In a world where institutional investors are staring at holed public equity market positions, pallid fixed income returns and read every day about how the public face of a company can mask an altogether less attractive private reality, quality of information has become a key issue. Its accuracy, extent and timeliness are vital. And in the world of private equity that means that more limited partners want to know more and be told more often: about the performance of portfolio companies, about valuations and about the everyday issues of where their money is and what it's doing.
?Effective information management has become a critical consideration for every private equity firm,? says one US gatekeeper who spends a great deal of time looking at and listening to what GPs deliver to their LPs. ?But what we're finding is that many are still struggling to establish an orthodox approach to this. You'll get the evangelists who pour everything out, then you'll have the agnostics who will try a bit of this and a bit of that, then there's the old school who say ?this is how we have always done it and we see no need to change? ? and we see it as part of our job to help make things a bit more standard.? He could have added that the information delivery could not simply become more standard – at the moment there are no standard information or data protocols between GPs and LPs ? but also that much of the content could be made much better too.
?Effective information management has become a critical consideration for every private equity firm?
Scott Brown, runs the PrivateEdge Group at State Street which provides consultative and administrative services for over 20 LP and GP clients with approximately $50bn invested in private equity. This team provides services such as investment monitoring, market analysis, performance measurement and peer group analyses, investor reporting and financial preparation. Says Brown: ?There is considerable room for accounting and disclosure standardisation and automation around many of these issues from both the service provider and GP sides of the aisle.?
But if this sounds like investors and their advisors are deeply dissatisfied with their general partners' lack of communicativeness it's worth remembering that we are talking about an asset class that does not, and cannot, follow the simple reporting rules of public equities. And the buyside is aware of this. Says Brown: ?The private equity information flows and therefore the ability to analyse private equity via conventional portfolio analysis and risk measurers such as Modern Portfolio Theory (MPT) will naturally not get to the public market level, as MPT is based on the Capital Asset Pricing Model assumptions of truly efficient markets, which require the highly liquid and publicly available pricing mechanisms available only in the exchanges.?
More prosaically, private equity is also a comparatively young, but fast-maturing, industry where most general partnerships still consist of a handful of key personnel who are spread thinly across a range of responsibilities. It is inevitable therefore that firms are running to catch up with investors increased expectations. As Brown comments: ?With the cooperative efforts taking place throughout the industry we do get all of the information that we need in the end.?
Getting the technology right
One of the most obvious, and beneficial, areas where GPs can take significant steps forward in both improving information management and LP communication is by using specialised, integrated software. A number of technology firms have developed software solutions aimed expressly at private equity companies: some are designed to help manage the investment process whilst others put far greater emphasis on the back office administration of a firm's funds and their reporting to LPs. And all have recognised that their prospective clients are typically working at present with mainstream software (MS Access and Excel being the most prevalent) that has been allowed to develop ad hoc across the firm.
?There is considerable room for accounting and disclosure standardisation and automation?
?90 per cent of private equity firms have no formal systems,? comments David Kipling, the CEO of UK-based ICOSR that has developed a web-based portfolio management system for GPs. ?Most of these firms are essentially small businesses and have continued to use off-the-shelf software despite having outgrown the software's capabilities.? If one looks into a private equity firm the typical scenario is for various individuals to have developed their own systems and databases in order to help their work: hence deal makers may have set up their own transaction management spreadsheets (on an individual basis even) whilst the CFO or controller will have their own separate systems to deal with capital calls and distributions and so on for the firm's LPs. Even something as fundamental as the contact details for a particular LP may be loaded on several databases ? or may be merely a photocopy of a business card sat in a Rolodex on a secretary's desk. The fact that these systems are detached from one another means that not only is effort duplicated but there is also the considerable risk that the absence of the individual who built and ran a particular database or spreadsheet renders it virtually useless. ?And if that person leaves without the information being captured, a huge amount of valuable knowledge is lost to the firm,? adds Kipling.
Kipling: 90 per cent of private equity firms have no formal systems
Installation of an integrated system that can accommodate most, if not all, of a private equity firm's information requirements can counter such operational risks. It can also counter a more discreet but arguably more fundamental risk that LPs as well as GPs are beginning to recognise. At a time when portfolio companies are requiring considerable amounts of time and input from their private equity backers, and when regular and effective investor communications has also become far more important, key people at a private equity firm can find the majority of their time being taken up by these two tasks. It has been estimated that around 65 per cent of a GP's time is at present being spent on existing portfolio companies ? and if you run a fund with significant TMT companies in your portfolio that percentage is probably even higher. And those necessary back office tasks ? such as reporting to your LPs ? can take a further 20 per cent of the GP's time.
