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PE LP's Are Utilizing Operational Due Diligence to Make Their Voices Heard
1. 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.
