Streamlining the relationships between fund administrators and fund managers

Working with a third-party administrator has been the norm in hedge funds for a long time; it’s nearly universal in private equity and venture capital and is increasingly common in real estate. In fact, according to Convergence, mandates for administering almost 38,000 funds were signed between 2019 and 2021.

Hiring a fund administrator comes with a huge sense of relief, particularly for those outsourcing for the first time. With accounting experts and end-to-end investment lifecycle technology powering fund accounting, treasury, and investor services, their internal back office can pivot to more value-added tasks, and the fund manager can focus on the reason they got into this business in the first place: finding, investing in, and managing promising private assets.

But first, the GP needs to onboard their new fund administrator, as much as the fund administrator will onboard the GP.

While the fund administrator will handle accounting, record-keeping, and reporting, that team is not a replacement for a CFO or controller. Many strategic decisions are, and will always remain, beyond their purview. These decisions may fall to the CFO, COO, or General Counsel, but someone in the general partnership will need to make overarching decisions regarding the financial strategy of the fund.

A good example is the capital call strategy. To fund a deal, the GPs must call the committed capital. Typically, GPs call capital from LPs 10 days before the deal closes. But call it too late, and the closing may be delayed, and the firm might lose the deal and risk looking inept. On the other hand, call the capital too early, and IRR can take a hit.

So what does the GP want to do? Call capital early to be “on the spot” when the deal closes; call it ten days out and cross your fingers; or set up a Subscription Lines of Credit (SLCs), which involves establishing a facility with a bank through which they can fund a deal without calling capital? This is a classic example of a financial strategy that remains with the GP to set. The fund administrator cannot tell the GP what should be done; it can only say what it has seen previously. Moreover, the administrator cannot legally approve a capital call notice—that has to be done by a lawyer.

Another financial strategy topic includes the financial reserves a GP may wish to hold. It may be a percentage of the fund, a percentage of each specific deal, or decided on an ad hoc basis. Here again, the fund administrator can’t say what to do, but the team can provide examples and advice informed by experience.

Similarly, the fund administrator will pay an invoice, but it’s still up to the GP to approve the expense. In short, the administrator relays best practices and executes the strategy, but they cannot make the final choice for their client. GPs must make many decisions about what’s right for the fund, taking advice from any number of groups—the advisory board, legal counsel, and the fund administrator among them.

As an extension of the firm, the fund manager (including the back office) and the fund administrator need to establish a collaborative relationship from the start. Think of this as a mutual onboarding program.

It starts with designating someone as the owner of the relationship—it can be a member of the finance team, the CFO, or the COO—but it’s important to streamline the communication channels as much as possible. On the flip side, administrators committed to delivering best-in-class service stay responsive to the fund managers' needs and questions and should also provide GPs with a dedicated contact.

As with onboarding any organization, the first reporting period will be a process of getting to know one another. The GP must be able to articulate what they’ve done in the past. The FA will comment on how they’ve typically worked with similar firms. The two parties need to reach an agreement about what works best for both, ensuring the LP experience isn’t negatively affected.

The key thing here is that this process should happen before embarking upon something that is time sensitive and stressful, like tax and audit season. Be sure to talk through the process, setting expectations and timelines, before needing to execute a capital call, launch a portal, or create quarterly investor reports.

Just as each relationship is different, the communication model that works between each firm and the fund administrator will be unique. Some work well with weekly meetings or calls; for others, it’s too much. For some relationships, the right model varies depending on the time of year and the work the fund is doing at that moment. Fundraising or year-end may require frequent communication; operations during the rest of the year may involve less. What’s critical is that the GP and the fund administrator communicate about this openly.

By leveraging the expertise of a fund administrator, fund managers can more easily:

• Respond to evolving investor demands & actively strengthen relationships with LPs

• Mitigate the risk of employee turnover and the loss of institutional knowledge

• Adapt to a world of data ubiquity by structuring investment data with an emphasis on security, aggregation, and reporting

• Leverage automation to make internal teams more efficient

• Minimize risk by enhancing controls

But to take full advantage of the relationship with their administrator, GPs need to understand the roles and responsibilities of all parties involved. Establishing clear swimlanes up front and over-communicating goes a long way to building long-term success.