Chris Gale 00:02
Thanks for joining us. This is episode seven of the Private Capital Talent series. We have Michael Stellwagen of PKF O’Connor Davies and Ryan Burger of PFA Solutions. We’re here to talk about arming emerging managers for private capital 2.0. For those of you with us today, on the bottom right you should see the opportunity to ask questions. At the end, we’re going to tackle some of those. We’d love your feedback afterward about this and other past webcasts. Stay tuned for more, like Bill Trace coming up on May 14.
Let’s get started. Mike, tell us about you and PKF.
Michael Stellwagen 00:57
I’m a partner in the financial service advisory practice of PKF O’Connor Davies, where I lead our emerging manager practice. I started at PricewaterhouseCoopers when it was Coopers and Lybrand, part of the Big Eight. Then I spent 25 years as a chief financial officer for several emerging managers in both private equity and the hedge fund space.
At PwC I had several financial management clients — back in the days of trading floors, when there could be some yelling and screaming, paper being thrown around. The movie Wall Street was just coming out. I was fortunate to be hired by Larry Fink, the emerging manager launching BlackRock. That was my first building block. I went on to help several other emerging managers — David Stockman, Richard Breeden, Doug Bronson, and Jim Parsons — launch their funds from basically sheets of paper to multibillion-dollar organizations.
I think we all have different reflection points in our careers. About a year ago, I looked at what I’ve done throughout my career. If I were going to do something else, what would that actually be? What would that look like? I thought about hanging up my shingle and doing a consulting firm to use the skills that I’ve acquired in a different capacity. Some of my former colleagues and I talked about starting a firm together. Then I happened to be approached by PKF O’Connor Davies with the opportunity to help them further build out their financial services advisory practice. I’ve been here a bit under a year at this point and could not be happier with that decision. It’s been an exciting time.
Chris Gale 04:27
With that range of experience, what are emerging managers seeing now that’s different?
Michael Stellwagen 05:03
A lot has changed. Look at the explosion of new tech and business ventures when the cloud and AWS brought down the cost of business infrastructure like servers, and automation enabled us to speed up a lot of processes being done manually. It helped improve those industries. That wave is happening within private capital now, accelerating over the last couple of years. We all know the fundraising environment is quite challenging at the current time, but the tools available – funded counting, carry, and compensation analytics – are within reach now for emerging managers. I wish the tools we have at our disposal were around when I was going through the ranks.
When I first joined BlackRock, I had to build out the financial and operational infrastructure of the firm. I had two offices and PCs. We did consolidated financial statements: I literally took a floppy disk and had to go to each computer to do the consolidations and all of that – a very taxing process and prone to errors. Fast forward a bit to when I ran Breeden Partners: we had in-house server racks and had to make backups. I remember every week changing the tapes, bringing them into our vault, and exchanging them. I forget which hurricane it was – one of the big ones – but our office in Greenwich, Connecticut got hit bad. We had water damage, the servers got fried. We were offline for over a week. Our traders had to trade manually, they kept the trade records in notebooks. That was a very difficult period of time. With the evolution to where we are, with the cloud and technology, you don’t have those same worries or needs. It has been an unbelievable transformation.
Chris Gale 08:34
So you’re saying that Larry Fink might have started in an earlier cycle of private capital’s maturation to where it is today, but the emerging managers you’re working with have more tools to distinguish themselves in a saturated market?
Michael Stellwagen 08:58
Yeah, absolutely. Look at all the tools at the disposal of clients I’m working for. With outsourcing and software, they really can focus on the front office and trading. They don’t have to worry about physical space or having servers in-house and can be more effective managers. They have dashboards and KPI metrics at their fingertips, as opposed to traders running down to my desk to ask, “Where are we in this position, where is our exposure?” With the evolution of technology, traders or front-office executives can have a dashboard. I’ve built these out so that they have real-time KPIs and can make the decisions that they need to make in real-time. It’s great for firms like ours to advise and help our clients and put those systems and analytics in place.
Chris Gale 10:11
A further question is on AWS software as a service: there are things seemingly as mundane as, “Should we be on teams or Google workspace?” But private capital is highly complex, highly nuanced, highly sensitive. There are things in the market that are professional services with tech capability, and then there’s software. As much as tech investing has become a major theme in private equity, sometimes you need some help to understand it, implement it, or manage it. Can you tell me more about those sorts of questions?
Michael Stellwagen 11:01
I think for firms like Ryan’s, there are a lot of products out there that can do everything I need to do, but the implementation can be problematic – there could be a lot involved with configuring it. Sometimes trying to get somebody on the phone can be problematic. But when you engage directly with a consultant, we can advise and implement a plan that will meet your needs, because to your point, everything needs to go smoothly to get those KPIs and metrics, but you need a team that can help you implement all that infrastructure and get it up to speed.
