The Private Capital Strategy Series Episode 10: Co-sourcing
Counting on your fund administrator’s technology alone to insulate them from the industry-wide talent shortage may be only a temporary solution.
More firms are crossing the “co-sourcing” chasm and separating their general ledger from their fund administrator to ensure less exposure to industry churn.
In this episode of The Private Capital Strategy Series, Bob Chowaniec lays out the proven steps from real world experience for crossing that chasm before it gets too big.
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Mike Trinkaus 00:02
Hello, everybody. My name is Mike Trinkaus. I’m joined here today by Bob Chowaniec, the COO of 4Pines. We have a really exciting and interesting topic to discuss today. Before we get started, I want to mention that we love questions. Please don’t hesitate to ask them – the more interactive, the better. To kick things off, why don’t we start with your background, Bob? I think it would be great for everyone to know more about you.
Bob Chowaniec 00:30
I have a little bit of a strange background for fund administration. I’m an engineer who worked – gosh – for more than 15 years in electronic manufacturing. I started off designing electronic products, went into designing processes, running factories, mostly overseas, working on global supply chains – that kind of fun stuff. In the last five years, I got into contract manufacturing. Surprisingly, after coming back stateside and joining the fund admin industry, I discovered that, actually, contract manufacturing and fund admin have a lot in common. They’re both third-party service providers where you’re building relationships and learning to make your clients’ products hopefully better, more efficient, and more cost effective, giving you the value proposition of why they would outsource. So it’s been an interesting transition. I find that most of the things I learned in the rest of my career have applied to this work. I’ve been in fund admin now since 2014.
What are some market conditions that are driving the need for co-sourcing?
Mike Trinkaus 01:39
It’s certainly an interesting background role that led you to fund administration. The parallels, based on some of the discussions we’ve had over the years, are striking. It’s great to see that crossover in two very different industries. Thanks, Bob.
Let’s get started.
So I’m sure everyone that’s on the webinar is familiar with the accounting shortage in the market that we’re currently experiencing. It’s been well publicized in major news outlets. The bad news is, in some ways, it’s not going to get any better. If you look at enrollment across accounting majors across our universities here in the US, they’re down. The industry is coming to a crossroads. What does that operating model look like as we move forward? Or, at the end of the day, is it really just the fund admins’ problem?
Bob Chowaniec 02:39
Well, it’s the fun admins’ problem until it becomes a GP’s problem. If your fund admin starts making mistakes and starts missing deadlines, then it becomes your problem. In addition to the accountant shortage, you’ve also got all the regulations now. There’s more talk about increasing burdens, of regulation coming down the pike, which is going to put more pressure on staff. Short staffing and that type of atmosphere aren’t good. It also becomes a GPs problem if they’re trying to shadow their fund admin, which a lot of firms still do. Now not only is your fund admin having difficulties finding accountants, but you need accountants to shadow them, too. This is the type of scenario that we are seeing recently, and why we’re seeing an uptick in the use of co-sourcing to solve the problem.
What is co-sourcing?
Mike Trinkaus 03:30
Some folks may not be familiar with the term, co-sourcing. If you don’t mind, can you take a second to define co-sourcing?
Bob Chowaniec 03:42
Co-sourcing is when the manager licenses the fund accounting platform themselves. They own all the data themselves. They own the system themselves. Basically, they provide logins and licenses to the fund admin who can go in there and do their work. It ensures that managers are not 100-percent reliant on the front end for absolutely anything and everything.
Who handles the transition to a co-sourcing model?
Mike Trinkaus 04:11
If we have some time, towards the end of the webinar, we’ll go into some of the advantages of co-sourcing that we’ve noticed over the years. Everything we do in this industry, every decision we make, has a tradeoff. Understanding those tradeoffs is important as you go down this path of trying to figure out whether or not a co-sourcing relationship makes sense for you. Interestingly, the evolution of co-sourcing over the last 10 years, including the reasons for doing it 10 years ago, while they still remain true today, are only some of the many positives.
To that point, if I’m a GP and I want to own my data, I want to control my own destiny, so to speak, and I decide on the co-sourcing model, whether I’m outsourced or whether I’m self-administrating, who handles that transition? Is it the GP? Is it the fund admin? Or does a software vendor take care of all of that for me?
Bob Chowaniec 05:21
It’s case dependent. They can all play a part. The fund admin, you know, obviously has the knowledge of how they want to do the work day-to-day. But they might not have sufficient resources to dedicate to the full migration and system setup. They also may not have the particular technical expertise in the system that the manager has chosen. To be honest, a lot of admins don’t feel incentivized to go into a co-sourcing relationship because it makes it easier for the manager to fire them.
