Private Capital Talent Series Episode 4: Raising your second fund and managing talent liquidity

We’ve invited top tier private capital consultant Melanie Cohen and PFA’s Ryan Burger to talk about raising your second (or third fund) and talent liquidity in private capital.

Chris Gale  00:02

Welcome to episode four of the Private Capital Talent series from PFA Solutions. Today, we have Melanie Cohen and Ryan Berger with us. As always, we welcome questions. Also, stay tuned for announcements on Episode Five, which will probably air in about two weeks. Feel free to spread the word. Melanie, let’s get started. Tell us about your career and how you got to where you are today.


Melanie Cohen  00:47

Hi, everyone, I’m Melanie Cohen. I’m an accountant by trade, a CPA. I worked in public accounting at Deloitte for three-plus years, then went into private acquisition work while earning my MBA at NYU at night. Then I went into the alternative sector, starting at JP Morgan Partners, which was the private equity arm of Chase at the time. When they merged with Bank One, which already had its own private equity arm. Myself and some others from the management team proposed the launch of a private equity fund administration business within JP Morgan. I was at JPMorgan for 14 and a half years, running everything from client onboarding to larger client relationships on the closed-end fund administration side of the business. Then I went to Deutsche Bank and headed up the Americas closed-end fund administration business, and later, their global fund administration practice. I was there for about three years, at which time, they decided to sell the business. Ultimately, it was sold to APEX. As a result, I went to APEX where I ran their global closed-end fund administration business for about two and a half years, building up SOC 1 coverage to global product teams in services that they were doing integration work. About two years ago, I left APEX and started doing advisory and consulting work on my own, in the alternative sector, ranging from outsourced CFO to target operating models and many other things.


Chris Gale  02:36

That’s fantastic. Because of that wealth of experience, there’s so much we want to ask you. It is hard to focus on just a few things. But first, reflecting on the teaser that we put out ahead of the webcast, we want to ask you about second or third funds, even fourth funds. From PFA’s perspective, there seems to be something that happens when there’s a shift from raising the first fund. What’s required and whom are you trying to market to for your second or third? Could you tell us about what you see generally? Is raising your second or third fund today different than it was early in the pandemic or before the pandemic?


Melanie Cohen  03:33

When firms are raising their first fund, they’re trying to see if they can make it a go. So to be honest, the last thing anyone is thinking about is the accounting, the operations. They’re just trying to figure out certain things: Can we get investors? Can we raise money? Can we find investments? Is this real? Once they are through the first funds, they’re like, okay, well, we’ve got a business. It’s when they are going into their second or third fund that they start thinking more about having a robust back office and finance team. Before that, I think a lot of people think they can use just Excel, they can use QuickBooks – you know, it’s easy, it’s inexpensive. They might be right – it gets them by.


But when you start getting into the second or the third fund, you then start thinking you want stats across all the funds, investments, and investors, and that you might get more institutional-style investors that require more information. That’s kind of the breaking point when you say, okay, are we going to implement a real system that is a GL with allocations, or are we going to outsource and not worry about that facet? Historically, that’s always been the case. That’s the way it has always worked. The differentiator right now is the talent market. So I would say on the fund admin side, it’s always been the high turnover side of the business. There’s a lot of money, administrators do get turnover on the teams and that’s across the board. Everybody can range their percentages, but that is the reality.


Whereas, on the fund side, you really had less turnover. It was very appealing to people to be part of a fund considered a bit more prestigious. Consider though, of course, that I was always in finance and considered it more appealing to people that there was less turnover on that side of the business. That’s no longer the case. The talent pool is definitely not as liquid as it was and it is harder to hire people. I would also say I get clients saying to me a lot now, “Do you know anyone?” It’s hard to get people to stay on both sides now, which makes the issue that I mentioned – when you get to your second and third fund – even more complicated. Because you are now thinking, how do I make sure people stay? Because a lot of the institutional memory is with these people because these are smaller firms. So that’s the added complexity that I would say that we’ve had over the past three years, since COVID hit.


Chris Gale  06:11

I’d love for us to come back to that specific point about talent. Before we do, are there other things happening? For example, we’ve all read the headlines about what’s happening in the markets. Are there other things happening that are also putting pressure on raising that second or third fund, or making the leap to a larger fourth fund?


