Book Summary Private Equity Operational Due Diligence
Book Summary Private Equity Operational Due Diligence
Book Summary Private Equity Operational Due Diligence
General Operational Due Diligence Process for Private Equity Typical Private Equity Decision-Making Process
1. Data
0. Define Collectio
Goals of = smell test
n and
ODD Analysis
2. Service
5. Continued Provider
Monitoring Confirmation
and Review
4. Report
Generatio 3. On-
n and Site
Recomm meeting
endations
0, Goals of ODD
Being able to understand the internal operational processes of a particular private equity fund and also be able to explain them to
another investor. Ask yourself: What are you trying to get out of the process?
Investor will not allocate capital to a private equity fund that is not associated with a firm that has managed capital
before.
Previous experience in managing funds in a particular sector.
Perhaps a minimum track record of say 3 years.
Certain firm-wide assets under management size e.g. $1 billion.
Confidentiality Agreement (“confi”) AND Non-Disclosure Agreement (NDA). NDAs could be referred to as a subset of
confidentiality agreements. Reciprocal confi’s are an important leverage point.
For the Private Equity Management Company For the Private Equity Fund(s) under Consideration
1. Core Compliance / Regulatory Documentation 3. Core Fund Legal Documentation
1.1. Compliance Manual 3.1. Offering Memoranda (OM)
1.2. If not included in compliance manual: 3.2. Subscription Documents
a. Employee personal trading procedures 3.3. Articles of Association
b. Electronic communication policy 3.4. Limited Partnership Agreement
c. Antimoney laundering policies and procedures 4. Other Core Fund Documentation
It is advisable that an investor reach out to a private equity fund's service providers to confirm, at a minimum, that the
relationship actually exists. Without the oversight of a third-party custodian (as opposed to self-custody), there are more
opportunities for this fund to either perpetrate fraud or operational issues resulting from this situation. Common Service
providers utilized by PE firms and funds include the auditor, administrator, legal counsel, custodian, information technology
providers, compliance consultants, and cash-management firms.
3. On-Site Meeting
Face-to-face communication provides enhanced quality and depth of information. Answer the following questions:
Is the fund manager’s space shared or subleased to any entities that were conveniently not referenced in any of the
fun’s documentation
Does the firm claim to have 50 employees but show only 20 desks?
Is everyone conveniently out to lunch or on vacation during the day of the on-site visit?
Is secure access maintained to the firm’s offices?
Is secure access maintained to certain areas such as server rooms?
Important Lessons:
1. Operational Due Diligence is an ongoing process, not a one-time event. Operational Due Diligence > Fraud Detection,
however first priority is to detect fraud.
2. To determine whether fraud is material, must satisfy both conditions: (a) Whether the particular area matters to the investor?
(b) If overlooked can create losses or future liabilities?
3. With private equity, manager selection plays the most crucial role – look at competency, skill and quality of the private
equity managers themselves.
4. Common offshore hedge fund jurisdictions: Cayman Islands, Luxembourg, Liechtenstein, the Isle of Man, Jersey and
Guernsey. Common private equity offshore jurisdiction: Malta.
5. Most due diligence (including investment due diligence) is performed when the initial capital raise occurs.
6. Document everything and draw up a due diligence file. These documents in such a file can include:
Copies of any communication (e-mails, document request lists, log of phone calls) between the parties.
Details of any internal discussions regarding the decision to investor (or not to invest), including meeting minutes,
records of votes.
Copies of any documents collected.
Documentation of any analysis performed on these documents.
Conclusions drawn based on reviewing documents.
Details and agendas of any on-site visits.
Details of any service provider reviews.
10. A starting private equity fund is effectively not much more than a legal shell.
11. Document Request Lists (DDQs) [also called request for proposals (RFPs)], just like pitchbooks, are marketing documents.
12. NB: Try to develop an understanding of and inquire about operational procedures, as opposed to simply regurgitating a
private equity fund manager's own descriptions about their own processes.
13. Employee Compensation must vest. We want true alignment between investors and the general partner.
14. Additional considerations: Advisory Board, Financial Statement Due Diligence = Audit Standards + Accounting Standards.
15. Real Estate Process: 1) Initial Research 2) Sector Analysis 3) Feasibility Study 4) Analysis Tools 5) Acquisition Plan &
Committee Review 6) Technical Due Diligence 7) Property Acquisition 8) Logging of the Purchase and Sale of Assets 9)
Property Management 10) Post-Deal Management 11) Credit Research 12) Fund Procedures (e.g. valuations)
Sample Assets under Management Threshold for a Private Equity Firm to Use Third-Party Valuation Consultants