TMF Group experts talk to Private Equity Wire about the important role technology has played for fund managers during the coronavirus pandemic.
2020 was arguably a defining moment for the private funds marketplace, as technology – or more broadly, digitalisation – helped fund management groups maintain business as usual in the face of extraordinary circumstances.
In the main, firms had already been on the path towards digitalisation to varying degrees, and had the technology in place, prior to Covid-19; but what the pandemic did do was to accelerate the pace of adoption to support operational activities.
"It's really been a case of making sure the infrastructure was there to enable a broader business use of technology tools such as MS Teams, Slack, etc. Do they have the bandwidth in their infrastructure? This is something global firms have had to look at over the past 12 months," comments Oliver Sinclair, Funds Services & Capital Markets Application Portfolio Lead at TMF Group.
Technology is becoming an adjunct, an enabler to support GPs, as they steadily modernise their operating model. And while it is difficult to offer broad generalities on the pace of technology adoption, there are a few key areas where technology has made its mark over the last 12 months: 1) Virtual Fundraising, 2) Virtual ODD, and 3) Virtual AGMs.
The question is, to what extent will these activities remain in the virtual realm. Will they represent long-term change, or a temporary solution?
On the issue of virtual fundraising, which has enabled GPs to better connect with their LPs without the inefficiency of global travel, it has been a game changer. For example, UK-based Tenzing Private Equity, a tech-focused investor, was able to raise £400 million in just nine weeks, without conducting any face-to-face meetings, as reported by Private Equity International on 7 September 2020.
Another example is Waterland Private Equity Investments, who closed Waterland Private Equity Fund VIII with a hard cap of €2.5 billion in three months in a fully virtual capacity.
This is evidence of video conferencing technology improving productivity levels.
"I would say a fund marketer is going to have a much higher success rate with existing investors," says Howard Eisen, Head of Fund Services Sales for North America, TMF Group.
"For new investors, it is hard to establish anything more than introductory relationships in the virtual realm. There's an old saying that people do business with people they want to do business with. I don't think the virtual environment is the right format to really get to know a new manager."
He goes on to suggest that a first derivative impact of technology on the current environment is how technology has enabled the flow of documents – i.e. the subscription process, the capital call process – and reduced the amount of friction, "to allow managers to continue to operate and raise capital in this environment".
Anja Grenner is Head of Fund Services Sales for Luxembourg, TMF Group. The Grand Duchy is a popular fund jurisdiction for many of the world's leading private equity and real estate groups, as well as an increasing number of new managers. Grenner observes that last year many of the new managers extended their fund launch dates and fundraising activities into Q1 and Q2 2021.
"They knew that without making the acquaintance of investors it just wouldn't work," says Grenner.
"For established fund managers, we've noticed that investors have tended to stick with them as they've sought to concentrate their PE portfolios. What this ultimately means is that the big managers keep on getting bigger and vice-versa. Fundraising as such seemed to be pretty good last year, with managers able to raise higher amounts for their latest funds compared to previous vintages. One can do many more virtual meetings in a day compared to travelling from city to city, so in that respect, technology has certainly made fundraising more efficient.
"That's good for the industry, as private equity continues to mature and industrialise."
As well as improving fundraising speed, established managers have also sought to leverage video technology to get closer to their portfolio companies, hosting more frequent online meetings with management teams to keep on top of operational issues. According to Anibal Wadih, Founder and Managing Partner of Brazil-based GEF Capital Partners, this has fostered a greater feeling of shared responsibility.
"It was a case of saying: 'Let's focus on the immediate operational issues, and fix them'."We organised calls among all of the CFOs of our portfolio companies during the early period of the lockdown to talk and exchange ideas. Then we did the same with the CEOs." He says that GEF Capital plans to introduce this collective idea-sharing approach on a permanent basis going forward.
Much like the fundraising process, one might expect virtual ODD to have long-term benefits only for those with an established reputation and track record in the industry. First time fund managers can't expect prospective investors to get comfortable with their operational – and investment – processes without meeting in person. There will be limitations to how investors are able to get under the hood of such managers: investment committees have a fiduciary responsibility after all.
An investor needs to know what makes people tick, what their personalities are. They can't achieve that by looking at someone on a computer screen.
"With regards to virtual ODD, there is a degree of consensus that this is acceptable for managers with whom investors already have longstanding existing relationships," states Eisen. "It only requires doing due diligence on the manager's latest fund vehicle, which is far easier to do if they've already invested in Funds I and II, for example.
"However, it does not prove to be as serviceable for new managers, to whom investors have never allocated capital before, and do not have a rapport with."
