February 1, 2012
Interviewed by: David Snow
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Excellent Investor Reporting

Investors want more information on just about everything related to their private equity portfolio, and the increased burden of reporting has become a major challenge for private equity firms. What do LPs want to know and how are GPs delivering the data?

In “Excellent Investor Reporting,” William Hupp, a Partner and Chief Financial Officer of Adams Street Partners, Daniel Reid, a Director of Financial Services Regulatory Practice at KPMG, and Adam Weinstein, a Managing Director of New Mountain Capital, discuss trends among their investors and clients, as well as how they are rising to meet the challenge of increased transparency.

Topics discussed in this program include the history of LP-GP transparency, why hedge funds are even more transparency-challenged, the effect of reporting standards, financial transparency versus performance transparency, investor “obsession” with debt levels, confidentiality, CIO demand for data, the positive effects of negative attention, transparency at the GP management-company level, and the right mix of resources and people in the IR function.

Investors want more information on just about everything related to their private equity portfolio, and the increased burden of reporting has become a major challenge for private equity firms. What do LPs want to know and how are GPs delivering the data?

In “Excellent Investor Reporting,” William Hupp, a Partner and Chief Financial Officer of Adams Street Partners, Daniel Reid, a Director of Financial Services Regulatory Practice at KPMG, and Adam Weinstein, a Managing Director of New Mountain Capital, discuss trends among their investors and clients, as well as how they are rising to meet the challenge of increased transparency.

Topics discussed in this program include the history of LP-GP transparency, why hedge funds are even more transparency-challenged, the effect of reporting standards, financial transparency versus performance transparency, investor “obsession” with debt levels, confidentiality, CIO demand for data, the positive effects of negative attention, transparency at the GP management-company level, and the right mix of resources and people in the IR function.

David Snow, Privcap: Today when one talks about private equity, one also hears the term transparency quite a bit. The two terms didn’t used to be in close proximity throughout much of private equity’s history. It was a non-transparent, at least to the outside world, asset class. Maybe it was more characterized by the GPs saying, “Hey, just let us do our job and we’ll send you the checks as they come in.” Now, of course, not only do the investors want a lot more information, but there’s a regulatory expectation that there should be more information in private equity.

So I’d love to talk about reporting with the three of you.

Maybe we could start with maybe the changed expectations among investors today. They clearly want a lot more information. It falls on people just like you to provide that and to think about how it’s provided. Bill, what have you noticed by way of investor expectations around reporting? What’s changed?

William Hupp, Adams Street Partners: So I actually think that your characterization is not actually accurate. I think that those of us who have been investing in private equity for a long time have had a lot of transparency. The relationship between the LPs and the GPs is a very close one.

We reinvest in almost all the funds we invest in over time. That trust gets built up over time. There’s this performance attribute that good funds have of being able to repeat that over time, which is not something that’s typical in the rest of the investment management world.

So from our perspective, the communication that we have with the GPs going into these blind pools is extremely important, and we spend a lot of time on it. I know we were unusual in terms of having spent that amount of time, and now it’s being legislated that there’s more of that. But we really don’t have any problem getting any of the information that we need for transparency purposes from our GPs. I think that’s really a much more accurate characterization of the hedge fund world rather than the private equity world, where we give the cash out and we know where it’s going and we give these quarterly reports back. Then over time, the money comes back to us and we know exactly how that money was spent.

So I think that transparency is actually excellent in private equity and venture capital, and I think not so good other places. We’re getting broad brushed into this. But I do think that it’s taking longer to get to exits. So I think from that perspective, there’s just a natural need for more information in that process, and we’ll have to sort through how we get to that.

There are some standards out there. The PEG Group and the European Venture Capital Association have had reporting guidelines out there and that really covers more than just the financial reporting, but all the investment reporting that needs to be done. I’m on the International Private Equity Valuation Board. We’ve taken on the job of updating and coming up with some international rules for reporting guidelines.

