Over the years, chief financial officers (CFOs) for private equity firms have played an increasingly important role in helping private equity managers build the value of their portfolios. In addition to their traditional responsibilities of helping the core business runs smoothly, private equity CFOs have also taken on a more strategic role leading efforts to deploy a robust financial IT infrastructure, automate processes and upgrade back- and front-office talent.
Now that they have achieved these objectives, private equity firms are embracing the next wave in their development, building out more rigorous operating models for their management companies that put them on par with larger financial institutions. This push toward a more mature operating model for the management company was one of the key findings in our 2022 Global Private Equity Survey.
The output of this strategic thinking has been two-fold: make informed decisions to protect the established brand and continue to look for ways to build sustainable asset growth. Creating long-term value through a well-thought-out talent management plan and incorporating environmental, social and governance (ESG) considerations are two increasingly important initiatives for many private equity and venture capital firms.
Private equity lifecycle
We view this forward step in maturity as part of the natural private equity lifecycle. More firms are evolving from smaller organizations that manage a handful of funds into larger, more complex financial institutions with responsibility for multiple portfolio companies and the growing alternatives allocation from investors.
With so many company valuations at all-time highs earlier this year, this new rigor is also a strategic necessity. The risks of making a bad decision or missing out on an opportunity can have enormous consequences in this competitive environment, especially in times of market volatility.
As increasing amounts of capital flow into the private equity space and firms are seeing high multiples paid for private equity business, fund managers realize the stakes of making the right choice are growing exponentially higher. In the past, companies might have been able to afford to back the wrong company, but with so much competition for increased deal activity and media scrutiny on private equity, the risks of making a mistake are huge.
That’s why many private equity firms are moving to adopt more mature business processes, from internal reporting and compliance to fully developed financial planning and analysis (FP&A) functions. While larger firms (those with in excess of $15 billion in funds) are leading the way in this area, all firms are stepping up their game as they keep pace with the larger players.
This shift toward a more institutional mindset is reflected in the 2022 EY survey results. In the past, CFOs cited operational concerns relating to the funds, such as enhancing back-office processes and management and implementing technology, as top of mind.
In 2022, besides asset growth, the top three strategic priorities listed by private equity firms are talent management, product and strategy expansion, and ESG initiatives and offerings. This reflects the fact that more CFOs believe they and their teams have adequately addressed these back-office issues by building out infrastructure and creating a scalable operating model.
When asked to rate the institutional maturity of their management company, 84% of the largest fund managers said they are generally ahead of other managers, compared with 71% of midsize fund managers and 56% of smaller firms. Fund managers were less likely to say they were best in class, however. This seems to indicate that although managers feel relatively comfortable with their management company operations today, there still is room to mature and take a step forward.
Expanding oversight
In past years, many management teams handled a wide range of responsibilities that reflected an all-hands-on-deck approach. Now, nearly 97% of the largest firms said they have teams dedicated to overseeing corporate operations. While smaller firms lagged a bit in this area, they have clearly realized that private equity firms require someone to have oversight over all key business functions.
In previous years, accounting and reporting for the management company lagged in importance to the funds. Historically, management companies were owned by a small number of founders with little external investment. Today, management companies are fielding inquiries about equity investment, accessing the public and private equity and debt markets, and evaluating the best-case scenario for succession planning.
Further reflecting the sharpened focus on building out a broader set of processes at the management company level, more than 43% of the largest firms said they had significantly increased their investment in people, processes and technology over the past two years. Midsize and smaller companies were less likely to say they have, but roughly one in five said they had increased their investments significantly (19% and 23%, respectively). Building out these processes has allowed for more informed decisions to be made by the growing firms and decisions are no longer made by “taking a gamble.”
On a positive note, many firms indicated that the benefits of prior technology implementations were helping them curb costs. Among the largest firms, 63% said past technology deployments were still paying off, while 40% of midsize firms and 37% of smaller firms said those actions were still helping them reduce costs.
We also believe these investments in technology and a more robust infrastructure should have a longer-term payoff for many firms. As we enter an era of increasing market volatility, private equity firms with more mature, established business processes and operating procedures will be better positioned to survive and prosper this year and in 2023.
By Christopher Smyth
Full report available here
