The necessity of good administration

You've managed to close the new fund, albeit with more investors than planned and with the most complex set of fund documents yet. You're ready to get out there and start doing deals, and the last thing on your mind is how you're going to administer the fund and who in the office is going to look after this. But you've got a group of increasingly inquisitive investors waiting to hear from you: regularly, substantively and in a way that evidences your commitment to good LP relations. It's time to get serious about fund administration.

If specialised technology can provide a powerful information channel, efficient fund administration is the way that a GP can offer coherent, integrated information to its LPs. It's also where many private equity firms can fall down. Says one UK-based limited partner: ?With some private equity firms we deal with you can't help but think there's one junior person trying to hold it all together: and they frequently drop the ball. Statements are late, information requests have to be chased and there are even times when the distributions arrive later than expected too.?

There are a number of reasons why this can happen. There's the small business syndrome that sees too few people trying to do too many things. There's the lack of competent software and an over-reliance on paper-based document distribution. And there's the fact that administration does not come that high on the list of priorities for some GPs. As Laurence McNairn, the director at Guernsey International Fund Managers (GIFM), which is part of the Barings Financial Services Group, says: ?Many GPs have come out of investment banks and similar institutions with extensive back office infrastructure. These guys aren't accustomed to doing their own administration.?

Two other important factors as to why administration has become more demanding is that fund structures have become complex and the number of LPs in any one fund has increased dramatically too. As Denzil Boschat at administration services group Abacus Financial Services Group comments: ?Basically we translate the legal structure of a fund into an effective and efficient operational structure – so that it actually works in practice – and today that can be increasingly demanding given the increased sophistication of fund structures used.? Besides private equity firms having to produce more complex fund documents, a related point is that funds have had to travel much further and closed more investors to raise the required capital ? witness Cinven's most recent buyout fund that had over 100 limited partners when it closed at €4.3bn in April this year. This means that there are many more counterparties who need to be looked after throughout a fund's life.

Although fund administration lacks the glamour of deal making, it is a vital part of how limited partners develop their understanding of a private equity firm's operation and performance. ?If you're making regular cock-ups in the small stuff people are going to start wondering what you're like on the bigger stuff too ? and suddenly you're on the defensive when your IRR goes pear shaped. To simply blame market conditions can begin to ring hollow,? says the GP quoted earlier who counts a number of big US public sector institutions amongst his LPs. Adds McNairn: ?A GP ignores the administration requirements of an LP at their peril.?

These are all factors as to why a growing number of private equity firms are preferring to outsource their fund administration, contracting often sizeable specialist administrators who are well versed in servicing a variety of investment funds (not just private equity but hedge funds, real estate and mainstream equity too) and who are typically based in the offshore financial centres where most of these funds are registered. These administrators are set up to cover all aspects of the administration process, whether it be arranging for draw-downs of committed capital and the payment of distributions, preparing all the quarterly and other reports for LPs, the valuation of the fund's underlying assets or checking a third party's valuation or the co-ordination of all tax and regulatory filings and the supervision of the audit process.

A good example of the kind of scale a third party administrator can achieve, which can then be brought to bear on administering a private equity fund, is how Mourant International Finance Administration has grown. Originally based in Jersey, Mourant is a multi-faceted specialist services group now covering 17 jurisdictions via a growing network of offices and alliances. The firm overall employs 600 people (450 of whom are based in Jersey) and the fund administration unit (which has a 40 person team) has 18 private equity firms as clients who manage over €14bn of capital. These include CVC Capital Partners, Axa, Chase Manhattan, Merrill Lynch and Mercapital. Mourant clearly likes to present itself as a ?one stop shop? for a private equity firm and can take advantage of its size to convince prospective clients that bigger, when it comes to good administration, is better. ?When a client signs up they have a team allocated to them: a partner leads this group with a business manager looking after the day to day coverage of the account with two administrators and two book keepers in the team as well,? says Rupert Walker, a partner and section head at Mourant.

Besides body count, external administrators are able to exploit a depth of knowledge regarding fund administration practice born of many years experience across many varieties of funds and often many jurisdictions. These firms make a point of recruiting trained personnel from the legal and accounting professions, who are able to deliver expert advice on tax structures and compliance issues for example, as well as being able to liase effectively with a client's other key advisers (the law and accounting firms). One challenge for several such firms that stems from this need to resource specialist personnel is recruiting and retaining this talent in the often small labour pools found in offshore centres. In response some firms are now taking advantage of the far more extensive labour pools in onshore financial centres by splitting the accounting of a fund, which can be conducted onshore, and the administration tasks that for tax reasons must originate offshore.

What's the cost/benefit?
You'll find a much smaller team involved in a fund's administration within your average private equity firm (the exceptions being the older, multi-fund firms such as 3i or Carlyle Group who have elected to grow sizeable administrative teams themselves). Most other private equity or VC firms will make do with a CFO type figure or perhaps controller co-ordinating the process with a financially literate assistant. And nowadays, when many private equity operations are keen to trim costs wherever possible, the cost of undertaking fund administration in-house begins to seem expensive. Iain Stokes, who works alongside McNairn at GIFM, estimates that many young private equity firms would have to spend a minimum of €150,000 per annum to run a small administration team and this can seem a significant overhead when the partners are looking hard at every cost eating into the management fee. In contrast many third party administrators will charge their clients based on the actual level of activity required to administer the fund(s), eschewing fees linked to the net asset value of the fund or on a flat per fund basis. It's also worth remembering that the fact their offices are also based in offshore centres means that the bills do not incur VAT.