I know ILPA has been out there doing that, too. These will probably be a little bit more industry friendly, can I say, in terms of having had everybody at the table and participating in that process. But we hope to have those out fairly soon and hopefully that’ll get people all talking about the same thing.

We did the valuation standards and now we’re working on the reporting guidelines. The interesting thing about the reporting guidelines is it’s like discussing a grocery list because it’s a big long list of things and everybody has different interests at times and it’s hard to get a lot of consensus around that.

But I think I’ll take some time for that. We’ll have to have it out there, and we’ll have to update it over time. But I think that process is well under way. I think the other people in my position from the fund-to-fund side would also say that the GPs they work with, the good GPs that they work with, that they plan to reinvest with, they’ve been getting good information from.

Daniel Reid, KPMG: The issue that we’re focusing on a lot with our clients– and Bill, this is along the lines of what you’re saying– is really the issue of forced transparency, so where it’s regulated transparency and there’s not the opportunity to build the consensus that there might be about what sorts of information should or could be provided to LPs when it’s being legislated or declared by regulation in a manner which maybe doesn’t allow for that opportunity to build consensus. I think that’s something that our clients are having a much harder time addressing than some of the transparency that their investors have expected in the past.

Adam Weinstein, New Mountain Capital: I would say that I think I partially agree, partially disagree with Bill on– I think where the private equity community as a whole has been very good with transparency, going back a long period of time, has been on certain aspects of reporting. So I would categorize those as you put $10 into this investment, you got $13 back. We gave you a $2 dividend before, here’s a $5 gain, and how it works through our waterfall. I think people have naturally been more transparent about that as a community. I think where people have been less transparent has been on the actual performance of the operating businesses that they own, so whether it’s revenue and EBITDA information, whether it’s embarking on social responsibility, how many jobs have you added and things like that.

So I think where I’d categorize us in that equation is I think we always had an open door policy, and a lot of firms did and if people asked us questions, we were always happy to comply. If people gave us requests, we were always happy to answer them. But I think what has happened over the last few years is there’s become much more of a formalized process to change the more standardized reporting that’s going out to people.

So not that Joe from ABC Investor calls me up and says, “Can you tell me how all your businesses did in 2010 versus 2011 at the actual operating business level,” it’s now more I’d like to see you put that into some deliverable that you actually just distribute to me on a quarterly basis. I think on the reporting aspect of things on how much I’ve distributed to you, how much I’ve called, what’s your remaining commitment, I think there’s definitely been a push to expand what is given to people. But I think most GPs for a long period– and this is where I’m agreeing with you– I think most GPs for a very long period of time have been very transparent about that. Part of the reason is that they know on the LP side of things, regardless of how you think they should analyze your actual investments from an operating business perspective, they need to know how to book their returns.

Also you’ve gone through the other period which is the LP community– a lot of the LP community, again, is being requested by their CIOs and the people in charge and their trustees to gather a lot more of this information or understand what this information is before they make certain decisions. At the same time, as we’ve obviously seen a recession, we’ve seen a leg down in investing generally. And so I think these firms are not as equipped as they would like to be to analyze some of that data. So they are actually just leaning on the GPs more to provide the information.

I’ve probably had four or five dozen requests in the last six months for– great, thank you for providing this information. Do you mind populating it in this spreadsheet, in this format? Because it’s just helpful for them, they can then use technology to upload that and look at things on an aggregate basis.

Hupp: I think from a regulatory standpoint and from a market standpoint, you had such a huge growth in the last 10 years in the private equity space that the investing ran ahead of the ability of those groups to do the due diligence including the ongoing due diligence, the monitoring due diligence. So I think that it’s catching up. It’s a natural thing of wanting to know what you’re invested in. And the people don’t know unless they ask those questions, unless they get those answers.

Snow: Bill, you mentioned the term grocery list. So I’m going to guess that for everyone, the grocery list of items of information requested is getting longer and longer. Can you give some specific examples? Does it have to do with sector groupings or does it have to do with, as you mentioned, the performance of the underlying portfolio companies? What have been some notable requests that you’ve gotten recently?

