EY's second annual CFO survey of the global private equity industry. Many believe the overwhelming demand for private equity labels it as the asset class of choice. As the industry positions itself for further growth, private equity firms recognize that investors are focusing on operational excellence as a key differentiator. To address the importance of investors’ perspective, CFOs have been appointed as the senior executives responsible for not only tactically handling today’s issues, but also strategically thinking about tomorrow’s emerging concerns.
Across the industry, private equity firms are preparing for an influx of capital; almost three-quarters of the firms we surveyed plan to raise significant capital in the next two years. They know that performance has been and always will be an investor’s top criterion, and recognizing this, most firms maintain consistent investment strategies, including defined target maturities, investment size and geographic focus. Investment professionals realise uncertainty is not their friend.
But in sharp contrast to the private equity landscape of the past, stakeholders are pressing firms with inquiries regarding regulatory and operational risk management, as well as the transparency of communications. One might even say that investors have added a new layer — proven operational excellence — to their definition of “performance.” To truly compete as best in class, private equity firms must now demonstrate that their front, middle and back offices all are operating effectively, as well as efficiently. CFOs that skillfully manage the inherent risks of rapid growth will become legitimate difference-makers and create competitive advantages for their firms.
Regulatory: managing risk
Building and maintaining excellence requires the CFO to move beyond traditional operations, a transition that began several years ago as regulators increased their scrutiny of the private equity industry in the wake of the financial crisis. Today, the CFO is asked to master the intricacies of operational and regulatory risk, portfolio monitoring and valuation, as well as direct interaction with investors.
In recent years, CFOs have been spending more time than ever dealing with regulators, including the US Securities and Exchange Commission (SEC). Although CFOs believe that regulatory issues will no longer consume the vast majority of their time, compliance will remain a core concern. Investors are increasing their focus on private equity firms’ fiduciary responsibilities, and regulators continue to sharpen their examinations of the industry. On the global front, the European Union’s Alternative Investment Fund Managers Directive (AIFMD) promises to increase the compliance burden, with many private equity firms and investors yet to truly assess its impact on their business activities.
The SEC’s continued interest in expense allocations, as evidenced by the continual increase in its public comments on the topic, is cause for concern among private equity firms. CFOs would be wise to make sure that they have the right policies and procedures in place — and the documentation to back them up. At the same time, CFOs are being asked to mitigate, if not eliminate, operating risks. Top among those risks is cybersecurity, which is a pressing issue for regulators, but even more urgent for the business: protecting confidential information involving investments, investors and the private equity firm itself has quickly developed as a fundamental issue.
Reporting: the critical link
The mandate is clear: private equity firms that report in a transparent, timely and reliable fashion will demonstrate operational excellence. Reporting is more than the critical link between private equity firms and investors; it’s also the most prominent area for firms to gain a competitive advantage.
As the burden of portfolio monitoring increases, the CFO and the finance team are being asked to automate a process that, for many, is still spreadsheet-driven. Investors want granular information concerning valuations. They want detailed explanations of inputs, assumptions and formal approvals. In general, they want to increase their comfort level by developing a complete understanding of how private equity firms operate behind the scenes.
Investors’ desire for more robust and more customized reporting only increases the CFO’s workload. Investors have little patience for information that moves slowly, with nearly all indicating they want quality data — fast. Three-quarters of investors want tax reporting within four months after year-end, an accomplishment that could place a private equity firm head and shoulders above the average. Overall, private equity firms expect requests for customized reports to increase with incremental asks for both quality and quantity. As the primary channel of communication with investors, CFOs who master the complexities of timely and transparent reporting have a right to celebrate a job well done.
Making the best use of resources
Investor demands and requests of private equity firms engaged in due diligence will only increase; CFOs must optimally manage their teams to meet these rising expectations. This entails looking at new technology and new processes, including outsourcing. Investors clearly expressed comfort with private equity firms moving to an outsourced model for tactical areas, including tax and fund accounting. Investors would prefer compliance, investor relations, portfolio analysis and valuation to remain in-house, but are not against exploring them as third-party functions.
For those functions that remain in-house, merely adding headcount will not address the capacity challenges at hand; technology solutions might. Most understand that transparent and timely reporting is data-driven and process-oriented. The operations of private equity firms that are data-centric and defined by superior management, analysis and digital presentation of information will find success. Unquestionably, innovation and optimization, implemented according to each firm’s needs and capabilities, will allow businesses to scale, minimize resource constraints and enable CFOs to focus on strategic priorities.
CFOs, in extending their focus, face a series of challenges. The first is infrastructure. The second, closely related, is resources. With spreadsheets and manual processes prevalent, private equity firms are generally limited in their ability to respond to the rising tide of reporting requests. With finance teams’ headcounts not generally keeping pace with increases in responsibilities, implementing the right policies and procedures for given circumstances is likely to require a reallocation of resources — especially as assets under management increase.
Getting in position
As private equity assumes its role as the asset class of choice, the role of the CFO is growing exponentially more complex and important. CFOs have been tasked with optimizing traditional finance functions, vital to the success of the firm, and as investors have clearly acknowledged, CFOs have a mandate to extend their reach into the new definition of performance — one that is based on proven operational excellence. To conquer these formidable challenges, CFOs must move beyond tactical actions to strategic priorities. This year’s survey reveals one area where investors and private equity firms are in agreement: both value the CFO more than ever. We are convinced that CFOs will skillfully position their firms to win the competition for capital.