How do GP’s and software vendors handle the data migration?
Mike Trinkaus 05:50
That’s an interesting point that I’ve talked to a lot of folks about over the years. One of the advantages of co-sourcing is aligning the GP, the software vendor, and the fund admin in the same direction. You might be asking yourself, why isn’t it easier to fire, get rid of, or move on from your current fund admin? With co-sourcing, it’s literally as easy as turning off a license on Friday and turning on a new one on Monday. In practice, of course, it’s obviously a bit more complicated than that.
One of the challenges in this space is committing to a data-migration process. In a co-sourcing relationship, if a partner isn’t delivering for you on the fund admin side, you can take that data migration off the table. Historically, that’s one of the biggest mitigating factors as to why folks don’t want to move from one service provider to another. Co-sourcing eliminates that challenge and risk altogether. It’s important to think through all of these little details.
Whether a GP is currently outsourcing or not, it’s very likely they don’t have a big team, they don’t have a ton of excess capacity with regard to accountants or human capital for their operations platform. So they likely don’t have people to move the data into a new platform. How about the software vendor? Are they the best folks to handle that data migration into a new system?
Bob Chowaniec 07:42
The software vendor can do it, obviously. But their main business is building the software platform and maintaining the software platform. They usually don’t want to dedicate a ton of time to a big custom implementation, which is really what a lot of PE shops need, because they all do business a little differently. You need it customized for your business. In these cases, a lot of times, the GP or the software vendor will bring in an implementation partner that can help with that transition.
Mike Trinkaus 08:16
They basically bring in a consultant who is familiar with the platform, can work through an implementation plan, and help you get the data, but maybe not reconcile the data. That typically falls on the GP. So if a software vendor has a consultant or a partner that they endorse who can implement the software, that should work, right?
Bob Chowaniec 08:37
In the best-case scenario, it absolutely will. To be honest, though, the implementation firms have their own staffing issues. Usually, the people who have the knowledge to implement the systems in the most efficient way are fairly limited. So you’re counting on a key person to do it, and they can’t do all the work themselves. You have to make a good strategic decision on exactly who you want to partner with and which groups you want to bring together that will allow you to cross this chasm into co-sourcing successfully.
Mike Trinkaus 09:11
How does the GP cross that chasm?
Bob Chowaniec 09:27
You work with people who have done it before, people who have a playbook for how to do it, and how to do it successfully. They would be people who combine the knowledge of technology, deep knowledge of the technology, with the ability to analyze your back-office requirements and see how you’re operating. Then they would show the willingness to dedicate the proper manpower to get the job done. Because, as you mentioned, even once you get the system set up correctly, and you think you have all the data in there, there’s a lot of work left to make sure that everything is working properly before your next deadline.
What does implementation look like in the real world?
Mike Trinkaus 10:03
What does that look like in the real world? Can you share an example or two so folks have something tangible to think about when they start analyzing whether co-sourcing opportunities are the right path?
Bob Chowaniec 10:38
One frequent scenario is when the GPs purchased the software platform but, due to the workload of their staff and their lack of knowledge of the new system, they haven’t been able to implement all the software’s efficiency features because the world doesn’t stop turning when you do this. You bring this new software in, it seems great, and you’re going to use it, but your staff still has all their day-to-day work. They still have to get reports out on time. In these cases, a lot of times, they fall back on more difficult practices. Rather than going through the proper implementation, they fall back on what they know. They put information into Excel, manipulate it in Excel, and then manually enter information into the system to get back into their workflows. This is done all the time.
This situation is good for us because this is something we’ve gone through a bunch of times. We know how to deal with these scenarios. We can come in, look at the system, look at the setup, and especially look at where you are doing things off-system. Why did you do that? We help them to design a setup that’s more conducive to efficiency and getting all the features out of the system that they’ve invested so much money in.
Another successful scenario is when the GPs bring us in along with the implementation partner. The implementation consultants know the system. They design this great back office system, making everything efficient. Then we help with our knowledge of the day-to-day. We come in and say “Look, you know, that’s a great setup. But really, on a day-to-day basis, we can help come up with a better plan.” More importantly, when we work with the implementation partners, we have the manpower. Like we mentioned earlier, you need a lot of work to make sure that these systems have been implemented properly. Usually, that falls on the GP. And they don’t have the staff to go through and do all this while they’re doing their day-to-day work. We supplement. We augment their staffing with ours. We do a lot of that work for them, make sure that we’re working in parallel, and get everything up and running correctly.