Melanie Cohen  06:41

There is also pressure to differentiate yourself. What is going to make you the most appealing to investors, which has always been the case – what’s your goal for your investors? What about your firm can be differentiated? Is it the speed with which you reply, is it the level of detail that you give, the transparency? So you are seeing many more firms where it’s almost as if the investors are part of the ownership of the firm. You do see extremes where members of the firm will meet with investors weekly and go over the deal pipeline and have to get approval from the investors – not all of them, but a select few – to go forward with a deal. I don’t think you saw that as much in the past. Now, you are seeing that more and across the board. The level of reporting and speed of the response has skyrocketed. Because now, that’s the way to differentiate yourself to investors and make it more appealing for them to want to come to you.


The other thing you are seeing for the past five years is that more investors are demanding fund administrators. I’ll never forget this one time when we were selling fund administration. There was a client that we pitched. They said, you have to come over, you have to pitch today, we have to close in a week. We wanted to close this investor, and we knew they wouldn’t close with us unless we had a fund administrator. They felt that, by having two parties, there was a control mechanism. You are seeing a lot more of that where investors are dictating how the operations and controls are set up. I’ve had a ton of target operating model work and clients who are bringing me in, saying, “What have you seen? What’s the optimal way to set this up at this stage?”


Chris Gale  08:55

I’ve already been thinking about reporting pressures, the SEC rules that are coming out, and questions about ESG. Now you’re saying also that investors are demanding a greater level of reporting, especially when you’re moving to that second fund or third fund. I’m going to come back to what you were saying about talent and liquidity. I’ve been reading about it in other industries, where talent liquidity can mean different things when people leave. How can we retain folks then, despite the assumption that there’s going to be a certain amount of liquidity, so the talent that comes in can ramp up faster and the talent that leaves, leaves you with fewer vulnerabilities? Meanwhile, I’ve heard about internal talent liquidity in terms of folks moving around within the organization. I would love to hear what you’re thinking about talent liquidity in terms of this equation, of moving toward the second, or third fund and the pressures out there.


Melanie Cohen  10:19

I think you summarized it perfectly because there are different facets to that. Number one is attracting the best people as you’re hiring, as you’re growing, because, even if you outsource, there’s still going to be some level of retention of what you need to do on the fund side, which people always discount, but you still need to review it. You still need to sign off. It’s still your books and records.


Number two, how to hold on to those people, once you have them? This pertains to what I was talking about earlier. There has always been turnover on the fund admin side. So what can you do to get people to stay? The third thing is, assuming people are going to leave, what can you do to attract the best? For example, on the fund side, traditionally, they would give carry on the operational finance side of the business only to the very senior people on that team. Now you’re seeing that across the board, where they are giving carry to even the more junior members. It’s a carrot to keep them. By the same token, it’s making sure they understand that. Because if people don’t understand that, then they don’t know what they’re staying for. You don’t manage to have that retention. Still, it was a good point that you made, and it’s a little bit harder on the fund side, because they’re smaller than on the fund admin side, even if you just compare the two. People do want to continue to grow and learn and, on the fund side, if you have a small team, it’s sometimes hard to do that.


So what are the ways you could do that? You could rotate roles, for example, whether they get involved in tax, whether they go into different industries, or whether you have them help with some of the deals so that they feel part of it. You have to get creative to keep people once they come in. Otherwise, they get bored. Going back to the point that you made about attrition, assuming there’s going to be some. A few ways to tackle that are: Number one, systematize things as much as you can. Number two, what I’ve also seen a lot of is the procedural-izing of things. I’ve had a lot of clients come to me and say, can you interview us and put together extremely granular procedures so if we expect turnover, I can hand something over to someone else and it’s not all dependent on Mary, for example, who knows the fund since the beginning. Instead, she can give this to other people. What’s very good about that is, you get people questioning things. It’s always hard to do that because you’re interviewing and if people know it so well, they’re not thinking about steps one, two, and three. But it does get them thinking about what’s right, questioning things. So it’s also a good process to go through, which can then be used to automate things.


