Chris Gale 00:02
Welcome to the Private Capital Talent Series. This is episode five with Jeff Solomon from Paddock Capital Markets and Ryan Burger from PFA Solutions. We’re looking at what to watch for in fund administration and consolidation. Jeff, can you get us started? Tell us about yourself and Paddock Capital Markets.
Jeff Solomon 00:33
I’m one of the two co-founders of Paddock Capital Markets. We are a middle-market investment bank. My background is in consulting and investment banking. Before I started Paddock with my business partner, Bill Salus, I worked at Moelis & Company. Before that, I was at Bank of America and Merrill Lynch, in their M&A group. So my background is doing deal execution, large and small ticket. When I was at Moelis, I did a lot on the sell side, middle-market M&A. In many cases, it was an asset that was owned by a financial sponsor. We would take it to a broad auction, and it was sold. That’s my background.
Bill was from a very different background than me. Bill came from fund administration. He was an executive at Apex Fund Services and a few other places before that. When we met, he was a consultant doing strategic advisory work for a lot of these big fund admins. We had this vision. This is a very fragmented market with a lot of activity. It would be great to be doing M&A in that space. But Bill, having a background as an executive, didn’t necessarily know all the ins and outs of M&A in my background. Obviously, doing M&A execution complemented him very, very well. We started out squarely focused on fund admin in February of 2021. We did our first deal when in April 2021. Since then, we’ve been off to the races. We’ve continued to service the fund admin space from an advisory perspective. But we also have found adjacent markets to fund admin, like corporate services and private wealth. Financial technology also has been, obviously, a massive and very, very hot industry, as well. We have a number of different transactions in our pipeline today.
Chris Gale 02:52
Can we focus on fun services? Can you talk about what’s happening now?
Jeff Solomon 03:16
Since we’ve been in business in the last year and a half, it’s been a highly active space. We just saw deals up and down the food chain. One of the things that ties them all together is the nature of the business. The ones that have a lot of capital behind them tend to win out at the end of the day. That’s what people are looking for, as far as achieving revenue, synergies, and strategies, It’s been highly active. I don’t necessarily see it slowing down, although, obviously, there are a lot of things to talk about with macro trends and potentially heading into a recession. But I would say, up until today, at least, it’s been very, very solid.
Chris Gale 04:19
We’ll be coming back to that point about sponsors and how that might be changing or not. You also serve tech companies and private capital. Can you tell us what you’re seeing there? Private capital tech companies? Or is it still early innings in terms of where tech is headed in private capital?
Jeff Solomon 04:51
Fund administrators are trying to get more tech-savvy and add more technology to their service options. In many ways, that increases their value proposition to their clients. They’re definitely circling around looking at technology as a potential investment, as something to buy potentially. I don’t necessarily agree with that 100 percent. But I do think there is some hesitation from administrators to potentially own a piece of technology that they would then be selling to other admins. There might be some sort of competitive issues there. They think they might lose clients that way. But I don’t know if that’s necessarily the case, because there are large tech companies that have other tech companies as clients. That’s not necessarily a big concern that we see. But, there is some hesitation. That being said, these companies in many cases are also flush with cash. They’re looking for places to deploy it.
Right now we’re in an unusual cycle in the fintech space because valuations had been just astronomical. I don’t know that those are going to be supported down the road. When you look at fund administrators, they’re going to be a little more disappointed with how they’re deploying their capital. Do they want to spend 50 times revenue to invest in some small tech startup where they like the software but don’t know where it’s going to go? Or is it better to just simply buy a smaller fund, and then you can get a lot of synergies and kind of roll that into the larger machine? So there’s definitely interest there. But it hasn’t come to full fruition at this point.
Chris Gale 06:26
What are you seeing in terms of acquisitions, and trying to rationalize and integrate different tech stacks and specs?
Jeff Solomon 07:11
Every situation is different. But it’s important to think about the big picture in terms of what the tech roadmap is going to look like down the road. The most important thing when you are integrating these technologies is to not disrupt the client, right? Depending on how one administrator uses technology with one client, you’ve got to make sure that there’s continuity and a plan of how you’re going to transition to potentially a new service offering on the tech side if that’s the right answer. In every deal now, we’re seeing more focus on the data, data coming from different systems, and how you aggregate that data together to create useful and valuable reports that your clients can use. So it’s more about the data itself. The clients care less about the means of how they get that data. As long as your technology approach can keep that intact through a transaction, I think that you’re going to be okay. But it is definitely something to think about when you do due diligence on a company. There are certain costs associated with transitioning over to another technology, but it’s a one-time cost that you can absorb and write off down the road.