Weinstein: I think you touched on some of them. I think people want to know revenue, EBITDA, capex, debt, at the underlying operating businesses, which helps give them a gauge into how they would think about it. They want to understand your entry point. They want to know, what did you pay for this business? I think that is definitely an area the private equity community never used to be very transparent on.

Again, I think we always thought we were transparent and we’re happy to share it. We usually put them in our thesis letters going back to the beginning of our firm. But I think some people said, “I don’t necessarily need to tell you that.” And so if I payed 10 times for a business or 14 times for a business, and I had 10% equity and 90% debt because the debt markets allowed me to do that four years ago, and I could sell that business and earnings were up 10%, I’m doubling my money.

So there was a little bit of the mentality, and it was I think a bit overconfidence that I didn’t need to show you. Now people want that. So entry multiple, they want to know where you’re carrying the business. They want to understand how you’re valuing the business today. I think as we’ve seen– and Bill, you touch on some of the fair value stuff going on– I think as we’ve moved further and whether some might argue it’s better and some might argue it’s worse, but we’ve definitely moved to a more robust, more comprehensive valuation process today than we’ve ever had before. I think people want to understand why are you valuing this business at a multiple that seems incredibly high to what you paid for it, or a multiple that seems out of whack with other transactions that have happened?

We don’t get specific, detailed questions usually on some of that stuff. But there might be something that pops out and people ask. But people are really focused also– and I still see it today, and hopefully we don’t have another leg down in the US economy, but we don’t know– in debt. People have become obsessed with debt.

So they want to understand what debt do you have at your underlying companies today? What are the debt maturities? What do they look like?

If you have in two years a business that is down 30% in earnings because it got hit hard by the economy and you’re coming up for a refinance of your debt next year, they’re worried that there’s a big chance you’re losing the equity. So I think that there’s a lot of portfolio company specific information that people are asking for. It does play into industry sectors and other things.

Hupp: It raises some real questions as to confidentiality. Can you really give out information on private companies? So there should be some kind of a barrier there.

I don’t think any of us would disagree with the idea that there’s a barrier there in terms of what’s confidential in terms of what might harm the business, probably more on the venture side. But I do think that one of the thing’s driving the regulatory aspect of this and the disclosure aspects really goes back to the systemic risk question. And my perception is that in private equity, there wasn’t a whole lot of systemic risk other than, as you mentioned, Adam, the wall of debt that was out there, which was covenant-lite, and everybody was worried about. But everybody seems to have worked through those issues.

I think people want to know, is that going to effect me again? So if there was another downturn, people wouldn’t want to be left hanging not knowing if there is another issue out there. Is there lots of grease in there somewhere that’s going to roll through and hurt the values on these things? From a valuation standpoint, I think the entry multiples and the exit multiples, whether they bought too high or where they’re at, that’s something that we’ve talked about in our firm all the time and we have a sense of.

But there definitely should be a wider community that understands that. There needs to be data that supports that so we don’t have any problem. Again, we’ve always gone and gotten that information if it wasn’t provided to us.

If it’s going to be provided to us in the normal course of things, we’re all for that. If it can be electronic, that’s even better. If we can get to that standard, that’d be great.

Weinstein: I think people are focused on a lot of things. I think the debt points are definitely what they’re focused on. They’re also focused on what have you really done?

I’m paying you a management fee. You’re getting, in most cases, 20% of the profits here. If you’ve just done a financial engineering exercise, and that’s what made your fund successful from 2004 to 2009, that really doesn’t mean anything in the next period of time because leverage is less. What you’re able to put on the business is less. Maybe profitability is going down.

So people want to see, you bought this business at $28 million of EBITDA and you sold it at $26 million, but you sold it in 2006 and so you got a lot more of a multiple, that’s great. That means you’re really good at the deal dynamics. But are you good at the fundamental business building?

There’s really a return in private equity. I think it was always there, but I think some firms weren’t doing it that way. There’s a real return to true business building.

