Virtual reporting: Lost in translation

The key difference between COVID-19 and other macroeconomic downturns is that concurrent with its knock-on financial, operational, and psychological effects, investors have been pinned to their desks more than ever before. As a result, stakeholders are not only dealing with a spike in things to keep track of – they're obliged to keep track of them in new ways.

The no-travel factor as a disruptor of due diligence and fundraising was understood early in the pandemic, and in some ways, the shock-to-acceptance pattern has run its course in market behavior.

Interest in technology companies known to be benefiting from the new normal has never been higher. Meanwhile, fundraising has generally contracted but is seen to be rebounding confidently, at least in anecdotal terms. For example, more than half of LPs continue to establish new GP relationships at the same rate as before the pandemic, according to a recent survey by Coller Capital. Every industry professional AVCJ contacted for this story concurred with this narrative.

In terms of GP-LP reporting for existing investments, the emergence of an all-virtual industry has had a subtler and more lingering impact. In the early days of the pandemic, a rapid increase in remote communications between GPs and LPs reflected the anxieties of a suddenly locked down world. But this practice has not tapered off with a more stable macro picture.

To some extent, the persistence of higher frequency portfolio updates via video can be attributed to genuine efficiency benefits, as well as being part of a long-unfolding trend involving greater demand for reporting disclosure and stricter environmental, social, and governance (ESG) compliance norms. However, it also hints at continuing discomfort with the whole process of assessing companies and ruminating on those findings entirely in cyberspace.

"Contractually, GPs are typically entitled to receive information like monthly sales figures, so LPs assume that – at least theoretically – the numbers are right. But there are softer elements to portfolio monitoring too," says Thomas Swain, a director with Credit Suisse's private funds group.

"Scrutinizing the data is easier if you have the ability to meet people, check up on growth drivers, and understand what is actually happening on the ground. I've had a lot of conversations with people on really understanding the impact of lockdowns – and it's not always intuitive where companies are impacted across areas like suppliers, employees, and sales."

Increased engagement

Formal changes in this aspect of the industry's digitalization happen slowly. GPs and LPs will not tweak a reporting template in the middle of a fund life. Vehicles launched during the pandemic have started to reflect new reporting standards through side letters requiring additional datapoints or context – but a shift in industry-wide protocol will not be detectable on a quarter-by-quarter basis.

The more visible effects are behavioral, especially in the form of GPs holding quarterly or semi-annual webinars for investors in addition to their usual reporting packages. Interactions in this vein do not include material information that is not in the formal quarterly, as it would be unfair to share such data unevenly among LPs. They are mostly a tool for providing comfort around fund-level transparency and portfolio-level engagement.

By most accounts, LPs have welcomed video portfolio updates as timely and smartly presented, although still sub-optimal in terms of the reliability of remotely compiled data. There is also unease about the slickness and scripted nature of the productions since non-partners and portfolio CEOs are rarely involved.

Michael Li, a managing director at private equity software provider and fund administrator SS&C, is tracking some behavioral signals of disquiet in this environmental. For example, his firm is helping GPs meet LP demands for more immediate quarterly reporting; the usual 45 to 60-day window after the end of a three-month period has in some cases been compressed to 30 days.

"No longer are investors just looking for your run-of-the-mill reporting of what's happening in the past quarter. They're asking very pointed questions about how portfolio companies are dealing with the pandemic. They're not micromanaging – they just need to understand the manager's view on companies and feel that the managers are engaged," Li says.

"There's more qualitative analysis of portfolio companies now. Rather than just saying, ‘Here's the revenue, expenses, and margins to date,' the qualitative part has been beefing up over the past 18-20 months."

Size matters

LP satisfaction with virtual qualitative reporting is directly related to the size and professionalism of the fund manager, although there is scope for this correlation to loosen. For now, global and larger pan-Asian GPs are seen as running highly competent and comprehensive video programs. They have teams on the ground in all of their invested jurisdictions, so there is less uncertainty about company-level assessments.

Fundamentally, big deals involving brand-name GPs are more easily understood in terms of raw data such as sales figures. At the smaller end of the private equity and venture spectrum, intangibles such as team chemistry, morale, personality, and culture loom larger, as do concerns around in-house bookkeeping. It remains to be seen if buyout investors' increasing exposure to minority tech deals will therefore translate into a weaker reputation for credible virtual reporting.

"With the use of various technology solutions such as Zoom and Microsoft Teams, it is now easier than ever to have constant communications with portfolio companies and be appraised of the current situation and outlook from management," says Kenneth Leong, COO and CFO at Axiom Asia, a fund-of-funds that backs regional middle-market and venture GPs, while also making direct technology investments.

"While this may not fully replace physical interactions, virtual video conferences have certainly cut down a lot of time spent on the road and allow more parties to get on a single call to run through details. One advantage of virtual sessions is that previously lengthy physical meetings can now be split into multiple but shorter calls focusing on specific areas, allowing for more thoughtful and in-depth discussions."

Concerns to the contrary are most acute regarding first-time managers with small teams, developing market players, and those writing the smallest checks. As a result, development finance institutions such as Netherlands-based FMO are among the most sensitive to the limitations of virtual GP-LP relations and remote operational monitoring.