This means that a fund's dealmakers can be spending as little as 15 per cent of their time working on new transactions and that can spell disaster for a fund's returns. Says Kipling: ?GPs will micromanage and lose sight of the macro position.?
New investments and exits are the lifeblood of a fund's performance and there is the very real risk that GPs are failing to recognise that the extra time they spend on their existing portfolio and on reporting will damage their IRRs. Unsurprisingly, the software suppliers are keen to emphasise how their products will help reduce the amount of time required to do both.
Online, on time
A telling aspect of how software suppliers are developing their private equity products is the extent to which delivery of information and data is achieved via the Internet. The attraction of being able to access the facts and figures you need at any time and from any where is significant. Also, and with the key proviso that such a system has to be fed regularly by the private equity firm, online delivery goes a long way to counter the accusation that GPs drag their feet when it comes to delivering information in a timely way. Although it's worth remembering that the technology provides only the medium and that the content is still very much determined by those who buy the software (the GPs), online reporting seems an obvious, and inevitable, step to take. Most of the software houses supplying the means to deliver online information are also keenly aware of the simplicity and ?cleanliness? such a solution provides. Feeding the web serber's database via the internet not only ensures that content files can be converted to HTML pages and sent to a user's browser ? meaning that an LP need only have net access to use this system ? but it also ensures that the information can be presented in a user-friendly and visual way.
A number of firms have been developing this technology. They include Vitech Systems whose Equitrak offering can be either installed at a client's offices or run on the Web; IntraLinks who saw the opportunity to use their ?digital workspace? concept as a means to create a reporting space online and DMLT, the former technology affiliate of fund administration specialists DML who, since DML's acquisition by the BISYS Group, have been growing their technology offering into a combination of products grouped under the Investment Café name. There is also AnalytX and Relevant Equity Systems, both originating in the US but growing overseas as well as ICOSR in Edinburgh. All of these firms are working hard to extend their products' deployment, at a time when most estimate that as yet no more than 10 per cent of private equity firms worldwide are using specialised software to manage and disseminate information ? and some think the reality is much nearer one per cent. The rest of the private equity community are continuing to make do with their MS Excel spreadsheets, something that seems bound to create problems for all concerned.
?Delivering too much information about private equity into a public domain could be dangerous?
?The quality of existing data at many [private equity] firms is poor,? says Frank Vitiello, president of Vitech. ?It's fragmented and often incomplete, and this creates problems when installing a new system because the ability to create a complete, retrospective picture is compromised. If you can't find the information you can't load it into the system.? When a private equity firm embraces a new technology that can integrate information across a range of private equity functions including direct investment administration, fund investment administration and partnership and investor administration, it can at once serve as a rude awakening for the GPs who had faith in the quality of their data but also brings into stark focus the need for the firm to resource its information gathering responsibilities properly.
?You have to make sure that all the key people at the firm buy into the project,? says Kipling at ICOSR, ?You can't just buy the kit and expect a secretary to input everything thereafter.? To get a dealmaker to use the system can be a tough proposition though, with some regarding the task of capturing information as being too back office to merit their close attention. The solution is to make the technology both easy to use and genuinely useful ? both in terms of in-house activities and external communications. If, for example, instead of ducking phone call inquiries from LPs you can direct them to your secure server, the system's benefits become obvious. As Vitiello says, ?then you will find a deal professional will want to use it.?
Technology itself is not the solution
The adoption of sophisticated information management software at a private equity firm will not in itself transform that firm's ability to collect and disseminate the facts and figures that matter. It needs to be part of a broader effort to develop a more structured and processdriven approach to the running of the entire business.
One firm that has made a principle of instituting clear systems and controls across its entire operation is Baring Private Equity Partners (BPEP), a private equity group that manages over €2.2bn in capital, has LPs scattered across the globe and 80 per cent of its capital allocated to emerging markets. CEO Chris Brotchie (interviewed by Private Equity International in our September issue) has made it a point of principle that the firm become synonymous with clarity of information. Responsibility for this falls to David Huckfield, a BPEP veteran of 16 years who is group chief operations officer and the senior partner responsible for operational risk management. He is busy developing an online reporting system that will give LPs personal access to things like their capital accounts, which allows him to see the immediate benefits in terms of reduced enquiry traffic and enhanced LP relations.
