Welcome to our Spring 2011 newsletter
Spring 2011 has brought an encouraging number of new fund closes in Asia. In this newsletter we have chosen to focus on a topic that should be relevant in the improving climate.
Many newly established private equity managers ask us about how they should go about building the finance function for their fund. We share here some experiences that I hope will be helpful. Please do contact myself or any of my colleagues if you’d like to get some support in thinking through this topic, either for your own fund or one that you are advising.
Building the Finance Function of a Private Equity Fund
Typically the first question asked by newly established fund managers is “Who do we need to hire?”, but it’s usually easier to start with “What do you want the role of the finance function to be?”
Typically the finance team within a Private Equity fund might deal with any or all of the following issues:
In many funds the CFO might be happy to expand or enrich their role but may also feel time pressure, especially so when they do not have support from a proactive fund administrator.
The investor relations aspect is likely to be focused on maintaining the working relationship with existing Limited Partners. Specific tasks will include reviewing the investor financial reports, oftentimes writing the quarterly letter to investors, plus coordinating with the principals of the fund and the investment teams for the written review of the investments and their valuations. At the closing of the fund there will also be involvement in the AML/KYC process – helping to problem solve difficult cases with the fund administrator so that the fund can comply with its legal, tax and regulatory obligation whilst minimizing unnecessary disruption to busy investors. During the life of the fund, being able to demonstrate that the investment process has been adhered to is extremely important. Institutional investors want to see a well defined and robust investment process being employed with the aim of producing consistent and sustainable performance.
Finance management is a broad role that usually covers both the management company (often a Hong Kong / Singapore investment advisor), and aspects of the fund itself. Cashflow budgeting and the associated management of payments are often the most crucial function: the management company is often a new business and will need to plan carefully to manage its liquidity, especially as Establishment Expenses can be quite substantial and reimbursement from the Limited Partners may not arrive for some time after first close. Management company side activities also include monthly management accounting, submission of tax returns, payroll, monthly expenditure, management of internet banking, and preparing for the management company's audit (where good record keeping can substantially reduce audit costs). For finance management on the fund side it will mainly be necessary to keep good records of payments made and the associated invoices so that the fund administrator can properly classify expenditure in accordance with the legal documents and maintain the accounts.
Operations is another major role that also divides between the management company and the fund. It is often also the most significant demand on the time of the finance team. For the management company, this comprises everything that might be expected in a business: managing office leases, insurance, travel, employment contracts, provident fund contributions, and usually quite a lot of IT. On the fund side there will be a hand off with the transaction team, but typically the finance team will get involved in the establishment of SPV’s, opening of brokerage accounts, coordinating the signature of fund notices, arranging offshore investment committee meetings, and other matters to support the structuring and execution of deals.
Compliance will be a formal role for those investment advisors that are regulated. It includes drafting the compliance manual, submitting and managing the SFC/MAS license application, responding to alert notifications, maintaining and reporting regulatory capital, also ensuring any licensed personal comply any with all relevant regulatory filing and reporting requirements.
Tax management is oversight to ensure that the Fund abides by all relevant tax regulations to minimize any potential tax risk to the Fund and so to its ultimate LPs. This is especially applicable in Hong Kong with the Revenue (Profits Exemption for Offshore Funds) Ordinance 2006 (“Safe Harbour Rules”).
Lastly, many funds with larger deals (including take-private transactions) also need a finance team to support portfolio monitoring by reviewing the substantial amount of financial reporting that these entities will be producing, and alert the portfolio monitoring team to relevant events and trends.
In terms of the right people, some funds will appoint a key senior person, often designated as CFO or COO, who will take on a substantial amount of responsibility. Other funds prefer to hire a finance manager to work under the close supervision of one or more of the principals.
It’s probably clear that there is no one-size-fits-all approach to hiring the finance team. With a good fund administrator who is proactive and reliable, the finance team will have time to focus on the running of the management company and to assist with the execution and financing deals. If the fund administrator is providing more minimal support, or has a ‘transaction service’ only approach, then a larger finance team will have to do relatively more of the work themselves.
This article barely scratches the surface of the topic and there is plenty of help that we can provide to people thinking through their own middle and back office activities. Please do get in contact with us if you would like to talk through any ideas.