Back office seen critical as emerging GPs compete for LP dollars

  • First-time GPs must bring more to the table: Whiteman
  • LPs fear firms that lack institutional-quality controls
  • Few emerging managers are prepared for institutional LPs

Investors have become increasingly picky when it comes to how new private equity firms manage their back offices.

Limited partners now demand institutional-quality accounting, oversight and operations from new managers, particularly after regulators homed in on several firms for misallocating fees and expenses, several speakers said on July 19 at Buyouts’ Emerging Manager Connect 2016.

“There was a point many years ago where … you could start out [with an office] above your garage and that was it,” Stellex Capital Management founder Ray Whiteman said in a keynote. “The institutionalization of the asset class has forced you to bring a lot more to the table.”

Risk management is catalyst

More than 80 percent of LPs have upgraded or plan to upgrade their back-office technology, largely to improve risk management, according to Coller Capital’s  2015-2016 winter survey.

A similar focus on risk management led a growing number of LPs to check whether their GPs, including first-time managers, also possessed back-office capabilities to manage capital from institutional investors like pensions and endowments, said several panelists.

The emphasis on back-office functions and controls is particularly important in the current regulatory environment. The SEC’s focus on how firms disclose fee and expense information to LPs can pose serious challenges for managers who are raising funds for the first time.

“To the extent LPs see something’s not institutional quality, they’ll get scared right away,” said Elizabeth Campbell of Portfolio Advisors, speaking on a panel about emerging managers.

Those challenges are compounded by increased competition among new fund sponsors. More than 625 firms raised a first fund or held a first close through the first 10 months of 2015, according to Preqin and FPL Associates data cited by Dow Jones. Several months later, Preqin reported that first-time firms closed on just $16.7 billion in 2015, a 16.5 percent decline from the year before.

“Is it crowded? Yes,” said panelist Jason Lamin, founder and managing partner of operations-service provider Lenox Park. “There’s a little bit of a challenge in this space because only a narrow sliver of that is institutional-ready.”

One factor that could set an emerging manager apart from competition is a solid back-office infrastructure, panelists said.

LPs help out

Some LPs have begun to assist first-time managers with outsourcing back-office functions like accounting, auditing and legal services. Last year, Buyouts reported that New York City Retirement System helped managers develop contacts with service providers to institutionalize some of these functions.

“The demands on the GP are dramatically different than what they were 20 years ago,” said Derek McDowell, managing partner of lower-middle-market firm Boyne Capital. “We want to provide [LPs] the comfort and transparency of third-party review.”

According to Lamin, Lenox Park spends 80 percent of its time, resources and travel ensuring that firms’ operations and oversight are in line with expectations.

“[Here’s] the way to think about operations; it’s very unlikely you’ll get past a certain level if you don’t have it intact,” Lamin said on the panel.

Action Item: Reach Stellex:

Stellex Managing Partner Ray Whiteman (left) and Buyouts Senior Editor Steve Gelsi at Buyouts’ Emerging Managers Connect 2016 conference at the Harvard Club in Manhattan on July 19, 2016. Photo by Karolina Tarczynska, Buyouts.