Ryan Burger 08:29
I completely agree. The M&A market is hot and the fund administrator space is certainly a hot market right now. We actually have some fund admin clients who were acquired by fund administrators who then got bought by a third fund admin. Technology is a huge part of the operations of a fund admin, of course.
When there is an acquisition, in an ideal state, it would be great for the buyers’ solutions to complement the seller’s, and the seller’s solutions to complement the buyers’. In reality, there’s a lot of duplication. They might be using the same systems but setting them up differently. Or they might have completely different software solutions. Post-acquisition, we’ve seen a number of different models. The first is, leave everything as is. Let the newly acquired company run independently. Use all the same solutions they were doing before. I think there are pros and cons with that. It goes with your point, Jeff, on not disrupting the client at all because you’re staying the course.
The second option is figuring out where you can rationalize things and normalize and use the best of both worlds. The pros and cons with that are that you have to migrate data over to a general ledger, especially on the private equity and venture capital side. It’s an enormous amount of effort to migrate this data from one system to another. On the GL side, other things might be easier. Like CRMs and LP portals, you still need to make sure that LPs have the right paths.
The third thing that we’re seeing is picking and choosing which solutions are best on an ongoing basis. So any new clients that come on board, you get this general ledger, you get this LP portal, you get this CRM, get this analytics platform, all of that. We’re seeing that as well. A variation of the third option is letting the clients choose the solutions. Our fund admin clients will sometimes show our system, FirmView, to their potential clients. They’ll also show another vendor system, or they might show something that they built homegrown to their clients, and let the clients decide what to use. There are certainly a lot of decisions to make when there is an acquisition, especially with the fund admins that are buying a lot of different vendors or other fund admins. They have even bigger decisions on what to do with all these different systems across all the fund admins that they’re purchasing.
Jeff Solomon 11:31
It’s unfortunate that it’s not a higher priority, especially in the near term, to come up with that technology roadmap, post-acquisition. There might be an earnout component or some sort of deferred component to the purchase price, which means the target is going to be focused on achieving that earnout versus coming up with what’s the best technology solution and working to integrate technology as fast as possible, rather than to be focused on you achieving some revenue or EBITA target.
This whole thing gets punted down the road, unfortunately. Maybe it’s something to think about. When buyers are structuring deals, if the earnout is too difficult or too lengthy, you might get distracted from potentially other areas where you can save costs.
Chris Gale 12:25
Ryan, can you give us a little more detail about FirmView as a whole?
Ryan Burger 13:06
FirmView has multiple offerings. The first is the carried interest and co-investment compensation component. The second is performance management, which is a GP and LP portal. We provide a tool for fund managers to track all their employee and partner allocations and vesting schedules and produce employee statements and other management reporting. Clients are also using it for carried interest forecasts, unrealized carried interest, which is the result of the waterfall, as well as generating distributions right out of the system. Some of our clients are also adding full compensation salary benefits bonuses into the platform, as well as the co-investments where employees are also investing their capital. So they have this full internal application to track anything related to compensation and incentive plans. Contacts and investors can pull down documents with these dashboarding capabilities.
The second offering is what we refer to as performance management. This is an interactive dashboard and analytics platform where we ingest data from fund admins or from fund accounting systems to provide easy access to investor and investment data. We also integrate with other sources as well have some lightweight portfolio monitoring capabilities and Excel scraping solutions as part of that.
Chris Gale 14:57
There’s a bit of a talent crunch right now. You’re trying to hold on to folks, but there’s a certain amount of churn that you’re going to have. So what guidance, in terms of carry and compensation, and with FirmView, is there?
Ryan Burger 15:49
There are two ways that that at least the Carry Management Module addresses that particular question. The first is by making things easier for the CFO or the head of finance to manage all this data. There are improved controls and efficiencies and better analytics for them to provide to senior management. It makes their day-to-day processes easier. The second component provides a better client experience to the employees and the partners by offering data on all their compensation, all their carried interest, and how much is their carry award worth right now and could be in the future. Providing that transparency lets employees see what things are worth today, what their carried interest awards can be worth down the road, and providing that in a nice statement format or even through online access through an employee portal.