Chris Gale 12:02
I’m a big believer in that. Ryan, let me pivot to you. There are various types of service providers helping private fund managers with carried interest, which is something PFA is especially focused on with co-investment compensation platforms. Can you describe the various models?
Ryan Burger 12:36
I will say that I am old enough to know what floppy disks are, but not old enough to enter this industry when Larry Fink was only $100 million at BlackRock. Interesting experiences from Michael. A lot is going on in the carried interest and compensation co-investment side, where private capital firms are starting to dip their toes into using service providers for the management of carried interest, co-investments, and other compensation.
There are three models we’ve started to see evolve. The first is using a fund admin to do front-to-back processing and reporting compensation carried interest co-investments. The second is the software model. That’s where we come in. We have a product called FirmView, where firms license the tool to manage all their carried interest allocations, vesting schedules, compensation arrangements – the full gamut of reporting for the carried interest compensation function. The third option is a hybrid, where firms are using software products like FirmView, and then service providers like PKF O’Connor Davies or other companies to do all the day-to-day processing – the heavy lifting from a labor perspective. We’re excited to see how the private capital market has evolved. Certainly, product service providers weren’t doing this 15 years ago when I started working in the space.
Chris Gale 14:16
What are some of the benefits and challenges if you look at those three?
Ryan Burger 14:27
On the servicing side, the pros are you can outsource your processes. When I was doing management consulting in a prior life, whenever we’d meet with CFOs, a big topic of conversation was, “How much can we outsource and who can we outsource to?” We would map out all the functional areas out of a private capital firm and then tag which areas were right to outsource. I’m sure Michael has his views on how things have evolved over time, but we would go through the list and say, “You can outsource this, you can outsource that.” With the carried interest and compensation area, it’s a great area to outsource. However, it comes with a lot of challenges. There are nuances and complexities, it’s your most sensitive data. So that’s where the challenges come in with that particular model.
Chris Gale 15:20
If carried interest feels politically sensitive inside an organization – there’s a lot of angst and maybe enthusiasm wrapped up in it – what have you seen in terms of who owns the data?
Ryan Burger 15:42
Right now, in a lot of our firms, it’s usually the CFO or controller – they take responsibility. Sometimes the founders, the CEOs, are the ones managing this data. From a service provider perspective, they are sometimes unwilling to relinquish full control of it, but sometimes they are. We’ve seen both models across the board. We might be biased in that the firms coming to us want to use a system or software vendor, but then still have ownership management of the data and the reporting out to their employees. That’s the conundrum we see with our clients. They want to outsource as much as possible, but in this particular function, there’s sometimes some trickiness. We do have a couple of clients outsourcing to a third-party admin to do all the day-to-day activities.
Chris Gale 16:37
Would that be a hybrid model? It seems like it’s the perfect option in that case.
Ryan Burger 16:45
The hybrid model, that’s a great model. A handful of our clients are licensing our software. Then they’re hiring third-party admins to do all the day-to-day activities associated with managing the allocations if a new joiner comes in, processing that in the system, and then working with us on building out the reports. I would say if I were a private capital firm, and I was selecting a provider, to make sure to do the due diligence and find a provider that can handle the nuances, the complexities – that they know the business because of the bespoke nature of how creative private capital firms get when it comes to the compensation and various incentive plans. But that model works great if the CFO can find a third-party solution or service provider to be an extension of the team, and then separately license the software product.
Chris Gale 17:46
Speaking of sophistication, nuance, and understanding the importance of the data, Mike, as a former CFO helping CFOs help emerging managers, I’m sure in some ways you’re counseling your former self. What are you saying to them, given what Ryan is saying about the hybrid model? How would you counsel them on decision-making?
Michael Stellwagen 18:14
The best example is first-time fund managers that have worked at funds where they know there were people to do all of these things, and not have direct experience on what exactly they need, what are the right models, or what should they be outsourcing. Out of the gates they try to outsource as much as you can. They might not have the cost to bring the funds rather than bring somebody on, but I think it starts for the traditional emerging managers as almost a full outsource and then it does go into a hybrid model.
On Ryan’s point, and also at PKF O’Connor Davies, we’re pretty unique as an accounting and consulting firm. We have a fun administration practice. One of the two areas we’ve been asked recently to assist with is traditional fund accounting. But we’ve had a fair number of clients ask us to do the GP reporting, taking capital account statements for the GPs, and doing all different types of financial analytics. I had a very in-depth conversation a few weeks ago with a client about what Ryan was talking about – helping them build out the vesting model on all the carried interest allocations. This one is a little bit complex as they have multiple funds. They’ve had employees that have left, they have employees that are only in specific deals. From a CFO’s perspective, that area can be very complex, and difficult to even manage in the spreadsheets. Typically, as we all know, the managing partner is coming down to your office asking you, or telling you rather, “I need this data in two minutes.” What Ryan is doing, and having a software product to be able to have those analytics internally and produce kind of that metric on the fly, is terrific. The other ability is you can tailor it to whomever you want in the organization.