Chris Gale  13:33

Maybe there is a spectrum between, “I need help, how do I find the folks that can do that,” and then not just finding out if they can do it but also asking if they can break it down into a replicable system, which then presents an opportunity for automation. Ryan, I think this might be the right time to ask you about when you’re getting folks checking in with PFA. How does that equation work in terms of capacity and a sort of talent crunch and whether you’re looking for people or operations or some blend between the two?


Ryan Burger  14:25

I think there’s always going to be the people aspect, no matter if they’re on the finance side, investor relations, etc. Finance is involved in everything across the board. From a technology perspective, from a hiring perspective, and from an overall operations perspective, CFOs have responsibilities across the board. We’re seeing more CFOs involved in hiring now. There are a lot of challenges right now, as Melanie mentioned, particularly, in the fund admin world. But even consulting companies and our clients are facing challenges. So far, some of them have faced issues while others haven’t yet, but they are paranoid. We got a call yesterday from a really large firm that told us, you know, we’re scared of people leaving. We haven’t seen a lot of people leave yet, but we are scared. We want to get the right reporting to them ASAP. Our number one priority is providing transparency on their rewards, particularly carried interest awards so that they can see what it’s worth now and what it will be worth in the future. Other smaller companies have come to us and said, ‘People have made decisions and left because they didn’t understand carried interest.’ So, they want to go through a whole training exercise of educating all of their employees about what these awards are worth, and what they could be worth three or five years down the line if they stick with the company because a lot of people are motivated by financial gains.


In addition to doing different types of work or joining different types of industries, it does mean a lot to several people. As Melanie mentioned, we are seeing, especially among our smaller clients, carried interest awards granted across the entire firm. Because it aligns interests and everyone wins if the firm performs well over time and generates positive carry. From a technology perspective, it always comes down to needing a system to avoid those key person dependencies where somebody wins the lottery, gets hit by the bus, and they are the one person managing this complicated spreadsheet impacting everyone’s carried interest. Some of our clients also want us to generate reports where they can assess that and say, “If this person leaves, if three people leave, what happens, how much is left?” That goes back to a reserve or house account bucket so that they could properly hire.


Going back to your first question, what does it mean from a technology perspective, the first three things they say are: we want to get off these crazy Excel spreadsheets, and we want to get better reporting, and we want to be at ease where there is some controlled manner of how the data is backed up. They want employees to log in and access that data via a portal or be automatically sending the statement to them to sign off in DocuSign so that there’s a stamp of approval and an audit trail associated with it.


Chris Gale  18:04

If I understand you correctly, especially on your first point, they probably came to you for the automation and the efficiency, rather than knowing how to figure out an Excel sheet.


Ryan Burger  18:28

One particular firm told us, “This is great – everything – we understand that this can help us from an administration perspective. But our problem is education. We hire a lot of engineers, people from Silicon Valley to do more AI-type analytics for investment strategy. But they don’t necessarily understand how traditional private equity venture capital carried interest awards are granted and what that means from a long-term perspective.” They wanted to focus on the educational side. So, we started thinking about it – maybe, we need some more pop-up boxes in the system to cover things, for example, what does this number mean? What does this number mean in the future? This company was saying, “Well, maybe we need instructional videos. We need to spend time with employees to educate them on what they’re receiving as part of their offer letters.” That’s been new on the education side. We will probably continue to see it. Then there are different types of awards. There are phantom awards versus partnership awards. There are awards because people are investing their own capital. We’re also seeing an uptick in hurdles, where if somebody comes in later, the company has to hit certain milestones before that individual gets paid out or gets their carry. So, there are a lot more things going on to define these compensation programs.


Melanie Cohen  20:23

That makes total sense. Remember, in the beginning, we were talking about how they are giving carry to everyone, to the more junior people. Education is key because it is not just the senior people or the select five that need to understand how it works now. It is the masses. It’s one of the more different things that I was hired for. It isn’t really what I do but someone was leaving a firm and really did not understand their carry and called me to say, “Can you go through all of my paystubs and carry and whatever, and explain to me what’s hypothetical now that I’m leaving, and what I get when I leave?” Obviously, there’s a lack of understanding.


Chris Gale  21:13

Understanding carry allows the employee to make a rational decision. In a previous episode, we might have talked about this, from a recruiting perspective. It seems the ability to show how much transparency you have can be a differentiator from a recruiting perspective. It can help alleviate those conversations with the CEO where you have to ask embarrassing questions.