Mike Trinkaus 13:04
Those are two really tangible examples. The role that a fund administrator can play is a bit different than a software vendor, a consulting firm, or GP. Fund admins have the benefit of understanding the complexity of the operations as well as the power of the system.
Sometimes software vendors will focus on certain aspects of the system. But, in everyday life, the application of that piece of the system isn’t important to the execution of deliverable deadlines and things like that. Whereas, if you go to the GP, they know all of the nuances really, really well around their operations, but they don’t know how to necessarily use the system. A fund admin can act as that bridge that connects those two worlds to say, “Hey, well, what about this? Or what about that?” This to us is a powerful way to connect your operations with your software so that you create efficiencies, automation, and connectivity to the best tools within that platform to execute in the best way. Is that a fair way to sum it up?
Bob Chowaniec 14:44
Absolutely. Along with, again, the manpower to be able to make sure it’s all right and do all the checks necessary to make sure you can implement.
Mike Trinkaus 14:53
In terms of making a decision to go down a co-sourcing path, how long does that typically take?
Considerations when making the transition to co-sourcing.
Bob Chowaniec 15:15
To do it properly takes a good three to six-month implementation. If this makes sense to you, you probably need to start thinking about it fairly soon, because the implementation entails a runway, too. Then all the things we started off talking about – the accountant shortage, the regulatory burden – that’s only going in one direction. The accounting shortage isn’t going to fix itself anytime soon. Regulations generally only go in one way. The burden is going to increase. All of that is going to squeeze staff. If you want to make this transition, you probably ought to start looking into it fairly soon. That’s where I’ll turn it back to you in terms of how you get across this chasm. You have the experience of helping a lot of CFOs get through this within their firm and make this decision properly.
Mike Trinkaus 16:22
It’s a good question. We’ve been helping clients with co-sourcing for about a decade now. We’ve had a lot of success. It’s been an interesting evolution with regard to the reasons for co-sourcing. That list of reasons continues to grow larger and larger as the market changes. It’s redefining how GPs should be thinking about managing their risk profiles. That’s a big part of it, as well. I’ll get into that in a second.
When we first started out with co-sourcing, it was, “Hey, let’s upgrade our technology stack. This QuickBooks world and this Excel world were great when we were a $100 million or $200 million firm, but now we’re a multi-billion-dollar firm. We need a better technology solution.”
Then it was, “We want to integrate some of our data across some functional areas. The IR folks need access to the accounting data. So is there a platform where we can all pull from the same world?” Even back then we would talk about how it’s easier to move on from underperforming service providers.
All of those reasons remain true today. But there is an evolution in terms of what we’re seeing and talking about with CFOs. Today, we’re seeing a massive push towards data and integration across not just the IR group and the accounting group or finance group, but firm-wide integration around data.
Why co-sourcing is an advantage
Cash will always be king. Those who are a little bit older on the webinar will probably remember that phrase from the late 90s and early 2000s. Cash was always going to be king. But today data rivals cash. Everybody wants access to data. They want to automate it. They want to integrate it. To me, data is a strong reason for integrating different platforms, connecting platforms to move that data that everybody so wants.
The reality is, today, regulatory pressures are much greater than they were 10 years ago around data. What’s a good way to address some of those pressures? What are some of those pressures? The SEC has proposed requiring getting information to them at a much faster velocity than we’ve historically done. In a non-co-sourcing relationship, you have to depend on folks to get that data to you. In a co-sourcing situation, you have access full access to the system to get that data. You don’t have to wait on people to get it for you. So that’s a big advantage of co-sourcing relationships.
Another interesting thing that came out towards the end of last year with regard to proposed regs is this ongoing service provider diligence. One of the things that regulators are focusing on is putting in mitigating strategies around your service provider. What better mitigating strategy can you put in place than having direct access to your data, having direct control over your data, at the end of the day?
Those are some of the reasons that we share with folks as to why co-sourcing makes sense.
Now we’ve got a couple of questions. Is there an industry group or peer group on the GP side that a person can go to and learn lessons about co-sourcing to see how others have done it?
Is there an ideal profile for a GP client for co-sourcing?
Mike Trinkaus 20:45
I would go to some CFO Slack channels that you can access. I’m not allowed in them as a fund service provider. There are the tech PFOA and CFO networking groups. I would go to anything like that and ask the question. You’re bound to get an answer from somebody.
Here’s a good question. Is there an ideal profile for a co-sourcing client?
Bob Chowaniec 21:30
An ideal profile would be someone who has already implemented a system and who is now looking into outsourcing. Rather than thinking about how most people would turn the data over to the admin – “How do I implement this? How do I get everything into the admin’s world?” – you’ve got a different thing to think about. If you like your system, you’re just looking for the admin to come in, hopefully, an admin that knows the system well and can actually help you get better use out of it.