GCM Grosvenor, the Chicago-based global investment and advisory firm, points out that many investors fear that without the opportunity to meet a manager face-to-face, watch their body language, assess their culture and tour their offices, the evaluation of that manager may be incomplete, and thus presents risks.
From an efficiency perspective, virtual ODD allows investors to schedule more frequent, focused meetings, not just with a GP's operations team, but with executives across the organisation. If this is a new manager, initial groundwork can be done virtually, and give investors more time to assess operational processes and controls. The same is also true for PE firms at the pre-investment stage, when analysing the merits of a potential deal.
Video calls can help to remove some of the usual vagaries of in-person meetings and prioritise key items or risks. Then, if the investor needs to complete the negotiations in-person, that final stage of the ODD process should be smoother. But, for allocations to managers with whom they have not previously invested, it will be rare for investors to become comfortable with either the investment process or operations without some in-person, on-site interactions.
Ultimately, any remote due diligence process will need to be comprehensive and provide investors with as much confidence as possible in how the manager negotiates, sources deals, reports and maintains governance controls.
According to a Rede Partners Covid-19 Pulse Report in September 2020, 92% of LPs believe remote working will be more readily accepted in their organisations over the long term. The implication of this is that virtual AGMs will likely become a more permanent change to the way LPs interact with GPs in their portfolios. This will also extend to due diligence as they re-up with GPs.
"With virtual AGMs taking place, the air we breathe here in Luxembourg has never been cleaner!" smiles Grenner. "We have clients coming over to Luxembourg for board meetings from the US and Asia, as part of a wider business trip to meet investors and other service providers in Europe. I haven't seen any problems with virtual board meetings; but even though you can do everything online it still doesn't replace personal contact.
"That being said, while I doubt we will see managers going back to frequent travelling just for board meetings, I think many will nevertheless be keen to get back to having client and service provider meetings, to address fund-related issues. "I hope we see an equilibrium struck between meetings that 'must' be done in person, and meetings that can remain virtual. But if we, as a fund administrator, have a good relationship with the manager, then virtual meetings are perfectly okay."
In Eisen's view, virtual AGMs might be an area where we see more enduring changes within PE groups, once we get past the pandemic:
"Speaking to managers, a number of them have said 'We've had our AGM online and found we were able to make videos and show them to our investors, such as pre-recorded videos of our investment principals talking about what had transpired over the last 12 months. Our investors can log in to listen to them whenever they want.' Some PE groups have also used video presentations from CEOs of their respective portfolio companies."
Managers will want to re-establish close contact with investors and portfolio companies, post-pandemic, but video technology will allow them to be more efficient with their AGMs, going forward. "They can do part of it virtually, and compress the length of their AGMs, which sometimes go beyond just one day; video content will allow investors to do things in their own time. So, I think AGMs will likely become a mix of physical meetings and web-based interactions," adds Eisen.
Cloud technology has supported business resilience
One of the key conclusions to take away from the last 12 months is how technology – driven principally by adoption of the cloud – has made all three of the above trends so easy to adopt. They have, almost overnight, become standard practices. The fact that global finance has operated without any serious shortcomings underscores how vital a role technology now plays, in all areas of finance.
"There haven't been any breakdowns in service, from our perspective, because the amount of technology users has dramatically increased," comments Sinclair. "When MS Teams was first launched three years ago, there were complaints about how well it worked, whereas now it is industry-standard. If Microsoft hadn't improved MS Teams, 2020 could have ended up being a very different year for private equity groups – and the financial industry at large."
Not that remote working is without risks. Cyber attacks have spiked during the Covid-19 pandemic, as threat actors seek to exploit vulnerabilities in home office networks to attack financial institutions. This has necessitated the need for PE firms to rely on their service providers to provide strict IT controls when accessing and sharing data.
"That's part and parcel of this new way of working – the amount of security and AI-driven antivirus tools we have to think about is becoming an increasing chunk of our infrastructure spend as we look to protect our clients' data from external threats," concludes Sinclair.
Technology has unequivocally played a key role in helping PE firms remain operationally robust over the last 12 months. Looking ahead, virtual functions and processes are going to become a permanent feature of the private equity model, with AGMs likely to be the biggest long-term change.
That said, one cannot overlook the importance of substance. Covid-19 pushed all substance requirements out of scope and it remains to be seen exactly how tax authorities will deal with the topic of virtual AGMs, in a post-Covid environment. In a worst-case scenario, it may force boards to revert back to attending AGMs in-person.
This article was written in collaboration with Private Equity Wire.
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