Private equity chief financial officers (CFOs), facing pressures including increased investor scrutiny and intensifying market competition, are seeking operational success via different pathways, according to the EY 2018 Global Private Equity CFO survey: ‘Operational excellence: one path or many?’
The fifth annual survey of 110 private equity (PE) CFOs – ‘Operational excellence: one path or many?’ – finds that many firms, especially larger firms with over USD2.5 billion in assets under management (AUM), consider technology transformation and talent development as key priorities, while smaller firms (under USD2.5 billion AUM) are more likely to view outsourcing as an alternative.
Mike Lo Parrino, Partner, Ernst & Young, says: “While ideal operational maturity may be defined differently for private equity firms by size, it is clear that this needs to be their focus in order to compete for talent and investment capital. CFOs are increasingly confident that they will be taking major strides toward operational efficiency in 2018.”
The asset management industry as a whole continues to face investor pressures around fees, and the private equity industry has not been immune. Seventy-three per cent of PE firms said they have experienced significant pressure from investors to reduce management fees, and as a result, 31 per cent of CFOs report they have experienced some form of margin erosion.
To protect their margins, private equity firms have had to take action. Nineteen per cent of CFOs neutralised margin erosion by strategically cutting expenses and growing top line revenue. Growth remains a top priority for PE firms, with record fundraising in 2017. Therefore, it’s no surprise that 55 per cent of CFOs said they expect to raise a new fund in 2018, and 60 per cent of CFOs expect the fund to be larger than the last fund raised.
To achieve operational efficiency and revenue growth, forward-looking CFOs are re-evaluating where they want teams allotting time, preferring value-add activities such as investment portfolio analytics, technology transformation and investor relations. CFOs intend to steal time back from tactical, routine areas such as fund accounting, treasury and human resources.
CFOs said that they are still in the early stages of next-generation technology development for practically every finance function, especially management reporting (51 per cent) and valuation services (53 per cent). Similarly, while PE firms understand that harnessing and managing data is a top priority, 62 per cent of CFOs feel their data is not well-integrated across the organisation.
There was also a marked lack of confidence from CFOs that their organisation could easily implement new technology solutions. The most highly cited roadblocks they identified were updating fund accounting systems (83 per cent) and management reporting solutions (75 per cent), followed by valuation (65 per cent), investor relations (64 per cent), and cybersecurity (59 per cent).
Despite the difficulties in incorporating new technology, over two-thirds of CFOs (66 per cent) said they currently invest or plan to invest in next generation technology. Firms are currently investing in emerging technologies such as digital data delivery (37 per cent) and advanced analytics (20 per cent). While they are just beginning to delve into robotic process automation (4 per cent), more CFOs said they are planning to do so in the future (14 per cent).
Despite larger firms’ reliance on technology, talent management remains one of the highest strategic priorities for CFOs across the board, according to the survey. They see human capital as a valuable asset, but on average, 48 per cent also identified talent attrition as a top risk. A trusted CFO with a capable team that exceeds investor expectations and upholds the firm’s reputation is an important piece that investors consider during due diligence.
While an average of 41 per cent of CFOs said they prefer a 3:1 ratio of investment professionals to finance professionals, only an average of 20 per cent said that this is their current ratio – which indicates many have yet to find the optimal technology or outsourcing solution as a viable option for their finance function. Likewise, in passing the leadership baton, CFOs are more confident that they have a strong pipeline of future investment leaders (76 per cent) than finance team leaders (54 per cent).
Although CFOs are trying to engage millennials and tech-savvy individuals to stay within finance functions, 35 per cent said it is difficult to attract talent in these functions. As a result, firms are increasingly offering other incentives beyond compensation to retain talent such as expedited title changes/promotions (62 per cent) and flexible work arrangements (51 per cent).
While full scope outsourcing is largely confined to firms that lack the scale to handle key business functions in-house, outsourcing enables smaller PE firms to gain operational efficiency and remain competitive without having to make significant investments in technology or talent.
If a “perfect” outsourcing model existed, CFOs believe that shifting routine finance areas such as fund accounting (67 per cent), tax (67 per cent) and regulatory compliance (62 per cent) to a third-party would be most valuable to their ongoing success. This allows internal employees to focus on client facing functions that require a more personal touch, with an average of 37 per cent of CFOs saying they will continue to handle investor onboarding internally, and 37 per cent saying they will do so for investor tax questions.
In the pursuit of operational perfection, CFOs are raising awareness of a very real threat: cybersecurity breaches. The increasing sophistication of cybercriminals poses a risk to private equity firms, regardless of size. Twenty-two per cent of private equity firms surveyed reported they have experienced a cybersecurity breach, but many more could have gone unreported. Over half (58 per cent) of those who had a breach considered it at least moderately serious.
To identify vulnerabilities and manage risk, most private equity firms (70 per cent) rely on externally-developed intelligence products to monitor cybersecurity. In addition, firms are beginning to recognise the effectiveness of a multi-pronged approach, taking steps to improve employee training (87 per cent), email monitoring (80 per cent) and using external vendors to perform ethical hacks (80 per cent).
