The trouble with Excel

This article is sponsored by Qashqade and first appeared in the December/January edition of pfm. 

As ubiquitous as Microsoft Excel may be within today’s private equity firms, it doesn’t have many fans. More often than not, the back office relies on the application because it was used before, and the alternatives are expensive, or hard to learn, or both. Although finance staff struggle with the ever-expanding spreadsheets and increasingly complex formulas, it’s still the devil they know. However, it may soon be time for GPs to finally overcome that institutional inertia.

We spoke with the founders of qashqade, a software company that offers an application that automates waterfall and carried interest calculations. The CEO, Oliver Freigang, and the chief product officer, or CPO, Gregor Kreuzer, discuss the market forces that shaped their own offering and what a post-Excel landscape looks like for the private equity industry.

Why do you think private equity firms have used Excel for as long as they have?

Oliver Freigang: For a very long time, there wasn’t a better option. It was what many professionals learned how to use, and they simply kept using it, even as the size and complexity of their funds grew. Excel might be fine to run a small home business or manage personal finances, but it’s not suited for the sophistication of the traditional buyout fund.

Gregor Kreuzer: It was never meant to be an accounting tool. It was supposed to handle very simple calculations and lists. And today, there are plenty of alternatives that exceed Excel, with the greater ease and the same flexibility.

There are plenty of CFOs that will argue that Excel served them well up until now, so why change? What’s the rationale for fixing something that isn’t broken?

OF: There are three big risks involved with relying on Excel. First, in many PE shops, there’s usually only one or two people who really understand how all the formulas work in Excel. And those formulas are the foundation of the firm’s performance data. It takes multiple layers of logic to get Excel to manage data for the various funds.

That’s fine if those people stay with the firm over the entire lifespan of the fund, but that’s not common. More often than not, those in-house Excel gurus will leave, and that carries a real operational risk. How easy is it for a new hire to step in and understand those formulas without missing a beat? So in a perfect world, there would be staff devoted to setting up and managing Excel on a full-time basis, and then someone monitoring that staff as well. From a compliance perspective, that can be a nightmare.

GK: Excel was never built for compliance purposes. There’s no way to track all the changes or who made them, which can make it impossible to audit with that kind of detail.

OF: Private equity may be lesser regulated as compared to traditional banks, but with stories like The Abraaj Group’s difficulties in the news, regulators are only going to ask more questions. And Excel offers no way to map who inputted a certain data point or amended a particular calculation. No one expects regulators to back off, so GPs will want to audit their internal process in a way that Excel can’t.

GK: It’s not just regulators that are motivating GPs to look for better alternatives to Excel. For example, say there’s a CFO at a large investor who wants to double check their numbers. The GP isn’t going to send them the raw spreadsheets. GPs have to build a system or use an application atop those spreadsheets to gene rate reports, which still may not include the data that LPs want. Investors are clamoring for greater transparency, and that’s inspiring GPs to find a way to provide it as efficiently as possible. In this case, it’s the market, not some regulatory body, driving these innovations.

And what are these innovations? How easy is it for these PE firms to move away from Excel?

OF: This was not always the case, but right now, there are some tremendously convenient solutions available. Our product is designed to be a user-friendly interface that doesn’t require the same kind of training as Excel does. A lot of that complexity is embedded in the code of our product, so that the deal partner doesn’t need a math degree to navigate it. That labor-intensive calculation is automated, so it allows a far greater number of people within the firm to use it. After 90 minutes or less of training, the staff should be ready to use it all by themselves.

GK: It’s essentially sticking a USB stick into the server and getting folks comfortable with the interface. After that, it can allow any party to run calculations, and simulated calculations very easily. So during fundraising, an LP may ask for waterfall simulation, and within three clicks, the partner can get them an answer, without having to go back to the finance staff to run the numbers and get the result a day or two later.

OF: Technologies like ours are letting GPs focus on the ‘real work’ of investing, which means selecting the right asset and managing it for maximum ROI. Our application can run simulations of a variety of exit scenarios so that partners can make better, faster choices.

Do these new technologies grant better oversight of internal processes from a regulatory standpoint?

OF: These are controllable tools, where not just anyone can edit the data. An auditor can use our application and know exactly who inputted and edited what, and how that impacted a given waterfall calculation. It makes it easy to report to the rest of the firm, to investors and even regulators.

Looking ahead, where do you see private equity fintech headed?

GK: Technology for private equity has lagged a bit because so much of its size and activities are by their very nature private, and if someone has experience in the asset class, the best financial rewards remain by staying at a fund manager. But market and regulatory demands for automation and transparency are encouraging new players and improved solutions. We’re only beginning to see what’s possible.

OF: Near term, we’re working with some players in RegTech that are looking into how to better handle the LPA. They’re aiming to digest those massive documents and reduce them to the few, pure information parameters that flow into our waterfall calculations, which is quite exciting. But further into the future, I’d expect some top-notch portfolio monitoring solutions to be offered. Right now, a lot of fund administrators are still doing that manually. And given how much banks can charge PE firms for making their frequent large transfers, there could be a role for initial coin offerings. Perhaps the GP creates an ICO that avoids the lousy exchange rates that banks offer today, which might be worth wading into cryptocurrency waters, even if it has a dubious reputation at the moment. It’s an exciting time to be in the space, and GPs should start taking advantage of the great solutions that are already here instead of only investing in the companies that provide them.