Snow: Adam, you mentioned that it’s actually the CIOs of the organizations of these LPs that are tapping the private equity investment staff on the shoulder and saying, collect some more information about X, Y, Z. What’s driving that? Why is, from the very top, there a greater need for information, even delving down to the underlying portfolio company level?

Reid: I think there’s a concern that the CIOs didn’t need to be looking at more than just some of these financial metrics that they might have been looking at in the past. There’s a demand for the completely holistic view of an organization and the individual investments. So those questions that the CIO might be asking to get more information about aren’t just in regards to those financial metrics anymore. They’re in regards to a whole range of issues that maybe weren’t on the table before.

So, for example, at maybe a fund to funds organization, you’re not just seeing questions come through the door of a financial nature. You’re seeing maybe a COO come through the door and a CCO come through the door and a number of people that haven’t in the past been a part of that question asking process, just to get a more holistic view of a whole picture that before might have been much more focused on true financial metrics.

Hupp: I do think institutional investors’ pension plans, for example, if they’re connected to unions, want to know where the money is actually going. Is it going to create jobs or to take away jobs in all the environmental, social and governance questions that come up? I think, Adam, as you pointed out, there’s a much greater desire to have that information.

A lot of times, it’s the trustees on the boards of those types of plans or their members who are asking those CIOs those questions. So they need to gather that information. In some ways, they’re indifferent whether it’s public or private.

That wall that we may have put up in the past from a privacy standpoint, we’re not going to be able to do that anymore. We’re going to have to– confidentiality, but we’re going to have to give them that information.

Weinstein: I think there’s definitely a push from the LP community for that. I think it’s a good step that comes from an unfortunate result, which is I think private equity as an asset class– like many of the other alternative asset classes and hedge funds are in that and I think venture capital somehow skates its way out of that– are being criticized, as Wall Street’s being criticized. I think people are a bit on the defensive just from the world perception of what private equity is. I think it’s actually doing some great things.

I think it’s causing firms to put together, hey, over here. I added 20,000 jobs through my portfolio companies. That added jobs in 260 zip codes in the US. So I think exercise like that that the private equity community is doing to defend itself on the world’s theater is incredibly important. It also helps with the LPs as well.

Snow: Here’s a question. In addition to investors being very interested in what’s going on at the portfolio level, I’ve seen in– there’s some new ILPA reporting templates that was included in this and also in some other areas. There’s a desire to learn more about the firm itself, the partnership of the GP and the health of it. What’s new here? Has this always been of interest to the LP? And what kinds of questions are they asking? Why do they want to know how the GPs themselves are interacting, sharing economics and feeling about each other?

Hupp: We’ve always wanted to know that information because it really tells us how repeatable their process is and is that firm going to survive. It is surprising how few firms actually blow up, if you will. But when you sign up, it’s going to take possibly 20 years to get through that particular fund in and of itself. You don’t want to have a lot of operating problems and inherit those, so keeping tabs on how the team is working. In fact, that may be one of the number one things that when our investment people go out and they go to the annual meetings, that’s certainly one of the big comments is how is the team doing? Where are their weaknesses?

Reid: It continues answer that question, too, of what value are you providing to me? If you’re asking questions about the management company as well about the investments, I think it’s easier to get that, again, whole view of what actual value did this management company provide to build the company that underlies this individual investment? Sometimes asking the questions about the way that a management company operates and the interaction between the partners and who’s around, who’s no longer around, helps to answer some of those questions that fundamentally get to the question of what value is being provided.

Weinstein: I think there’s a few things that people are trying to get to. I think one is, which is touched upon, I think they want to make sure that people are properly incentivized. Again, we’ve left our firm doors open for people to come in any time. But there are more and more people want to not just meet our CEO, they want to meet four deal people. They want to meet people on my team.

So there’s definitely a broader view. So since they’re underwriting the firm and they’re underwriting the firm’s point of view, obviously people leave from time to time from places and that happens. But I think they want to make sure, are you completely out of whack with how the normal economic split works in other places? If the answer is yes, they may not want to underwrite you as a firm because who knows what’s going to happen with your firm? So I think people really care about it from that perspective.

