This is a step-by-step guide to develop a flexible comprehensive operational due diligence program for private equity and real estate funds. Addressing the unique aspects and challenges associated with performing operational due diligence review of both private equity and real estate asset classes, this essential guide provides readers with the tools to develop a flexible comprehensive operational due diligence program for private equity and real estate. It includes techniques for analyzing fund legal documents and financial statements, as well as methods for evaluating operational risks concerning valuation methodologies, pricing documentation and illiquidity concerns. This title covers topics including fund legal documents and financial statement analysis techniques. It includes case studies in operational fraud. Companion website includes sample checklists, templates, spreadsheets, and links to laws and regulations referenced in the book. It equips investors with the tools to evaluate liquidity, valuation, and documentation. The following title is also written by Jason Scharfman: "Hedge Fund Operational Due Diligence: Understanding the Risks". Filled with case studies, this book is required reading for private equity and real estate investors, as well as fund managers and service providers, for performing due diligence on the noninvestment risks associated with private equity and real estate funds.
Preface xiii CHAPTER 1 Introduction to Private Equity Operational Risk 1 Introduction to Operational Risk 1 Operational Risk Compared to Operational Due Diligence 3 What Is Operational Due Diligence? 4 Operational Due Diligence in the Field of Private Equity 8 Operational Due Diligence as Distinguished from Operational Management of Portfolio Companies 9 Timing of Operational Due Diligence in the Investing Process 10 Operational Due Diligence Process 13 Historical Perspectives of Private Equity Operational Risk 16 Items Typically Covered during the Operational Due Diligence Process 23 Core versus Expanded Operational Due Diligence Reviews 25 Shared Commonalities between Private Equity and Real Estate Operations Risk 30 Differences in Operational Risk Factors between Private Equity and Real Estate 32 Country- and Industry-Specific Risk Considerations 33 Investment and Operational Due Diligence: Nexus or Blurred Lines? 39 Differences and Similarities with Hedge Fund Operational Due Diligence 40 Notes 49 CHAPTER 2 Importance of Operational Due Diligence for Private Equity Funds 51 Understanding the Goals of the Operational Due Diligence Process 52 Common Arguments against Operational Reviews of Private Equity Funds 55 Common Arguments in Favor of Performing Operational Reviews of Private Equity Funds 75 Conclusion 82 Notes 82 CHAPTER 3 Beginning the Operational Due Diligence Review: Core Issues 85 Goal Self-Assessment 85 Designing an Operational Due Diligence Program for Private Equity 87 When Does the Operational Due Diligence Process Begin? 101 Signaling Effects of Operational Flags 104 Requesting and Collecting Documentation 104 Nondisclosure and Confidentiality Agreements 106 Document Collection: What Documents Should Investors Request? 113 Document Collection Negotiation Techniques: Avoiding a Pass-the-Buck Environment 117 Document Collection: Hard Copy or Electronic? 119 Fund Manager On-Site Due Diligence Considerations 125 Key Risk Consideration Areas to Cover 128 Conclusion 133 Notes 133 CHAPTER 4 Additional Operational Due Diligence Considerations: An Expanded Analysis 135 Core Issues versus Expanded Analysis 135 Compensation Structures 138 Introduction to Private Equity Fund Fees 139 Manager Investment in Funds 140 Evaluating Service Providers 141 Additional On-Site Visit Considerations: Negative Operational Due Diligence 148 Additional On-Site Visit Considerations: Interview Techniques and Question Design 150 Asset Raising and the Use of Placement Agents and Third-Party Marketers 159 Cash Management and Controls 162 Business Continuity and Disaster Recovery 165 Understanding the Trade Life Cycle Process 168 Legal, Compliance, and Regulatory Risks 171 Insurance 173 Technology and Systems 174 Tax Practices 175 Diagnosing and Mitigating Reputational Risk 177 Conclusion 179 Notes 179 CHAPTER 5 Valuation Techniques, Methodologies, and Standards 181 Limited Partner Distinction between Fund Level and Portfolio Company Valuation Approaches 181 Valuation Considerations for Newly Formed Funds 182 Introduction to Valuation 182 GIPS Statement on Private Equity 183 IPEV Guidelines 185 FAS 157 189 Use of Third-Party Valuation Consultants 191 Valuation Output Process Documentation 194 Valuation Committee Review Scope 196 Additional Limited Partner Valuation Considerations 197 Conclusion 197 Notes 198 CHAPTER 6 Legal Due Diligence 199 Operational Due Diligence Specialists versus Generalists 199 Common Private Equity Fund Structures 201 Understanding the Private Placement Memorandum 201 Common Document Risk Assignment Terms 206 Exculpation and Indemnity 206 Trends in Indemnification and Exculpation Clauses 217 Other Legal Documents Considerations 227 Conclusion 228 Notes 228 CHAPTER 7 Financial Statement Due Diligence 233 Audit Standards 233 Accounting Standards 235 Other Financial Statement Formats 237 Considerations That Are Unique to Private Equity and Real Estate Financial Statements 241 Understanding Financial Statement Sections 2
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