Private equity chief financial officers (CFOs), facing pressures including increased investor scrutiny and intensifying market competition, are seeking operational success via different pathways, according to the EY 2018 Global Private Equity CFO survey, Operational excellence: one path or many?
The fifth annual survey of 110 private equity (PE) CFOs finds many firms, especially larger firms over $2.5 billion asset under management (AUM), consider technology transformation and talent development as key priorities, while smaller firms (under $2.5 billion AUM) are also more likely to view outsourcing as an alternative.
Mike Lo Parrino, partner at Ernst & Young LLP, says: “While ideal operational maturity may be defined differently for private equity firms by size, it is clear that this needs to be their focus in order to compete for talent and investment capital. CFOs are increasingly confident that they will be taking major strides toward operational efficiency in 2018.”
Private Equity CFOs are Looking for Various Ways to Improve Operational Efficiency
The asset management industry as a whole continues to face investor pressures around fees, and the private equity industry has not been immune. Seventy-three percent of PE firms said they have experienced significant pressure from investors to reduce management fees, and as a result, 31% of CFOs report they have experienced some form of margin erosion.
To protect their margins, private equity firms have had to take action. Nineteen percent of CFOs neutralized margin erosion by strategically cutting expenses and growing top line revenue. Growth remains a top priority for PE firms, with record fundraising in 2017. Therefore, it’s no surprise that 55% of CFOs said they expect to raise a new fund in 2018, and 60% of CFOs expect the fund to be larger than the last fund raised.
To achieve operational efficiency and revenue growth, forward-looking CFOs are reevaluating where they want teams allotting time, preferring value-add activities such as investment portfolio analytics, technology transformation, and investor relations. CFOs intend to steal time back from tactical, routine areas such as fund accounting, treasury, and Human Resources.
Next-Generation Technology Is a Valuable Opportunity for PE Firms
CFOs said that they are still in the early stages of next-generation technology development for practically every finance function, especially management reporting (51%) and valuation services (53%). Similarly, while PE firms understand that harnessing and managing data is a top priority, 62% of CFOs feel their data is not well-integrated across the organization.
There was also a marked lack of confidence from CFOs that their organization could easily implement new technology solutions. The most highly cited roadblocks they identified were updating fund accounting systems (83%) and management reporting solutions (75%), followed by valuation (65%), investor relations (64%), and cybersecurity (59%).
Despite the difficulties in incorporating new technology, over two-thirds of CFOs (66%) said they currently invest or plan to invest in next generation technology. Firms are currently investing in emerging technologies such as digital data delivery (37%) and advanced analytics (20%). While they are just beginning to delve into robotic process automation (4%), more CFOs said they are planning to do so in the future (14%).
Talent Management Is Still the Highest Strategic Priority Besides Growth for PE Firms
Despite larger firms’ reliance on technology, talent management remains one of the highest strategic priorities for CFOs across the board, according to the survey. They see human capital as a valuable asset, but on average, 48% also identified talent attrition as a top risk. A trusted CFO with a capable team that exceeds investor expectations and upholds the firm’s reputation is an important piece that investors consider during due diligence.
While an average of 41% of CFOs said they prefer a 3:1 ratio of investment professionals to finance professionals, only an average of 20% said that this is their current ratio—which indicates many have yet to find the optimal technology or outsourcing solution as a viable option for their finance function. Likewise, in passing the leadership baton, CFOs are more confident that they have a strong pipeline of future investment leaders (76%) than finance team leaders (54%).
Although CFOs are trying to engage Millennials and tech-savvy individuals to stay within finance functions, 35% said it is difficult to attract talent in these functions. As a result, firms are increasingly offering other incentives beyond compensation to retain talent such as expedited title changes/promotions (62%) and flexible work arrangements (51%).
CFOs View Outsourcing as a Way to Shift Finance Teams’ Routine Responsibilities to More Value-Add Activities
While full scope outsourcing is largely confined to firms that lack the scale to handle key business functions in-house, outsourcing enables smaller PE firms to gain operational efficiency and remain competitive without having to make significant investments in technology or talent.
If a “perfect” outsourcing model existed, CFOs believe that shifting routine finance areas such as fund accounting (67%), tax (67%), and regulatory compliance (62%) to a third-party would be most valuable to their ongoing success. This allows internal employees to focus on client facing functions that require a more personal touch, with an average of 37% of CFOs saying they will continue to handle investor onboarding internally, and 37% saying they will do so for investor tax questions.
Cybersecurity Breaches are a Reality for Which PE Firms are Preparing
In the pursuit of operational perfection, CFOs are raising awareness of a very real threat: cybersecurity breaches. The increasing sophistication of cybercriminals pose a risk to private equity firms, regardless of size. Twenty-two percent of private equity firms surveyed reported they have experienced a cybersecurity breach, but many more could have gone unreported. Over half (58%) of those who had a breach considered it at least moderately serious.
To identify vulnerabilities and manage risk, most private equity firms (70%) rely on externally-developed intelligence products to monitor cybersecurity. In addition, firms are beginning to recognize the effectiveness of a multi-pronged approach, taking steps to improve employee training (87%), e-mail monitoring (80%), and using external vendors to perform ethical hacks (80%).
For more information, or to view the full report findings, click here.