Although recognising the need to provide easy access, Huckfield is more sceptical though as to how much LPs actually want or need: ?At the moment there's a great deal of talk of the need for LPs to be able to interrogate everything and I suspect they actually don't need or want this.? Part of this answer comes from a concern that some of the information that could be disclosed, such as forwardlooking exit projections, is inevitably extremely volatile (not least when you're dealing with emerging market portfolio companies). Should LPs have sight of these? Given that these numbers change frequently and the assumptions underpinning them could be open to lengthy debate, the inclination is to say no.
Scott Brown at State Street also describes one possible outcome of releasing too much information for people to play with: ?More guidance on standards and automation around financial and other fund statistics and data transfer will be helpful to all participants in the asset class, but delivering too much information about private equity into a public domain could be dangerous not least because the nature of some of the outputs, such as IRRs on recent vintage, or J-curve funds, are moving targets and can be easily misunderstood by an inexperienced person with access to a large public audience.?
Huckfield recognises though that different LPs have different levels of expectation when it comes to access to information. At the top of the table of those investors hungry for information come the US public sector LPs: the CalPERS and CalSTRS of the world. These investors are themselves subject to increasingly intense scrutiny with regard to their investing practice and performance, making it imperative for them to garner as much information as possible so that they can deliver what some might describe as exhaustive detail to their own supervisory boards and trustees ? and to anyone else who wants to know. ?Those guys have got to be bullet proof,? comments one GP who counts several such funds as LPs in his firm's funds, ?and with the US media pushing the whole Freedom of Information Act thing (which obliges US public agencies to respond to all public enquiries about their activities), it's inevitable that they demand, and expect to receive, all the information they want, when they want.?
Whether you've got such an information hungry investor in your fund or not, if you are a private equity firm with more than a handful of docile limited partners (and if you are you're one of a fastdisappearing minority), it's wise to be gearing up now to ensure you can deliver the right information in the right way when transaction activity picks up. ?With deal flow down and the general pace of a fund's life currently slowed, now's a good time to get your house in order,? says Ben Mazza of DMLT.
?With deal flow down and the general pace of a fund's life currently slowed, now's a good time to get your house in order?
There's also the matter of rationalising your costs at a time when distributions have all but dried up and the firm's management fee seems to have gained disproportionate significance in the capital accounts. Adopting an appropriate information management technology can create significant cost savings and such an outcome will not be lost on your LPs. Mazza at DMLT remarks that some private equity firms hired personnel to improve their reporting and administration at a time when a few more salaries raised no comment internally or externally, but now in these straitened times the opportunity to ?right size? your staffing has become essential. It's a harsh truth but some of those back office hires can be laid off when a firm moves to electronic communication and information dissemination. It's not just the salary bill that can be reduced: online document distribution will save forests of paper and transform your courier costs. Ken Pierce at DMLT describes one GP they work with who has over 1000 LPs worldwide and who now never sends out any paper documents to its investors: ?Although more radical a step than some are prepared to take ? some investors seem intent on receiving paper still ? the sponsor is saving hundreds of thousands of dollars in production and distribution charges a year.? Arguably it's at this operational level that the software suppliers are going to attract the most interest from the GPs.
There's also a more overt message from a private equity firm that embraces the new reporting technologies: we care about supplying our LPs with the information they want. For a firm actively fund raising this can be a potent point to make to a prospective investor. Helen Steers at multi-manager Frank Russell Company makes the point that when they are undertaking due diligence on a firm, significant time is spent assessing the methodologies the company uses to deliver information, besides the content of that information. The firms are rated on their investment process, which includes reporting and administration. And for the firm that makes the grade Steers will continue to monitor the information flows: ?We give frequent feedback to GPs as to how they are responding.? Interestingly Steers also says that although online access is a good thing, this is only part of effective investor communications. There's another, and in Steers' estimation, more vital component: ?A fund needs to have a real person making regular, proactive contact with the LPs: we don't want to discover important information via the media, nor by relying on a PDF being posted online or emailed to us.?
For a new firm with perhaps just one fund under management there is considerably greater pressure to ensure best practice in information delivery ? there's the ever-present prospect of raising that second fund when your first fund LPs are going to be your first line prospects ? and many are quick to wear their adoption of online reporting channels as a badge of honour. That's why Adam Collins, controller at New Mountain Capital, the $770m US mid-market private equity firm that has recently signed up to IntraLinks will declare: ?We want to be best in class: best in the investments we make but also best in how we communicate with our limited partners.?