Any business has operating expenses, but for managers of the alternatives industry, like hedge funds and private equity, the accounts payable process is extra complicated. IntegriDATA CEO and Founder Mitch Schulman and Head of Business Development and Marketing Nick Molina say this industry, like many others, is plagued by paper-based invoices and expense management dependent on spreadsheets. But, they told PYMNTS, these manual tactics are particularly threatening to the wellbeing of, say, a hedge fund.
For one, explained Schulman, managers of this space must handle traditional expenses, like general operating expenses and T&E. But they also spend their funds on highly targeted services like market data and legal services, he explained — expense categories, he said, that are “very large and significant in terms of dollars and in detail.”
When it comes time to pay the suppliers of these services, the executives both explained, the accounts payable process is far from straightforward.
In a traditional business, an invoice is received, goes through the AP department for approval and then is paid. For entities like hedge funds, however, there are very specific ways invoices must be paid.
“What’s interesting about investment management and private equity, in particular, with their operating expenses, is that these companies have a bunch of legal entities beneath them,” Molina said. “Invoices have to be split out amongst all the funds … and that’s where the complication exists.”
Allocating those portions of invoices isn’t as straightforward as splitting up a bill equally, either, he continued.
“They are having to take an expense, a single invoice from a vendor, and splitting it amongst the funds; the calculation needed to perform the sharing percentage is very complicated, based on a legal agreement,” Molina explained. Investors of these funds specify how to break this up in their contracts. “They tell [managers] what types of expenses they’ll partake in and how they will do so,” he said. “For example, a fund may only partake in tech expenses.”
IntegriDATA’s solution targets this challenge with its Expense Allocation System (EAS), aimed to break up a bill across funds based on contractual agreements. Those rules to allocate expenses, by the way, change frequently, the executives noted. And typically, fund managers coordinate expense allocation through spreadsheets.
“Their invoices are paper, approvals for invoices are happening in Excel or they’re sending emails back and forth,” Molina said. “It’s a manual process, prone to error, and things can slip through the cracks.”
After targeting the expense allocation challenge, IntegriDATA is going after the issue of paper-based invoicing and manual supplier and AP management with the latest iteration of its Expense Allocation System. It’s part of the company’s efforts to address the AP and expense management needs that other platforms aren’t designed to address for this space.
Schulman explained that AP is also a particular challenge for the alternative investment industry, more so than others, because this industry doesn’t have a single general ledger system and a single accounting system. Across the investment companies and the management companies, the accounting needs for these two areas are different, he said.
“Therefore, you typically have two different general ledger systems, one purpose-built for fund accounting and the other for general running of a management company,” the CEO said. “Since there’s not a single general ledger, they’re not on the same platform. That’s one of the causes of fragmentation associated with these expense processing systems.”
Molina added that other accounts payable, accounting and expense management solutions aren’t built to handle the regulatory pressures that this industry faces, either.
“The SEC has made it a priority of theirs to investigate private equity and hedge fund firms who are not allocating these expenses to their funds correctly,” he said. “You can imagine the investors would be upset if they were over-allocated expenses. They’re paying for something they shouldn’t be paying for.”
In other verticals, if a business mismanages accounts payable, it means cash flow disruption for both the business and its supplier — and, of course, that’s no good. But for hedge funds and similar entities, misallocation of expenses leads to legal ramifications.
Molina said that, according to IntegriDATA research, the average settlement with the Securities and Exchange Commission for an alternative investments entity hit with a penalty is $4.9 million. “This is a legal and compliance issue,” he said. “It’s a pretty big issue.”