Three strategies to help private equity overcome efficiency bottleneck
Private equity is an increasingly vibrant industry. In particular, the US private equity sector has been growing dramatically over the past decade, with over 7,000 private equity firms, compared with some 3,800 in Europe and over 700 in Asia. As at the start of 2020, there were 3,524 private equity funds in the market. Private Equity, hedge funds and investment vehicles in the US market are expected to grow 7.4% to US$247.7 billion in 2022.
However, there is one general issue in the industry. When a private equity company grows in scale and its operations become more complicated, its operation efficiency and economic efficiency tend to decrease, and its revenue in relation to its scale and even absolute revenue may drop, so that the marginal revenue becomes negative.
The problem often has to do with the fact that when a private equity firm grows, it will have more entities to manage, thus leading to greater operational complexity. Besides, private equity companies have to deal with an enormous amount of clients and products, and big private equity funds have to handle different asset classes from around the world, making the firms’ operations all the more challenging.
While institutional investors are now facing ever stricter regulations, a more volatile market, higher operating costs, and more proactive fund investors, many fund companies lack a cross-departmental platform in back-end offices, so that fund managers do not get to acquire high-quality information timely to be able to make effective decisions. In the long run, the issue may undermine the company’s profitability and sustainability.
When a private equity institution fails to attach enough importance to digitalization in middle offices and back-end departments, asset managers will be distracted and may overlook certain tasks so that their work efficiency and the company’s profitability will be greatly reduced, and the increasingly stringent requirements of LPs cannot be met.
In view of the problem, Linnovate Partners proposes three strategies.
1. Digitalization to optimize different processes
Digital transactions, for example, can enhance economic efficiency of a private equity firm’s middle offices and back-end departments as expected, thus promoting profit growth of GPs. Digitalization also helps raise efficiency of existing processes, and eliminate inefficient or redundant business segments that add no value to the company. As a result, all company processes can serve customers effectively and achieve value-added results.
2. Subcontracting tasks of middle offices and back-end departments
Companies with sufficient resources can contemplate subcontracting tasks of their middle offices and back-end departments including financial matters and IT work, to fund service providers. This way, their top executives and professional team members can focus on doing what they are best at.
Meanwhile, because of market fragmentation, companies that provide services to private equity firms are increasingly competent.
3. Analyze data and embrace innovation
It is important to analyze data and investor relations of departments specializing in private equity business, and embrace management innovation of middle offices and back-end departments. Advanced analytics are a must-have for GPs today, since they can help speed up and improve the quality of decision-making processes of middleoffices and back-end departments and increase ROI.