What is Shadow Accounting and Why Do Private Equity Funds Do It?

August 4, 2022

Shadow accounting is the widespread practice of keeping a separate set of financial records. Fund accountants do it for all sorts of reasons, but the most common is to verify numbers calculated elsewhere. Private equity, venture capital, and other investment partnerships that outsource their fund administration to a third-party provider will often keep shadow accounts for assurance.

Improvements in technology and better integrations between private capital partnerships and their administrators can simplify the work of shadow accounting, making it more of an audit function than a bookkeeping one.

What is shadow accounting?

Shadow accounting is the practice of keeping a second set of financial records to verify information in the primary books or to make management decisions that are not supported by the general ledger.

Shadow accounting is a standard accounting technique

While the word “shadow” may make it seem as though shadow accounting is something secretive, it is actually a widely used, standard practice for better back-office management across a variety of industries and organizational types.


Funds use shadow accounting for verification, risk management, and investor communication

Shadow systems in private equity funds serve as an oversight layer between a general partnership and its fund administrator. It is a practice that helps catch errors sooner and smooth regulatory relationships. In addition, private equity funds often use shadow accounting to generate data used for risk management. The investment team keeps its own records of assets and liabilities to assess risk parameters in real time. This ensures that the vital work of portfolio management continues free of interruption.

In fact, many limited partners require outsourced fund administration in order to invest with a general partner. But for GPs, record sharing with fund administrators can be cumbersome. Shadow systems can help funds respond to investor requests even after passing the rest of the administrative services over to a third party.

Streamlined data access reduces the burden of shadow accounting

Because shadow accounting is a step down from the official records, private equity firms often try to do it in an off-the-shelf accounting system. The thought is that the records don’t have to be quite as usable, but the result is that records are almost impossible to use for decision making or are littered with embedded errors.

Purpose-build enterprise fund accounting software systems and many fund administrator offerings include tools that make shadow accounting less of a burden and, in some cases, turn it into an auditing function rather than duplicate bookkeeping.

Evolving technology can often eliminate the need for shadow accounting. For example, Allvue’s Client Hub allows fund managers to access the same general ledger shared with their administrator. Then, the general partner’s team members can generate reports off of that same single source of truth data and easily share them with their investors and other key stakeholders. They can also export the data or build dashboards and reports through PowerBI capabilities to quickly gather actionable insights.

By keeping the data in a single source of truth, fund administrators and fund managers can execute their workflows without duplicating efforts or introducing errors. Technology can help convert shadow accounting from a bookkeeping chore into a streamlined auditing and business intelligence process.

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