US Leadership Summit


Like this article?

Sign up to our free newsletter

Private equity’s outsourcing revolution

Third-party service providers were once focused on fund administration and accounting, but they are fast extending into the middle and front offices of private equity firms. Operational efficiencies and pressure from LPs will accelerate the shift…

After more than three decades of transforming their portfolio companies, private equity firms are bringing new operational solutions into their own businesses. In many cases, the answers lie with a new generation of technology service providers. 

In a survey by Private Equity Wire in June, almost half of more than 50 respondents said they had outsourced part of their firm’s operations over the past 12 months and around three-quarters of this group believed the decision had “added value” to their business. 

While fund administration and back-office accounting are still the first and most common functions to be outsourced, the trend is starting to hit fundraising and deployment too (see Chapter 1). 

According to sources across the industry, the trend has been accelerating over the past three years and still has a long way to go. 

“It’s partly driven by demand [from GPs] but there’s also more supply of these tech solutions – you see more start-ups coming into the front- and middle-office space specifically geared towards catering for the needs of private markets,” says a US-based source with one of the world’s largest private equity funds. 

Popular outsource solutions typically involve Big Data, NLP, machine learning, and “generally doing things that humans can’t do fast enough”, adds the source. 

According to a London-based lawyer who advises some of the world’s most well-known private equity funds, while there have been some early movers in adoption and outsourcing of tech solutions, an increasing in-house sophistication is visible among GPs across the board, particularly in the use of virtual portals where data on investments can be uploaded, shared and analyzed more efficiently. 

Firms with excess of $15 billion in funds may be leading the way currently, but all firms are stepping up their game to keep pace with the larger players in the space, according to EY’s 2022 Private Equity Survey. The move to a more “mature” business approach and institutional mindset includes improvements to internal reporting and compliance to fully developed financial planning and analysis functions, it found. 

Historically, or even 10 years ago, most of this work would have relied heavily on Excel spreadsheets and human interpretation. A former executive at a well-known private equity data provider says that the number of inputs on those sheets has probably multiplied by a magnitude of 10 since then with the growth of the asset class. 

“This is 30 years of firms doing this in Excel, with whatever model they’ve built, and have never tried to do something different despite how painful putting those models together might be,” says a technology consultant to private equity firms. 

“The industry has been slow to adapt to date but with so much more competition in the market, and a change in market dynamics, there’s no way you can turn a blind eye to [technology] and still be successful. There is lots of potential here in how GPs measure, manage, monitor what happens in their portfolio and use that to inform future investments.” 

There are three reasons why an outsourced solution makes sense for many GPs in the current market. 

Firstly, although some of the larger firms are building or acquiring their own technology solutions and teams to draw proprietary insights, the cost of doing so is still prohibitive for most. New software tools can be easier to use and a safer way to store sensitive data and are being marketed to GPs of all sizes. 

A shift in the size and type of private equity firms raising and deploying capital is the second driver. CFOs in mid or lower-mid market GPs want a scalable operating model that can take advantage of the recent growth in private equity allocations. New fund structures and the rise of crossover managers (from the public markets, for example) can also complicate collaboration between legal, finance, and IR teams, says Estrada. 

“A by-product of private equity growth is the need for more external support: more fund administrators, more custodians; more agents; and more partners. These extra touchpoints can compound the challenge of collecting, digitizing, and normalizing the data associated with a diverse and larger portfolio,” he says. 

Thirdly, and perhaps most visibly, private equity fund managers are becoming increasingly burdened with LP requests for financial information, which can often be processed more easily through such new outsourced solutions. 

A leading London-based placement agent says that prospective LPs are increasingly asking questions of fund managers on their tech stack and what has been outsourced before they commit capital – in order to assess operational risk but also the potential for value creation. 

“We see that in a number of ways at Arcesium,” says Estrada. “An interesting shift has been in their due diligence. We’re seeing more questions from LPs about our tech capabilities than we ever have before.”

What LPs want 

Some cornerstone investor commitments are now contingent on the use of an established back-office platform or fund administrator, and sources note cases of LPs specifying the level or type of administrator to be used. 

“For LPs, ensuring the backbone of the fund setup effectively is a key area of risk mitigation,” says one GP source. 

“We now have around three to four years of LPs expecting that the GP is leveraging technology in some way, whether it’s via an asset servicer or a fund admin, or whether they’re owning it internally. I don’t know that an LP necessarily cares who it is, as long as there is technology for them to deliver the reporting capabilities they need,” says the US-based source. 

Sixty per cent of LP respondents surveyed in the Brackendale Private Equity Technology LP Sentiment Survey H1 2022, said they would be more likely to consider allocating to a fund, if the fund manager had a tech-enabled partner to outsource their middle and back-office activities to. Only 17 per cent of the respondents said they receive responses to ad-hoc requests within a day of the request and the majority said this is at least partially reliant on manual processes within their GP/LP relationship. 

LPs want to assess the vulnerability of their investments to shocks or market downturns, as well as more transparency on ESG metrics such as carbon emissions or diversity. 

While back-office outsourcing is common, the decision to implement a middle-office or end-to-end technology solution is often based on the size of organization. 

Large fund managers may be building or acquiring their own in-house technology, but they can also be the most likely to rely on bulky legacy systems and software. New or recently launched fund managers can often more easily build a new technology strategy from scratch using best-in-class service providers. Their decision to outsource can free up limited human resource to more valuable tasks. 

Machine learning and natural language processing tools are also unlikely to be built and owned by the majority of GPs. “It’s not whether you own the technology itself, it’s how you apply the technology,” says the US-based source. 

According to the CFO at a large private equity allocator which has large volumes of GP data to track, a recent decision to use a new AI system has saved the cost of one full-time accountant. The software took 90 days to implement and the cost was negligible. The allocator is now working with the same provider for an end-to-end solution and hopes to eventually move to a 100% outsourced model. 

A smaller GP with an outsourced fund administrator is skeptical this approach will work for everyone, though. “If you need to be quick and nimble then outsourcing may not be the way to go – we have one fund admin who only checked their emails twice a day, at 11am and 3pm. We were banging our head against a brick wall [when we needed information quickly].” 

Whether such an approach is successful, or not, depends on the solution itself as well as the size of the private equity firm in question. 

Is there a baseline outsourcing approach that works for different sized private equity firms and should it include middle and front office functions? 

“It varies greatly,” says Estrada. “On the front office side of things, while our clients may not be outsourcing their ‘secret sauce’, they are looking for us to help them create a unified data layer to enable it. Private equity firms clearly want an end-to-end solution that helps them better manage data and investment lifecycles. But many have been hesitant to adopt new applications and others are still in the early stages. Whether our clients layer on new applications or fully overhaul their workflow, our goal is to help streamline processes to get the most value from their data.”

Like this article? Sign up to our free newsletter




Talk to Us

What would you like to talk with us about? *