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October 14, 2022
What percentage of portfolio companies outsource a part of their operations? Half of the respondents to a Private Equity Wire survey reported relying on third-party service providers. Three-quarters agreed that outsourcing operations — like fund administration and accounting — “added value” to their portfolio company. If you wonder how outsourcing compliance services contribute to growth, keep reading.
PE strategic outsourcing is a hot topic in private equity forums, thanks to the continual evolution of regulations, investor expectations, technology, cybersecurity, available talent and the global economy. There’s little doubt the swirl of uncertainty compels private equity GPs to find better ways to create long-term value by outsourcing key functions. Although outsourcing has been around for decades, today’s service provider offerings unlock competitive advantage. Here’s how.
The regulatory scrutiny of public and nonpublic corporate activity is increasing. While GPs watch these developments closely, they can’t afford to divert focus away from their core competencies. That means private equity is challenged with meeting statutory requirements governing mergers and equity or asset acquisitions, federal SEC regulations and ASC 606 revenue recognition rules; or international disclosure standards becoming regulatory frameworks for environmental, social and governance topics.
In particular, private equity recognizes that ESG assets have become much more attractive to investors, with J.P. Morgan & Co. predicting that the sector’s ESG investing will only grow. However, this global investment trend also means private equity needs to stay ahead of multiple countries’ ESG risks, such as carbon emissions, corruption, forced labor and white-collar crime. Monitoring the sustainability factors supporting or detracting from an ESG asset requires IT infrastructure, data analysis capabilities and expertise that private equity taps into through third-party compliance service providers.
Outsourcing was once characterized as the handover of a function like IT to a low-cost provider, in a relationship that often became untenable. But the arrangement between a portfolio company and third-party service vendor has developed into something far more agile and approachable today. GPs now may select pointed services like customer help-desk support within IT to maximize selling, general and administrative expenses.
A service provider with expertise and technology that reduces a portfolio company’s costs will support a healthy margin of earnings before interest, taxes, depreciation and amortization. Focused business services for private equity are less cumbersome and expensive, making this new approach more attractive to middle-market and small-cap companies. They can now select outsourced partners for specific activities within accounting, finance, risk management, human resources and IT. Such a business relationship provides synergies for the portfolio company and service provider as GPs seeks long-term value growth.
The savings realized by outsourced advisory clients ranges “from 5%-10% on the low end and all the way up to 30%+, relative to what a company might be spending on its own,” according to Greg Schooley, US value creation leader at EY-Parthenon. The advantage of outsourced business partners is how quickly they provide high-quality and scalable support to companies, he adds. For example, rather than expend the time and resources to hire a chief compliance officer to meet the short (3-4 year) and long (6-7 year) investment schedules, PE can turn to third-party compliance expertise.
Outsourcing to attain operational efficiency and create value has catapulted into a necessity for two key reasons: big data and investor expectations.
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Back-office services, including compliance, are drowning in data. The adoption of middle and back-office tech solutions is trending as more services become available to meet the needs of large, established and smaller, specialized funds. However, technology alone doesn’t provide the increased level of responsiveness demanded by investors. The outsourced business partner for today’s private equity must be more tech-enabled than legacy IT infrastructure and just as keen on customer service as an in-house team.
The use of artificial intelligence, robotic processing automation and machine learning to achieve operational efficiency is growing. According to EY’s 2022 Global Private Equity Survey, private equity firms with accounts under management worth more than $15 billion are spearheading the move to big data and automation for reporting and compliance.
As past market disruptions have shown, with foresight there is opportunity. Gathering, monitoring, measuring and acting on the data efficiently in a competitive and highly regulated environment requires an innovative solution. Middle-market and specialized firms are expressing avid interest in using the same computational power that larger firms do, recognizing its efficiency versus traditional human interpretation of big data.
With the level of uncertainty in the market, from geopolitical risks to inflation fears, every limited partner is seeking information on the vulnerability of their investment. Some 60% of LP respondents favor a tech-enabled outsourcing partner for middle and back-office management, according to The Brackendale Private Equity Technology LP Sentiment Survey H1 2022
Proprietary IT infrastructure that prevents cybersecurity threats for secure communication, traditionally an expensive endeavor, can be addressed by third-party service providers with the platform and customer service capacity to grow with small- and mid-cap companies. LPs want operational efficiency in the due diligence process so that GPs’ attention stays focused on critical investment decisions.
Private equity turns to compliance services partners with the know-how to meet regulatory obligations like ESG and ASC 606, as well as investors’ desire for transparency. So long as there is a gap between rising finance-accounting talent and retiring professionals savvy in the foundations of compliance, like revenue recognition models and generally accepted accounting principles reporting, there will be a need for essential business services.
Escalon does more than close gaps in a portfolio company’s back-office functions; we also:
The private equity trend of tapping outsourced compliance expertise responds to investors’ expectations of real-time reports on key performance indicators and a sightline of long-term value.
Celene heads up the marketing at Escalon. Passionate about helping companies grow their business, she spends her days finding new ways to bring essential business services to startups, SMBs, and growth-minded companies. Based in the PNW, she’s the proud owner of 8 pairs of Birkenstocks and a sassy, cuddly cat.
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