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Posted Aug 4, 2022

First time fund administration basics

John Rackerby

Top4 Considerations Blog 4x

Managing a fund is not easy. Most fund managers have strong investment backgrounds, but many are blind to the nitty-gritty mechanics of administering funds.

We’ll leave the dealmaking to you, but we can provide you with guidance on how to ensure that your financial reporting and investor service processes are as efficient and error-free as possible.

Today, let’s focus on:

  1. Establishing the right team for financial reporting oversight

  2. Knowing your governing documents

  3. Communicating the basics

  4. Prioritizing security, including configuring policies and procedures around financial reporting

Establishing the right team

Prior to finalizing your governing legal documents, have a subject matter expert conduct a thorough review. This can be your fund administrator, auditor, or tax advisors. A subject matter expert can help ensure that the legal language within the documents translates appropriately to the actual accounting.

Once your documents are in order, find the right people who have the competencies to help you navigate the financial reporting process. You’ll need internal oversight, possibly through an outsourced or interim CFO. Even if you work with a fund administrator, it is necessary to designate an internal resource to oversee the financial reporting process. In fact, due to high audit risk, most well-established public accounting firms require that internal competencies are in place to oversee the financial reporting process before proceeding with the client acceptance process.

Additionally, most fund administrators do not provide fund valuation services, therefore it is important to have someone on your team who understands the intricacies of valuations. Portfolio companies that report in accordance with investment company guidance under ASC 946 within US GAAP are generally required to report on a Fair Market Value (FMV) basis, with some exceptions mainly around real estate.

Knowing your governing documents

As simple as it sounds, you have to know your governing documents. Key areas include:

  • Distribution methodology (i.e. realized and unrealized/hypothetical liquidation waterfall)

  • Allocation of profit & loss methodology

  • Admission of new partners

  • Management fees

Distribution methodology

The distribution section is complex. Despite the best efforts of many attorneys, the language within the governing documents may not fully reflect your intentions leading to an accounting outcome with unintended consequences for you and your investors.

Defining preferred return is one example where the intent can be difficult to translate into legal language. Preferred return can be calculated in many ways, such as compounded annually (i.e. IRR calculation), monthly, daily, or not compounded at all via a simple interest method. Determining the daily count used in the preferred return calculation – whether actual/actual, 30/360, or actual/365 – can present another challenge.

These are just a few examples of considerations when modeling the realized and unrealized/hypothetical liquidation waterfall. In addition, be mindful of any side letters that could affect the unrealized/realized waterfall calculation.

Allocation of profit & loss

This is a critical component of your governing document since it relates to the allocations made to each of your investors. Most governing documents will reference the distribution section. This becomes important when the fund is in the “carry” or “promote” since this will have an impact on the profit and loss allocation amongst the GP and LPs. Before the carry, most governing documents allocate profit and loss pro-rata based on commitments. When the fund is in the carry, the profit and loss are split in favor of the GP, such as 80/20 between the LPs and GP as defined in the governing document.

To note, the above applies mostly to closed-ended funds. Most open-ended funds do not allocate incentive fees, rather they are expensed to the fund using high-water mark and crystallization – the point when the incentive fee is realized and distributed to the GP.

Admission of new partners

Admitting new partners can present unexpected challenges. For most closed-end funds, new investors will be rebalanced or equalized as if they came into the fund on day one. However, late admission often comes at a price in the form of catch-up or admission interest (generally based on preferred return).

For open-end funds, new investors gain rights to capital and profit and loss activity beginning the day after the subscription start date. However, because these funds are on a monthly or quarterly basis instead of striking daily Net Asset Values (NAVs), we typically recommend either granting rights beginning the first day of the month or the quarter following or before the subscription date.

Management fees

Make sure you and your administrator share a firm grasp of management fee terms, including:

  • The management fee rate

  • The management fee base

  • Management fee offsets

  • Timing of payment (e.g. advance, current, or arrears)

These areas can be common causes of misalignment between investors, fund managers, attorneys, auditors, and fund accountants. In addition, ensure that you understand the accounting implications of the individual side letters, such as modifications to the management fee rates. Paying attention to the details will ensure proper financial reporting which, in turn, will establish and maintain trust with your investors and auditors.

Communicating the basics

Effective communication processes are imperative to ensuring alignment across your team and stakeholders. Your administrator must have a firm understanding of the following:

  1. The strategy of your fund. This may seem basic but your administrator should understand your investment strategy, what you’re trying to accomplish, and the structure of your fund, such as closed-ended, open-ended or hybrid.

  2. The reporting standards used for your fund, such as general US GAAP, investment company guidance under ASC 946 within US GAAP, IFRS, US tax basis, etc.

  3. The governing legal documents of your fund, including any side letters.

Once you’ve established that shared understanding, it is important to work with your fund administrator to ensure that you have a production calendar in place. A production calendar synchronizes your workflows with those of your fund administrator so that you can meet quarterly and annual reporting deadlines. It helps ensure transparency and can prevent an end-of-quarter or year-end scramble to get everything out the door.

Prioritizing security

Securing your investors’ personal information is of the utmost importance. There’s no margin for error. Building your own security tools, processes, and internal controls from scratch is resource intensive and difficult to maintain. Partnering with a fund administrator, who has already built a secured system rigorously tested through SOC 1 Type 2 and SOC 2 Type 2 audits, is the most effective approach to meeting your investors’ security and internal controls needs.

A SOC 1 Type 2 audit tests internal controls over financial reporting throughout an extended period of time (six months to a year). Auditors test the controls over the design and implementation as well as the operating effectiveness of the controls.

A SOC 2 Type 2 audit tests the controls around security availability, processing integrity, confidentiality, or privacy over the same aforementioned period of time.

Partnering with an administrator who has successfully completed both audits offers additional reassurance to your investors and can help you avoid the hassle of implementing best practices on your own.


To conclude, investment expertise doesn’t translate one-to-one to fund management expertise. You need to align on the basics, establish the right team for your financial reporting process, understand your governing documents, communicate the basics and maintain a secure environment. With these fundamentals in place, you’re well on your way to mastering the discipline of fund management.

Unlock the potential of every investment partnership.

Modern Administration takes responsibility for navigating GPs through a changing environment, strengthening GP-to-LP partnerships, and focusing on business drivers. Talk to us to learn how to unlock the full potential of your partnerships.