It’s a good point, Chris, about who has access to all this information. Typically the carried interest information is quite sensitive, so only certain individuals have that. But again, it’s a great tool to have real-time data for compensation discussions for promotions for incentivizing current employees, and bringing on new employees as well. It’s an area where we’re seeing a lot of interest and a lot of questions.
Chris Gale 21:13
Before the webcast, you mentioned something about CFOs and strategy. When I think of emerging managers, real entrepreneurs, they’re starting their businesses because they see a gap in the marketplace, and maybe others don’t see it. Are there any examples, even if they’re anonymous, of how emerging managers are better able to do something different, and find support in terms of fundraising, given the technologies and sort of services you’re describing?
Michael Stellwagen 22:03
Having done this for so long, our role traditionally as a CFO was a debits and credits person, tasked with preparing financial statements in financial matters of the firm. The evolution of a CFO now is completely broad. It’s embedded, it incorporates some aspects of the Chief Operating Officer in many firms. What we’ve all been talking about through this webcast are the tools that provide the ability for CFOs and CEOs to become what they should be as the strategic advisors of the firm. Having an outsourcing model, or all the things that we’ve been touching upon, just allows those professionals to act in that capacity. Look, there are a lot of headwinds now with what’s going on in the markets – impossible, recessionary times. The CFO’s role really should be more geared toward the strategic aspect of running a business, as opposed to the nuts and bolts of debits and credits and “Is my computer infrastructure running correctly?” It’s just a unique time. Being through the evolution of doing all those things earlier on in my career, and now actually being in a role where CFOs can be more strategic, it’s been terrific.
Ryan Burger 23:50
To back up Michael’s point, there have been some surveys that ask, “What are your top priorities as CFO?” Recently, it’s been investment analytics, technology, CRM, industrial relations, and support – all of those areas have been at the top. Core financial activities have been at the bottom.
Chris Gale 24:23
Agree. But I do have a question: What about talent gaps on the LP side? You’re talking about the GP side and challenges with fundraising. But there have been news reports saying that LPs are experiencing problems with talent capacity that make it more difficult for them to look at more emerging managers.
Ryan Burger 25:02
I know that from a talent perspective, our firms are all trying to do things to make sure that their employees are happy and have a work-life balance, with the data they’re getting from our system. From an LP perspective, especially in the US, it’s even more challenging to find investment professional talent, because the pay is different – especially on the public pension side, where some of them operate as quasi-government agencies and can’t compete with private equity venture capital firms. Having spent time working with US public pension funds, there’s always been that issue: where can you have a large public pension, compete and pay the same as a fund or private equity fund? They haven’t historically in the US, and I think in Canada and other countries they have, but that’s just something I observed from working with a lot of pension firms and private equity and venture capital companies.
Michael Stellwagen 26:11
I think you’re spot on. Throughout my career, I’ve worked with CalPERS, CalSTRS – many of the large pension plans – and you’re certainly right. Given the government aspect of those institutions, they can’t pay top talent a Wall Street-comparable salary. What you’ve seen are more investments and certain direct investments in private equity and hedge funds. It has changed slightly. I think it’s CalPERS – I might be wrong – that instituted a different type of pay metric for some of their managers. They’re starting to see more allocation of direct investments. I know the funds that I worked at co-investment were always big, but you’ve seen reductions at some of these larger pension funds on allocating to PE and hedge funds, as they’re looking to do more in-house. How they’ve been able to do that is twofold: one, the point Ryan’s talking about, is different compensation metrics to get to your talent. But the pension plans have benefited from the evolution of technology and software, so they have more tools at their disposal than they did 10 years ago. Then the ability to attract higher tier talent means they can do direct, as opposed to going out to managers.
Chris Gale 27:49
Got a second question here. With the news and a follow-up from FTX, do you see a more difficult environment for either emerging managers or new investing themes?
Michael Stellwagen 28:07
It’s a hot topic. What I think you’re going to see from this, and there’s a proposal out with the SEC, is taking a harder look at outsourcing. I’ve always done diligence on all of our third-party providers. In some instances, I think there was a blind eye to a lot that was going on at FTX. It was a lot of hype, and people wanted to be part of it. What you’re going to see now is a further process of doing diligence on your third-party providers, and making sure that they’re doing what they’re saying. You as a manager are checking the boxes that you’ve done that proper diligence and don’t get caught up in the hype. I think FTX really will open the eyes of a lot of individuals in terms of taking a much harder look at doing diligence. If the proposal with the SEC comes about, that’ll certainly add emphasis to doing more.
Chris Gale 29:17
I’d like to thank both of you. Thank you, Michael, for joining us. Thanks, everybody, for joining us. We’ll have a recording of this that we can share with you. For those that had additional questions, we’ll take those in and maybe Mike or Ryan can respond directly. There might be some things happening from an event perspective that we can be in touch about. So thank you very much, everybody. Really appreciate it. See you next week.