The Importance of Being Flexible

The stunning growth in private equity, with average annual growth of 13.25% since 2000, has surfaced important fund accounting issues with which the industry must, and does, grapple.

Perhaps there was once a simpler time when the back office of a private equity firm was, literally, a back office. And with the limited number of LPs during the earlier days of private equity, this may have worked.

But the influx of funds, and the diversity among LPs attendant these funds, has brought fund accounting into sharp focus. Today, the deals, the funds, the terms and the investors are more numerous and more complex.

The industry owes a debt of gratitude to ILPA for their ongoing and persistent effort to bring important issues to fore and to promulgate consistent and carefully considered best practices for fund accounting. Advances have been made, and standards have been established.

That said, our experience has demonstrated time and again that a “one size fits all” approach to fund accounting is not always the best approach and can present significant challenges for GPs, a notion which is recognized by ILPA.

In this regard, our opinion is shaped by experience, investor populations and characteristics unique to private equity investors.

In The Numbers

Standardized reporting templates for private equity seems at times modeled after the disclosure standards imposed on public companies by the Securities Act, the Securities Exchange Act and accumulated amendments over the past 80 years.

These regulations work well, or perhaps well enough, in part because they are designed to inform investors en masse. Consider McDonald’s, with 1.6 million shareholders (actually more, since brokerages hold many client certificates in aggregate). Accountability to this many investors makes one-off disclosures or “clarifications” impractical, and likely a violation of securities laws.

But consider the composition of a private equity fund. A GP with $1 billion of committed capital might be accountable to just 40 or 60 investors, not hundreds of thousands, or millions. And because of this, we would posit in a fund with fewer than 100 LPs, investor requests for supplementary or specialized information not only can be accommodated, but should be accommodated.

In The Market

The most compelling reason for accommodation is that it helps keep these investors in the private equity market. Specifically, the opacity that can accompany a rigid approach to fund accounting, combined with the challenges faced by LPs in their own reporting duties might be reason enough for investors to consider other assets classes. Let’s not make investing in private equity harder simply because standardized reporting templates are easier to deploy.

But the importance of accommodation goes deeper. Unlike investors in public equities, LPs face capital calls. And while these calls are inviolate, when they occur amid what an LP might consider to be opaque reporting, an untimely call can dampen investor appetite for this asset class.

In Partnership

And finally, it’s not just the LPs who face challenges stemming from standardized reporting templates. General partners can as well. Well meaning reporting standards can provoke wholesale changes in how a GP reports. In addition, they can necessitate additional personnel, technology and compliance oversight.

Further, when outsourced fund accounting is delivered by organizations whose focus is on adherence to standards, GPs lose a valuable resource, and a partner who can help them navigate the challenges which accompany this vital and complex function. For instance, within the past year we have helped GPs find additional capital in callable cash distributions, decipher Byzantine waterfalls and accelerate their carry calculation based on an over allocation of expenses.

Our thoughts on fund accounting are not rigid. For an industry in the full bloom of innovation and expansion, robust conversations regarding standards and best practices for fund accounting are vital. However, we remain committed to the idea that no matter how much the accounting function evolves, reducing flexibility is the one change we don’t want to make.

To Learn More

FD Fund Administration is a subsidiary of Frazier & Deeter, one of only two nationally ranked CPA firms with a dedicated outsourced Fund Administration business.
FD Fund Administration offers a robust suite of fund administration services which include:
fund accounting,
investment reporting,
tax administration,
valuation and portfolio analytics,
investor communication and servicing, along with other special reporting and servicing.

Sources:

Prequin AUM Data
https://www.preqin.com/docs/reports/2015-Preqin-Global-Private-Equity-&-Venture-Capital-Report-Sample-Pages.pdf

MCD Shareholder Count (Item 5, Part II, Current 10K)
http://www.sec.gov/Archives/edgar/data/63908/000006390815000016/mcd-12312014x10k.htm#sAA3EE80A976EAD1B51C35520F7BCBB5B