We’ve heard from a lot of clients that they want to get ahead of any attrition by providing a better experience to their employees. Some also have said that they feel that employees have made poor decisions because they weren’t fully educated on what their carried interest and other incentive plans meant to them. They left the firm without all of those details. They left for compensation reasons, even though their overall awards could have been much greater than they expected. The firms have come to us and said, what’s the educational aspect? Because we want to make sure that employees understand these rewards fully before they decide for compensation reasons.
Chris Gale 17:41
Jeff, you mentioned sponsors, and how that role may or may not change in acquisition and consolidation. Are there particular takeaways about what to look for in the next six months?
Jeff Solomon 18:08
From a macro level, the alternative space is still very attractive. It’s massive. It’s growing by double-digits on the top line. That’s only going to continue, especially with the market volatility right now, in public equities and fixed income. The days of doing 60/40 allocations hoping for the best when you retire – I don’t know if that’s going to continue forever. People are seeking alternative places to put their money. Inflation being where it is right now further exacerbates that. From a macro demand perspective on the alt space, I think that’s still intact. Clearly, rising interest rates and high inflation create the potential for unemployment to rise. All those are negative headwinds in the market. We’re going to have to wait and see sort of how this whole thing plays out. That hurts standalone sponsors further on, unfortunately, because it raises their cost of borrowing. And they can’t add synergy. A lot of these deals might have a separate portfolio company. Or maybe there are cross-referrals with that sort of thing.
What’s going to continue is strategic M&A: companies that clearly can be acquired by larger companies will be acquired where there can be some level of back office savings, consolidation on essentially the tech side, but then more importantly, the revenue side, if there are other opportunities for revenue synergies. I think that will continue to be intact in the fund admin space.
Valuations will come down a bit just because they’re coming from such frothy levels. Clearly, the unicorns out there will continue to get very, very high premium valuations. But I think a lot of the smaller startups, the Series A and Series B, you’re probably going to start seeing a little bit of compression on those multiples. That’s just largely because they’re going to be fewer VC funds out there that are going to be willing to put that type of money into that type of value. There are just not proven yet. That’s probably temporary as the market goes into recession and recovers. We’ll see where we are in a couple of years. That’s my general take on things at this time.
Chris Gale 20:47
Are there any predictions or things you’re looking out for that we can return to at a future point? Are there any signals or things in the future that you’ve got your eye on?
Jeff Solomon 21:07
There are a number of pretty large fund admins right now. They’re pretty far into their cycle being held by private equity funds. I think that you’re going to see those probably come out into the market, maybe next year, but again, this depends on if there is a recession. There could be some level of pullback there and then maybe pent-up demand in the back half of 2023. We’ll see. There are a number of those admins that are looking to probably recap here in the near future. At least from the finance admin side, that’s something to look for.
Chris Gale 21:47
Great. We have reached the Q&A part of the conversation. I have two questions from the audience. Question one is on the fundraising side. Are there particular things in a recession that potential investors are looking for in fintech?
Jeff Solomon 22:20
The biggest thing is having that recurring revenue stream. A lot of these tech companies have areas where they can generate revenue. But they need to have those licensees, that contractual recurring revenue, year after year after year. They need that big market that supports that. It’s not just, simply, “Hey, we’re playing in a $50 million market.” I think the VCs that we talk to always want to find market sizes that are in the multiple billions, not millions. And they’re always looking at just that recurring contractual license fee revenue.
Chris Gale 23:12
Which fund administrators may come out on top in terms of acquisition and gobbling up the small ones?
Jeff Solomon 23:36
You have some very well-seasoned acquirers out there. Everyone can look them up based on the transactions that have been out there. Obviously, Apex continues to buy up lots of stuff. They recently acquired Maitland fund services in May. Waystone has really stepped up recently. They acquired Centaur. There are a lot of these guys out there. They just continue to find more and more places to put their money. If you’re trying to predict the next one, look for the fund admins that may have recently recapped or taken money from a new sponsor. In most of those cases, that new sponsor will want to put money to work in the form of M&A. Keep that in mind.
Chris Gale 24:28
Okay. That is it. That’s the end of our questions. Thank you very much, Jeff. Thank you very much, Ryan. Stay tuned for the next episode. Thank you.