Then I think people do care about it from a– you have four successful funds and then the fifth fund is the fund that blows up. The GP agreement’s written in a very loose way, and clawback becomes hard to get back. People just care about it from a I don’t want to look foolish that I’ve paid you carry all along in a fund, and then at the end of the fund I have no way to have any recourse towards you.

Snow: I’m going to ask a final question. This is a fascinating topic. And obviously, we’ve talked about a lot of information, gathering the information, putting it into various forms, maybe inputting it physically in some cases. This requires time, effort and people. So I’m wondering how you all are thinking about applying resources, applying people, to the reporting function, which sounds like it’s a bigger job these days than it was in the past? So Adam, how do you think about that?

Weinstein: Yeah, I think what we’ve tried to do is really leverage the deal teams on a lot of the portfolio company data. And the deal teams have in turn, I think, leveraged the CFO functions of the underlying companies. I think you’re 100% right that I think as it’s become more cumbersome, I think if you were to try to take that in-house you could add full time bodies just to deal with some of these reporting requirements. How we’ve done it is a little bit of a leveraged model.

Who is best to fill out what capex was at this company last year? It’s a CFO function at the company and so that person puts that information in. The deal team reviews everything they’ve put in and says, “Oh, that all makes sense,” and reports it to us. We’re able to then, through technology, pretty easily compile that into the template that we need. So that’s how we’ve employed it.

Hupp: We basically see two models out there. One is more people oriented, so they’ll maybe have somebody on the staff of the CFO of the finance group who takes charge of the valuation process. Then maybe that group grows a little bit to provide more of the portfolio company data, so there’s a reporting function that gets generated there.

I’ve talked to a number of CFOs who are constrained from adding people. So they’re looking at some of the software tools that are out there, specifically for portfolio company data. One of the firms actually has some supports. So they’ll do the data entry, they’ll put some of that information in there.

They’re going off for fundraising. They’re anticipating that they’re going to get asked a lot of these questions and they’re going to have to show what they have. So that’s one of their top priorities is to put in a system where they can put this information out on a more regular basis.

It’s a little bit unclear whether people need to get that portfolio company information every quarter or twice a year or once a year completely and get it updated or something. But there are still some things that need to get worked through from that perspective because, again, these are private companies. They’re not public companies reporting on a quarterly basis, so it’ll probably take us a while to get to that in terms of having people’s expectations.

Snow: But even if you don’t do it on a consistent, quarterly basis, someone might ask you anyway. And therefore, you have to go through the same exercise, so why not make it a–

Hupp: Somebody will have to make a judgment about whether six-month-old data adjusted for any changes that have happened is easier for them to maintain. But these people are going to be building these systems over the next 12 and 18 months, so they’re all looking at a lot of work to do.

Snow: Dan, what are your clients telling you as far as how they’re thinking about resourcing the reporting function?

Reid: I think what our client, specifically in the regulatory space, I think they’re looking much more at the latter model because there is an expectation and a rule requirement that this is going to– the information required by the various regulatory reporting requirements is going to be very much on a periodic basis and presumably remain the same sort of information, so very much looking at the latter, more automated sorts of models so that those reports, whether regulation requires them on a quarterly basis, an annual basis or whatever, are something that at the end of a quarterly period or at the end of an annual period you can almost press a button, immediately file it with the SEC or whatever the regulator is. That’s where, at least in the area of regulation, we see our clients heading.

Hupp: This is where the Form PF just came out. The instructions for it came out and it’s very much what we wanted in the private equity space in terms of timing and regularity and stuff, so they actually did listen. So that was nice. If we would’ve had to crank out monthly Form PFs, that would’ve been meaningless and a real bother. But I think they listened to us. So I think this will not be as bad as we thought it was, so it could possibly have been.

Snow: This is a fascinating topic. There’s a lot more to talk about in the topic of building a better firm. There’s efficiency. There’s how to deal with regulations. But I think we should pause for now. So thank you very much for joining Privcap today.

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