Article published in The Drawdown and written by Jon Whiteaker.
US-based fund administrator Petra Funds is becoming a specialist in an alternative solution for back office management, which while still rare in Europe could become more attractive to GPs seeking to cut costs while retaining institutional knowledge.
Speaking recently to The Drawdown, Stephen Coats and Paul Winters, managing partners at Petra, said they had recently completed ‘lift- outs’ of a team of 15 back office staff from one GP and a separate deal for a team of three.
Lift-outs involve a fund administrator hiring back office staff directly from a GP at the same time as taking on that firm as a client. The GPs former in-house team is now its dedicated resource working within its outsourced fund administrator.
A GP is able to lose the headcount cost while retaining the team, with the work they are doing now chargeable to the fund rather than paid for from the management fee. “Lift- outs can allow the GP to spend relatively more of the management fee on investment staff, which should be far more accretive for the GP and LPs than maintaining a small accounting firm within the GP,” says Winters.
For Petra, the strategy isa very effective way of scaling its business through the addition of experienced professionals.
“You don’t need 25-50 people on your back office team doing everything, you just need a solid core of high-value professionals and we can take the rest of the team,” says Coats. “You get the co-sourcing model along with individuals who have institutional knowledge about your firm.”
Coats is one of the founders of Petra, which itself was formed through the lift-out of a team from Riverstone Holdings in 2021. Notable lift-outs completed by Petra since then include Denham Capital in 2022, where Winters had been partner, general counsel and chief commercial officer.
While other large fund administrators, such as GenII, have also completed a number of lift- outs, Petra is notable for its significant appetite for acquiring back office teams. Coats and Winters claim they could complete three to four lift-outs of “comfortable size” each year.
“The Petra deal itself is interesting because what it has done has highlighted to asset managers that they can create value from their back offices and access the benefits of outsourcing,” says Martin Schnaier, CEO of recently launched fund administrator Palmer. “It creates a double financial benefit for the manager in that the fund is bearing those costs now and it has realised deal value from that back office team.”
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Though Petra has a team in London, led by former Riverstone European general counsel and head of ESG Charlie Chipchase, it is yet to complete a lift-out in Europe. There are significant differences from the US market that make lift-outs far rarer this side of the Atlantic.
One major difference is market penetration of fund administrators. While nearly all GPs in Europe have some relationship with a fund admin due to regulatory requirements, Coats estimates that is true for only about 40% of US firms.
“The service in the US is not a regulated service with an independence or oversight role,” says James Ireland, CFO of Palmer. “What they are largely doing is just outsourced accounting services.”
Fund admin relationships tend to be sticky and complicated to detach from, particularly in Europe where they are underpinned by a spider's web of jurisdictions and substance rule requirements. This makes moving servicing providers, let alone completing a lift-out, far trickier.
Schnaier says that he definitely sees these deals becoming more common in Europe, however, while fundraising remains difficult and firms look for ways to trim costs.
“We have already seen large asset managers shedding roles, even without outsourcing,” Schnaier says. “There is that pressure, without doubt.”
Jan Grüter, a partner in Addleshaw Goddard’s private funds group, also sees opportunities for more of these deals in Europe, and argues that economies of scale should mean it is ultimately cheaper to provide these services through the administrator than in-house.
“It’s not necessarily a one-for-one lift-out of the expense from the firm to the fund, as actually it is spread out across several other funds,” says Grüter.
To make these deals work, both the employees being lifted out and the LPs being charged have to be happy about the arrangement.
Despite only recently launching, Palmer has “already been approached by a number of people talking about these kinds of opportunities,” according to Schnaier.
Schnaier, Ireland and fellow Palmer founders James Bermingham, Jason Bingham and Phil Godley were all previously executives of Sanne, which completed lift-outs of its own before it was acquired by Apex Group in 2022.
A lift-out can be very painful to untangle and Schnaier warns: “You have to be very sure, when you take that step, that you have picked the right partners. There has to be cultural alignment.”
If a main part of the appeal of a lift-out is retaining institutional knowledge, the admin has to work hard to keep those individuals happy. The culture of working for a fund manager versus a large corporate administrator can be very different and Coats acknowledges that for the individuals being lifted out, it has to feel like a step up rather than step back in their career.
“Our base model is that the benefits and compensation offered by Petra have to be the same or better than the private equity firm they came from,” Coats says. “Our measure of success is that the quality of work is better, the employees are happier and we don’t lose any of the team.”
Keeping LPs happier may be trickier though. Grüter describes lift-outs as “a neat way of passing on the cost”, but adds: “I think LPs will start scrutinising that a bit more, as they are very focused on fund expenses right now.”
Grüter advises both GPs and LPs, and notes that the former are looking at various ways of passing costs onto the latter. This includes allocating some personnel costs, including legal and compliance, as a fund expense. He cautions however that a lot of LPs don’t like that and could also question the value of lift-outs.
“LPs want to know that you have the internal staff to know what is actually going on in the fund and not become completely reliant on a single administrator, losing the oversight and ability to take that back if needed,” Grüter says.
For Petra Funds’ Winters though, lift-outs are a consequence of the maturity of the market, with GPs assessing internal structures and needing to find efficiencies to address the frictions that have built up in the back office during the last decade or so.
“In five years’ time, it maybe a lonely spot in any jurisdiction to be the CEO of a PE firm that has a fully insourced accounting team,” says Winters.“Whether firms get there through traditional outsourcing, co-sourcing or lift-outs, I think the rates of adoption will be pretty comparable in both the US and Europe, because the writing is on the wall that the model is changing.”
