PE LP's Are Utilizing Operational Due Diligence to Make Their Voices Heard Increasingly, private equity investors, commonly referred to as Limited Partners or LP's, are performing operational due diligence prior to allocating to private equity funds. It is good to see that LP's have taken cues from their hedge fund counterparts, and are increasingly recognizing that private equity funds present just as many, if not more, operational risks to investors as compared to hedge funds. Unfortunately, private equity fund managers, commonly referred to as General Partners or GP's, have been slower than their hedge fund portfolio manager counterparts in listening to LP feedback. This is to be expected as GP's have long capitalized on the long-term nature of private equity investing to insulate themselves from frequent interaction with LPs. In the past, after an LP committed capital, there were little if any updates from GPs outside of prescheduled updates, generally quarterly, on portfolio performance. Such an arrangement has effectively robbed LPs of their voice as partners in the investing process. More LPs have come to acknowledge this fact, and are increasingly pro-actively sharing feedback with GPs after the initial and ongoing operational due diligence processes. So consider for example, an LP who is considering making an investment in a private equity fund. This LP has wisely decided to perform operational due diligence on the GP. After the review, the LP has a list of several operational deficiencies and areas in which the LP feels compared to their peers the GP could improve. Continuing our example, let us assume that from the LPs perspective none of these items are so serious as to preclude him from investing, but rather he would feel more comfortable if the GP took corrective action on these matters. At a minimum, the LP feels it is important to make the GP aware of these issues. While previously a GP may have politely listened to such feedback and taken little corrective action, more LPs are increasingly monitoring how well GPs respond to this feedback. This includes performing ongoing operational due diligence to both monitor process improvements, as well as to detect any new operational risks. Clinging to their old ways, however, many GPs aren't frankly interested in this ongoing LP operational due diligence process or receiving any such feedback from LPs that have already committed capital. To facilitate this lack of dialogue, GPs utilize a structure whereby they have so-called advisory boards upon which typically sit the largest investors in a particular fund. As such, smaller LPs effectively become squeezed out of the process. More LPs are beginning to realize the flaws in such arrangements and have decided to become proactive not only in their due diligence efforts, but in engaging with GPs in more frequent dialogues concerning both investment and operational issues.
A program of initial and ongoing operational due diligence for private equity can help ensure that an LP detects operational issues before committing capital, and is alerted to any new potential problems before they spin out of control. As this trend continues, LPs that do not engage in such programs may increasingly find themselves to be the exception rather than the norm. Originally posted in the August 2012 edition of Corgentum Consulting's Operational Due Diligence Insights. For More Information
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Corgentum Consulting is a specialist consulting firm which performs operational due diligence reviews of fund managers. The firm works with investors including fund of funds, pensions, endowments, banks ultra-high networth individuals, and family offices to conduct the industry's most comprehensive operational due diligence reviews. Corgentum's work covers all fund strategies globally including hedge funds, private equity, real estate funds, and traditional funds. The firm's sole focus on operational due diligence, veteran experience, innovative original research and fundamental bottom up approach to due diligence allows Corgentum to ensure that the firm's clients avoid unnecessary operational risks.
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