Private equity funds returned more than $120 billion to investors in 2013 topping the 2012 record of $115 billion (source: Cambridge Associates LLC). The importance of operational due diligence (ODD) in assessing private equity funds has never been more relevant than in today’s increased and complex regulatory environment.
This Private Equity ODD Check highlights five essential questions investors must ask in an initial private equity ODD review.
1. What is the corporate governance structure?
Reason: Private equity firms are often structured differently from traditional hedge funds. Understanding the authority of roles like the general partner of the fund are essential to understanding if sound corporate governance is in place.
2. Is there an independent valuation function?
Reason: While the manager may in most cases provide the valuation function, it is important to understand that this is performed independently from the portfolio management function with separate people, separate supervision and with no influence from investment management team.
3. Are potential investments approved by a formal risk management/investment committee?
How potential investments are presented, assessed and managed and which individuals hold veto power over investments is an important element to understanding if sound operational controls are in place.
4. Are performance fees paid with the liquidation of the fund or the underlying portfolio companies?
Reason: Performance fees paid on the liquidation of the underlying portfolio companies may create a scenario where performance fees are paid for a profit on one underlying asset but not balanced for losses on other underlying asset sales. Understanding how performance fees are paid, whether investors are entitled to clawbacks, and whether those clawbacks come with payment risk is an essential matter to clarify.
5. Could five questions ever be enough?
Reason: Comprehensive ODD requires the help of expert, independent advice. At Laven Partners, we provide investors with full-service, ongoing ODD reports that cover service provider agreements, background checks, legal contracts, cash segregation measures, trade flow and execution, business continuity protection, and overall enterprise risk management. We provide our ODD reports for hedge fund, private equity and real estate funds.
