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The tech requirements of private equity funds
Opinion: IT can help it become less arcane...

By Bob McDowall

Published: Monday 20 August 2007

Private equity has had a high, if mixed profile but its technology requirements are seldom discussed and reviewed. Towergroup's Bob McDowall addresses some of them.

Private equity funds continually refine their investment strategy, in order to develop better techniques to manage deal-flow in the interest of their investors and fund managers. There has not been an investment in information technology and infrastructure. The key areas of focus are exploitation of intellectual and human capital. As organisations, these funds tend to be run by a few people and have not required substantial amounts of technology. The focus is on business and people. This is changing.

Cheat Sheets

♦ Basel II
♦ MiFID
♦ Sarbanes-Oxley

There is now more analysis of how and where technology improves the efficient operation and risk management of the funds. Perhaps more important is the response to regulatory pressures through an examination by private equity funds of where technology may help them counter the criticism levied against them from a financial regulatory perspective.

The development of an internal technology strategy depends on the size and scale of the investment portfolio. By way of graphic example, excel is limited to managing a very small fund with few investments or limited number of partners. Excel can be used to supplement an accounting system but accounting functions within funds require capabilities to perform other tasks such as tracking each fund's investment performance and allocations of costs, revenues and capital to partners and partner organisations within each fund.

Private equity funds have many similarities in their demands for technology tools and financial data with venture capital firms, which fund enterprises at an earlier stage in their growth and development. They have common data management and screening requirements. The requirements to manage increased volumes of quantitative and qualitative information grow in line with the numbers and size of their portfolios.

All private equity firms require access to databases containing key and current information about investors, prospective investments and acquisition targets. Deal opportunities with deals-in-progress have to be tracked by and across time zones and by geographical regions. The results enable the funds to measure the productivity of their pipelines. Databases have to provide up-to-date information for managing and tracking investment performance.

Funds are seeking technology applications from vendors to improve communication and collaboration, track investment and revenue performance targets, monitor portfolios and manage deal pipelines. In effect there is a requirement to track fund performance and activity from the fund-raising stage to exit strategies and final exit.

Virtual data room technology (VDR) is an area of technology application that has proved an extremely cost efficient, secure application for private equity. Historically, all physical documents associated with a private equity deal or acquisitions were placed in a conference room at law firms for viewing at set times by the teams of dealmakers. No document could be taken out of the room. VDR technology incorporates financial and legal data, which is made available for evaluation, not for printing, guarding that access.

The technology of the virtual data room (VDR) allows dealmakers an initial viewing. They let the seller give multiple buying teams the same document at the same time. The whole presentation can, therefore, be very structured and transparent. VDRs are a place to collaborate and share information, They enable a number of Private Equity firms to work together to structure deals but do require a common platform to work with lawyers, to share documents leading up to the arrangement of the deal.

Private equity funds are under increasing political pressure to be more transparent in their conduct. To address this criticism, the British Private Equity and Venture Capital Association (BVCA) has proposed a voluntary code to make their businesses more transparent. Among their major proposals are publication of yearly accounts, better collection and analysis of data, more detailed disclosure of leverage covenants and debt repayment schedules, communication to wider stakeholders and staff and publication of details of investors by geography and type.

Highly granular reporting and analysis of the entire history of capital-raising efforts for the fund and how amounts are allocated will address many of these issues. Access to databases to enable investors and other permitted stakeholders to check the performance of investment portfolios - possibly over a web interface on a continuous basis with a password - would address criticisms of access and availability of information.

Read more about how MiFID is shaking up the financial industry

♦  Cheat Sheet: MiFID
♦  MiFID: The unanswered questions
♦  FSA upgrades tech to improve MiFID monitoring
♦  MiFID compliance - regulators in the spotlight
♦  Barclays Capital prepares as MiFID looms
♦  Banks gang up for MiFID reporting

A continual form of market pricing is critical to the management of market risks. This arises out of the growth of private equity funds and the demands of the underlying investors for a continual price. Some form of continual "market pricing", such as a means to offer for sale from time-to-time equity stakes in the investments made by the fund through an exchange would be a significant step to satisfying the demand for continual pricing. Continual pricing could start with a simple bulletin board and move upwards in scale and sophistication according to the demands for market exchange services and facilities.

They provide the optimal mechanism for price discovery, combined with the ability to price the elements of the portfolio on a continual fair market price basis. Some initiatives to establish a market in private equity underlying investments are underway in the UK from the London Stock Exchange via their proposed Alternative Investment Exchange and a new regional exchange in the UK's West Midlands. Exchanges would provide liquidity to the private equity market at least at the smaller scale or lower end of the market. Exchanges would enable private equity mangers to run their portfolio on much more conventional investment lines, if they wished.

Private Equity is being pressured to shed more daylight on its investment processes and performance to provide greater transparency. This will be a catalyst for more focused technology strategies. Technology tools and data applications will enable the funds to demonstrate the transparency, which politicians, financial regulators and prospective main-stream investors demand.

Bob McDowall is a senior analyst at financial services research specialist Tower Group