Ryan Burger  21:56

That’s a great point. We’ve heard a lot that if you can digitize statements or access the data, then it removes that extra conversation between the employee or the participant and the CFO as to what’s it worth right now. They can rely on receiving some sort of statement on a monthly or quarterly or annual basis but if they have a login to a portal and can pull that information, it avoids the CFO or whoever is managing it, going back into the files and trying to understand it and it avoids that conversation.

So that’s one piece. Also, we’ve heard from a couple clients about being able to toggle scenarios. So, if the projections that are standard in your reports is X over the life of the fund, and it is a $1 billion fund that turns to $2 billion, with a 20 percent incentive fee, that’s roughly 200 million that gets split across whoever is part of that program. If an individual can toggle that and say, well, it could be 3X, or it could be 4X. That’s something else that we’ve heard where an individual can have access to play with the numbers and can figure out, what will this be worth for me? Should I look for other options? Or should I stay here because of how we’re doing? So that’s something else we’ve heard that people want – that an individual can log in and toggle and see how much things can be worth based on various scenarios.


Chris Gale  23:39

I want to leave time for questions. Natalie, I have one for you. You mentioned your work in establishing or finding processes and how that can set the stage for automation. Without disclosing names or engagements, are there examples or best practices you would share? Where can you transition good workflows to?


Melanie Cohen  24:22

They’re both right. It’s workflows. But it is also written documentation of steps. For example, the basic ones, what happens with a capital call? What happens with financial statements? Everybody thinks writing procedures is easy. I always think of it like this: If my daughter was doing this and has no experience, would she know the next step? So, you want to walk them through it and then weave in the reasons and understanding so that it’s both a process tool but also a learning tool. Because you can go over things on day one but let’s say you go over a capital call process and then you don’t have a capital call for three months. No one is remembering in three months what they have to do. So, it’s number one, the documentation, the written aspects with screenshots or whatever. Number two, the workflow aspect. Both of those things help with turnover. But you can also utilize those tools to then automate things. If you decide to implement a system or to go to a vendor to understand how it works, it gives you a starting point to dictate how that process will work. I would say a lot of my clients will take a more proactive stance if you put it together. I wrote the SLA for our client then I said to the administrator, here’s my SLA. You tell me where it needs to be changed i.e., the client owes the administrator this on day five, then the administrator owes it back on day seven. It just helps things to flow. So, it could be number one for turnover, number two for process automation, and number three for outsourcing help.


Chris Gale  26:27

Another question. This one’s for you, Ryan. You’re focusing on carried interest. Can you tell us more about some of the other areas where PFA is automating? Its relevance to the talent, the liquidity issue?


Ryan Burger  26:52

Sure, we focus on carry as a base. However, it’s almost like a journey with our clients to add more from that talent perspective and the reporting to the individuals. A lot of our clients will also include co-investments in statements or other types of reporting that they’re providing so that they can see carried interest toward what’s vested, what’s not vested, what are the future projections of those, and also, how much money has each employee or partner invested of their own capital? What’s that worth? Sometimes it’s correlated to the carry. Sometimes it’s not. Sometimes it’s completely independent, where these employees are investing alongside outside limited partners. Another component that we’re seeing is adding in salary details, like bonus benefits, so that an employee can see all of their compensation. Also, how has it changed over time? What did it look like last year? What does it look like this year? What are the projected bonuses for the next year? So, we’re helping a lot of clients with carried interest, co-investments, and compensation reporting. We’ve had a couple of clients come to us and have us build out compensation recommendations, and analytics, where senior management can look at all individuals and see how to allocate bonus pools, see who is up for promotion, see all their levels, and have the breakout and the organization chart so that different leaders within the organization can see who their direct reports are, and then allocate their bonus pools within that. So that’s a new feature that a lot of clients are coming to us to ask about, particularly on the larger side, so that they can manage their mid-year and year-end comp review cycle and review process, all on a single platform.


Chris Gale  28:56

That’s pretty cool. I can think of some very large technology companies whose development managers could use that. We have reached the end of our half hour. Thanks very much to both of you. It’s been fantastic. Thank you to everyone who joined us. Stay tuned for the next episode.

PFA Solutions

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