Mike Trinkaus 22:15
Another thing that we see a lot from a profile is what size makes sense. If you’re a new manager, anything below $750 million in terms of assets, it probably becomes cost prohibitive. But again, it really starts with, “What are the goals? What do I need?” And then the trade-off. “Is it worth paying a little bit more to have access to all my data or not?” That’s the decision each GP will make on their own based on their own circumstances. But anecdotally, what we see is, once you hit that $750 to $1 billion range, that’s where folks really start asking themselves, what’s the right model going forward? I don’t think it’s predicated on the industry. I don’t think there’s a difference between venture or buyout, secondary funds – none of that matters. It’s the size and the access you need to that information that dictates whether or not co-sourcing is a good fit for you. That, collectively, is the starting point to understanding whether or not you’re a potential profile that fits or not.
Here’s a question. How long has co-sourcing been around? We’re hearing more about it today than ever before. Why?
Why is there a reluctance to outsource?
Bob Chowaniec 23:51
It’s been around for at least 10 years, when we started doing it. I think we’re hearing a lot more about it now for the reasons we talked about. There’s been this reluctance to outsource in the US. Only 50 percent of business is outsourced in private equity or the private markets in the US. Managers have been reluctant to give up control of data, systems, and their ability to integrate systems. What co-sourcing is provided is, “Hey, we can outsource and still keep control of this.” I think that’s why it’s getting a lot more traction.
Mike Trinkaus 24:53
It’s a natural evolution of the industry. If you think about the world that we lived in 10 years ago, we were 30 percent outsourced. We were very set in certain ways. That model continues to change, continues to evolve. What is the best world? Is it outsourced? Is it? Is it self-admin? Or is it a combination? I look at co-sourcing as a combination of both self-admin as well as outsourcing. You try to put the best of both worlds forward. Co-sourcing is the evolution of the market that we’re in, seeing that that hybrid of the two comes together. That’s what’s exciting to me when I think about the future and where all of this is going.
Here’s another question. Are there different levels of quality? Or types of features? Are there features I should be looking for or choices I will need to make?
Is all co-sourcing created equally? Are there different levels of quality? Or types of features?
Bob Chowaniec 26:07
Co-sourcing, basically regardless of who does it, whether it’s an implementation partner, whether you handle some of it yourself, whether you bring in an admin or the software vendor to help, you need someone to look at your systems, what you’re doing and what makes the most sense for you.
Back offices are so customized, they all do things their own way. You have to look at everything on a case-by-case basis, break it down and say, “Map it out. These are all the systems we’re using. These are the systems that we want to keep. If we implement co-sourcing, how are we going to make all these things play nicely together? How is it all going to work together? What functions do I want to outsource? What functions do I want to keep in-house? That’s what makes that decision very difficult. But it’s very rewarding if you get it right because you can get all these things to work well together, get everything to work smoothly, and increase your efficiency from where you are today.
How long would the transition to co-sourcing take?
Mike Trinkaus 27:21
Do you have any guidance with regard to how long that could take? Maybe some general guidelines would be great.
Bob Chowaniec 27:40
The analysis and design phase would take a month. You could get the implementation done over the course of the quarter unless you’re doing some high-end technology integrations. The reality is, people usually aren’t in that much of a hurry. They usually don’t jump into it that quickly. Usually, we see that the decision phase is a good three to six months. It doesn’t have to be that long. But, like we said earlier, the world doesn’t stop turning. You’ve got a lot of other stuff going on at the same time. It takes a little while to get this all mapped out and make the decision.
Mike Trinkaus 28:29
Who are the parties involved? When would you involve all of the parties – the consultant, the software vendor, the fund admin as well as well as the GP themselves?
Bob Chowaniec 28:56
You’re going to utilize all those parties. You would involve them all you want. Anyone who’s going to participate, you want involved. But the reality is, you know, people usually don’t bring everyone in like that. If you’re going to leverage your consultant, you would work with your consultant to map out the basics of it. And then you would loop in the software and the fund admin to finalize the details. However you want to start that initial conversation, it could be us, the admin. We can go in and do that for somebody. In the end, you definitely want all three parties to finalize all the details to make it work right.
Mike Trinkaus 29:38
Okay, great. Thank you, Bob. Very much appreciated. Thanks for taking the time. And thanks to everybody that joined us. If you have any questions don’t hesitate to reach out. We’re happy to have a conversation, share more insights, and get into more detail.