory framework, tax framework and business 45% conditions
0 20 40 60 80 100 120
The jurisdictions were rated based Cayman Islands British Virgin Islands on the following questions. Where respondents were asked to give Will you choose for next fund? Will you choose for next fund? three answers, the first answer was given three points, the second two points and the third one point. Regulatory framework Which of the following domiciles 45% 3% offers the optimal regulatory framework in 2019? Tax framework Which of the following domiciles offers the optimal tax framework in 2019? Business conditions Which of the following domiciles offers the optimal conditions for doing business in 2019, such as expertise? 0 20 40 60 80 100 120 0 20 40 60 80 100 120
58 Private Funds CFO • December 2019/January 2020 Analysis
Ireland Luxembourg Hong Kong Will you choose for next fund? Will you choose for next fund? Will you choose for next fund? 5% 36% 2%
0 20 40 60 80 100 120 0 20 40 60 80 100 120 0 20 40 60 80 100 120
Singapore Will you choose for next fund? 3%
0 20 40 60 80 100 120
Jersey Guernsey Australia
Will you choose for next fund? Will you choose for next fund? Will you choose for next fund? 6% 3% 1%
0 20 40 60 80 100 120 0 20 40 60 80 100 120 0 20 40 60 80 100 120
December 2019/January 2020 • 2019 Yearbook 59 Last word
Points of view on 2019
“One thing remains “The finance team will “There’s a sense on certain: the demand be incredibly small” both sides that the idea for transparency is to improve how we TIM JANKE, CFO of Xen, argues and consistency is here technology will streamline the finance do business” function to stay” SANJAY SANGHOEE of Delos Capital on co-operation between the SEC and TOM ANGELL of Withum on investor fund managers and regulatory scrutiny “The gap between politics and business “Far too often, the has gotten wider. Our “The biggest risks to private equity firms job is to seek to address deals and portfolio are like vampires” that as well as we can” companies right now are geopolitical” US Senator ELIZABETH WARREN is MICHAEL MOORE of the British not a fan of private equity Private Equity and Venture Capital Association warns of political BRIAN RAMSEY of Littlejohn & Co on turbulence the dangers of a widening political divide in the US
“What has been traditionally called the ‘back office’ is “The technology seems “These benefits come the heartbeat of the to be moving faster at what we expect to be business” than the regulators” a modest cost”
JAMES FERGUSON of Intertrust Executive search expert EMILY Blackstone CEO STEPHEN Group on blockchain and data privacy BOHILL on the indispensable role of SCHWARZMAN on his firm becoming the finance team a corporation
60 Private Funds CFO • December 2019/January 2020 WE ARE Global distribution
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