Jorrit Dingemans, a manager focused on private equity at FMO, notes that it's almost impossible for his firm to get a view on the real performance of companies in funds. The COVID-19 impact can be positive or negative – usually depending on the level of online exposure – but this is easily misrepresented or exaggerated, even by candid, well-intentioned GPs.

"Valuations might be stable or increase because they're based on comparables, and all the listed companies have gone up. That creates uncertainty of whether the valuations that are presented are still in line with reality. Sometimes the valuations do not seem to match our perception of what the market is doing in COVID restrictions," Dingemans says.

"Typically, that feeling of uncertainty can be mitigated by visiting, looking people in the eye, talking to entrepreneurs, and seeing companies – but that's not happening. Fund managers have continued to provide quarterly reports, but it's almost impossible to get what you want to know as an investor about the actual impact of COVID out of that kind of reporting."

Bridging the gap

Potential fixes to this problem are imperfect but, in some cases, eminently doable. Perhaps the easiest way to increase LP confidence in a virtual update on a given portfolio company is to include a representative of the company in the call. A more difficult option could be to identify hubs where travel is possible for all parties to meet in person.

As in virtual fundraising, part of the solution will simply be a matter of sticking with trusted people. In some cases, LPs will be engaged by a portfolio GP via video call with new faces on the line. If these are internal hires, the rapport may continue as usual. If they were brought in from outside, it can become harder for the LP to get comfortable.

The challenges around remote fundraising also bleed into virtual reporting in the sense that LPs might want to more closely monitor their first-time managers that are struggling to raise Fund II. This phenomenon has fed an uptick in LP requests for independently validated fund-specific IRR reports, as well as reporting on the basic survival metrics of a GP as a business itself.

"Some of the GPs that we're backing in emerging markets are not able to raise a follow-up fund because of the difficulties of virtual fundraising, which brings us into a situation where we want to know more about the sustainability of the GP," Dingemans adds. "So, reporting on GP budgets – which is not usually provided – becomes really important. I think that's going to be a bigger reporting topic as this goes on."

Even when the managers in question are global players with long track records, the softer portfolio reporting inputs that come with physical interactions can be indispensable. This is perhaps especially the case with annual general meetings (AGMs) which are now attempting to condense up to a full day's worth of portfolio presentations into a few attention span-testing hours online, without the deceptively revealing incidental chitchat.

As with the inter-quarterly video updates, LPs have found AGMs to be more satisfying affairs among the largest GPs, which have taken to staging multiple events to suit investors in various time zones. This enhances one of the best natural advantages of the virtual AGM, which is to accommodate an essentially unlimited number of attendees. Still, the experience is better suited to assessing past performance than future potential.

"When we're investing in a company for the next 3-5 years, we spend a fair bit of time on the forward-looking trajectory, and that is more opaque," says Alicia Gregory, head of private equity at Future Fund, an Australian sovereign wealth fund that backs a mix of global and domestic GPs across private equity and venture capital.

"All those characteristics in the way they talk about how aggressive or conservative it is – how strongly do I believe in that forward-looking plan? How do I feel about owning that for the next five years? How does this compare to what I underwrote? You're looking at the numbers to help you form a view, but you can get a lot of cues about how that's going in-person."

Incentive to outsource

Much of this is playing into the hands of back-end service providers, whose various reporting dashboards are seen as improving comfort around communication, if not the reliability of the data available.

Uptake of outsourced accounting and administrative work is more broadly attributed to increasingly strict fund registration rules and compliance requirements in areas such as ESG. But the advent of virtual reporting has accelerated the trend while introducing a greater emphasis on adding color to operating parameters. This includes more feedback on what managers are doing to increase market share, what they're doing from an HR perspective, and how they evaluate industries.

While younger managers engaging third-party support have historically chosen their partners by going with the lowest-cost provider, a migration to more established operators is said to be underway. Growing uncertainty about those managers' reporting is believed to be a key driver of this effect.

"We were working with a manager in Shanghai launching their second fund, and their first priority was to have an online GP-LP portal. In the past 18 months, that has become a must product," says Derek Tsoi, commercial director for fund services at Intertrust.

"We told them we could provide a portal where GPs and LPs can log on to our system to get access to reports and our reviews. Previously, they would have hesitated and said reports by email was okay. But this year, they need that kind of portal."

The shift to more service provider-supported reporting is also underpinned by increasing concerns about cybersecurity, which has implications all its own in an all-virtual reporting process. While formal quarterly reports on portfolio performance have long been transmitted as intercept-able electronic documents, the surrounding discussions and strategic brainstorming sessions have never been so easily recordable and disseminated.

There is reason to believe that risks around breaches of confidentiality will be elevated as the routines of online reporting and informal updates via online channels become more mundane among the professionals involved. But in terms pure data transmissions at least, an increase in paperless GP-LP disclosures needn't spell more pain at the hands of hackers.

"There is more vulnerability, but offsetting that, there is a huge amount more effort on cybersecurity," says Caroline Baker, a managing director at corporate services provider Vistra. "I can tell you, LPs are asking administrators about their cybersecurity policies, which never happened before. It was always very much the GPs that were onboarding service providers – but now it's being asked tenfold more of any service provider of any system that's being used to share reporting."

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• Topics
• GPs
• LPs
• Advisory
• Performance
• Axiom Asia Private Capital
• FMO
• Future Fund
• Investor relations
• covid-19
• Cybersecurity
• Credit Suisse