Good fund administration should not simply be conflated with cost efficiency though. It's a key part of the investor communications and investor marketing process. As Norman Leben, who helped found specialist administrator DML, comments: ?We're seeing LPs insisting that GPs map out how a fund is going to be administered before they are prepared to commit.? DML, which has over 50 core relationships with private equity firms and whose 100 strong team manages over 12,000 limited partner relationships, is now busily expanding its international presence. Leben feels the time is good to be growing his business: ?With the depressed state of markets in general there's a huge amount of investor nervousness at the moment and this fuels the fire in the private equity space: investors are demanding more clarity, more frequency and more substance for the information they receive. And although the administrator cannot drive transparency, it can through the dissemination of best practices help bring financial and investor reporting to another level.?

?The recent increase in information requests from LPs ? especially those in the US ? has been exponential?

External administrators have also found a growing number of private equity firms arriving at their door, eager to resolve an issue that clearly has moved up the agenda in the recent past. The administrators themselves already have stark evidence of the phenomenon: Stokes at GIFM, which looks after over 40 private equity clients, reports: ?The recent increase in information requests from LPs ? especially those in the US ? has been exponential. That's the biggest change I've seen and has huge implications for the business.?

How technology fits in
Embedded within this move to improve the quality of fund administration is the option to adopt some of the information management software referenced in this article. Most third party administrators you talk to are both quick to confirm that they see the progression to online information delivery as inevitable and that they are developing their own online information channels at the moment. Walker at Mourant, for instance, reports that they are currently testing an online administration system that will let LPs access their accounts online, whilst Abacus has developed a system that enables it to deal with all bank payments and receipts online with automatic ledger updating. Meanwhile, DML has been able to build its administration business with the LP Reporting System it developed with DMLT as a cornerstone of its strategy.

A related question though is the extent by which a private equity firm can at once reduce its in-house back office overheads by deploying such technology and improve investor communication without signing up for the services of an external administrator. Unsurprisingly, the answer you are offered depends on who you talk to. Many of the firms supplying this technology will tell you that their product will fulfil many of your administrative requirements. Hence Adam Sloan at IntraLinks will describe his firm's web-based offering as a secure communication platform where GPs and LPs can post and retrieve all the information they need when administering a fund. Tellingly, most firms will also do much more than sell you a software licence, instead offering free support not just to make sure the applications are running smoothly but even to capture and process data on the GPs behalf. Ken Pierce at DMLT makes the point that, at the moment, they see it as an essential part of the service they are supplying. ?We're not just providing a system: we want to give our GP clients all the necessary support to ensure they're delivering the best possible information in the best way.?

In answering the question as to how much technology-driven solutions will transform your fund administration, others though will remind you that the platform itself is not the key issue. Instead, as Helen Steers at Frank Russell Company remarks, they will tell you that you need to have a real person proactively communicating with the limited partners as well as decent systems. That person may be an individual inside the private equity firm or it may be an appropriate person at the external administrator. As Sarah Rayson at Mourant points out: ?A third party administrator has to be an extension of the fund sponsor's professionalism and therefore has to be able to deal with incoming requests from the fund sponsor but also has to be able to take the conversation to an investor.?

Administration in this context is clearly more than making sure the right tax notices get put in the right envelopes at the right time. It's the everyday essence of GP/LP relations. Do it well and you gain in stature amongst your supportive LPs, do it badly and you are going to have some fractious investors who will be far less inclined to accommodate you. The administration solution to adopt is therefore a fundamental choice to make for general partners: beyond the AGM and quarterly commentaries should the administration of your fund be discharged by an external agency or kept in-house? The answer is probably a bit of both: don't expect your external administrator (or that software system you bought) to transform the relationship with your LPs unless you undertake to support them with what one managing partner at a UK private equity firm (who uses an external administrator) describes as ?short, sharp bursts of quality input.?

AIMR proposes more reporting detail
In case anyone should start to think that reporting on a private equity fund is pretty straightforward once you have sorted timings and tax, here's a summary disclosure and reporting checklist of information that the US-based Association for Investment Management and Research (AIMR) is proposing should become additional provisions for private equity and venture capital funds in their Global Investment Performance Standards (GIPS). AIMR are inviting comments until 31 March 2003.

  • ? If the firm complies with any local or regional valuation guidelines;
  • ? Availability of the firm's documented valuation review procedures;
  • ? Net-of-fees and gross-of-fees annualised Since-Inception Internal Rate of Return for each year since inception;
  • ? Annualised Since-Inception Internal Rate of Return for a representative benchmark for each year since inception;
  • ? Unrealised appreciation/depreciation;
  • ? Total committed capital;
  • ? Paid-in capital and cumulative distributions to date;
  • ? Total current invested capital;
  • ? Investment Multiple and Realisation Multiple;
  • ? Ratio of paid-in capital to committed capital;
  • ? Ratio of distributed capital to paid-in capital;
  • ? Ratio of residual value to paid-in capital;
  • ? Ratio of total value to paid-in capital.
  • To see the entire proposal go to: http://www.aimr.com/pdf/standards/venture_capital.pdf