Private Equity Operational Due Diligence, + Website Tools to Evaluate Liquidity, Valuation, and Documentation

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  • Format: Hardcover
  • Copyright: 2012-04-10
  • Publisher: Wiley
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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. Covers topics including fund legal documents and financial statement analysis techniques Includes case studies in operational fraud Companion website includes sample checklists, templates, spreadsheets, and links to laws and regulations referenced in the book Equips investors with the tools to evaluate liquidity, valuation, and documentation Also 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.

Author Biography

JASON A. SCHARFMAN is a Managing Partner at Corgentum Consulting. He performs operational due diligence reviews of hedge funds, private equity, and real estate funds on behalf of institutional investors, pensions, high net worth individuals, and ERISA plans. Prior to forming Corgentum, he was the Director of Operational Risk at Graystone Research (Morgan Stanley). As Director, he was responsible for managing global operational risk assessment for all U.S., Asian, and European funds. His articles have appeared in Pension & Investments and FINAlternatives.com. He also teaches a course at New York University, has consulted with the U.S. House Judiciary Committee on the subject of hedge fund and private equity regulation, and provided training to financial regulators on the subject of hedge fund and private equity due diligence.

Table of Contents

Prefacep. xiii
Introduction to Private Equity Operational Riskp. 1
Introduction to Operational Riskp. 1
Operational Risk Compared to Operational Due Diligencep. 3
What Is Operational Due Diligence?p. 4
Operational Due Diligence in the Field of Private Equityp. 8
Operational Due Diligence as Distinguished from Operational Management of Portfolio Companiesp. 9
Timing of Operational Due Diligence in the Investing Processp. 10
Operational Due Diligence Processp. 13
Historical Perspectives of Private Equity Operational Riskp. 16
Items Typically Covered during the Operational Due Diligence Processp. 23
Core versus Expanded Operational Due Diligence Reviewsp. 25
Shared Commonalities between Private Equity and Real Estate Operations Riskp. 30
Differences in Operational Risk Factors between Private Equity and Real Estatep. 32
Country- and Industry-Specific Risk Considerationsp. 33
Investment and Operational Due Diligence: Nexus or Blurred Lines?p. 39
Differences and Similarities with Hedge Fund Operational Due Diligencep. 40
Notesp. 49
Importance of Operational Due Diligence for Private Equity Fundsp. 51
Understanding the Goals of the Operational Due Diligence Processp. 52
Common Arguments against Operational Reviews of Private Equity Fundsp. 55
Common Arguments in Favor of Performing Operational Reviews of Private Equity Fundsp. 75
Conclusionp. 82
Notesp. 82
Beginning the Operational Due Diligence Review: Core Issuesp. 85
Goal Self-Assessmentp. 85
Designing an Operational Due Diligence Program for Private Equityp. 87
When Does the Operational Due Diligence Process Begin?p. 101
Signaling Effects of Operational Flagsp. 104
Requesting and Collecting Documentationp. 104
Nondisclosure and Confidentiality Agreementsp. 106
Document Collection: What Documents Should Investors Request?p. 113
Document Collection Negotiation Techniques: Avoiding a Pass-the-Buck Environmentp. 117
Document Collection: Hard Copy or Electronic?p. 119
Fund Manager On-Site Due Diligence Considerationsp. 125
Key Risk Consideration Areas to Coverp. 128
Conclusionp. 133
Notesp. 133
Additional Operational Due Diligence Considerations: An Expanded Analysisp. 135
Core Issues versus Expanded Analysisp. 135
Compensation Structuresp. 138
Introduction to Private Equity Fund Feesp. 139
Manager Investment in Fundsp. 140
Evaluating Service Providersp. 141
Additional On-Site Visit Considerations: Negative Operational Due Diligencep. 148
Additional On-Site Visit Considerations: Interview Techniques and Question Designp. 150
Asset Raising and the Use of Placement Agents and Third-Party Marketersp. 159
Cash Management and Controlsp. 162
Business Continuity and Disaster Recoveryp. 165
Understanding the Trade Life Cycle Processp. 168
Legal, Compliance, and Regulatory Risksp. 171
Insurancep. 173
Technology and Systemsp. 174
Tax Practicesp. 175
Diagnosing and Mitigating Reputational Riskp. 177
Conclusionp. 179
Notesp. 179
Valuation Techniques, Methodologies, and Standardsp. 181
Limited Partner Distinction between Fund Level and Portfolio Company Valuation Approachesp. 181
Valuation Considerations for Newly Formed Fundsp. 182
Introduction to Valuationp. 182
GIPS Statement on Private Equityp. 183
IPEV Guidelinesp. 185
FAS 157p. 189
Use of Third-Party Valuation Consultantsp. 191
Valuation Output Process Documentationp. 194
Valuation Committee Review Scopep. 196
Additional Limited Partner Valuation Considerationsp. 197
Conclusionp. 197
Notesp. 198
Legal Due Diligencep. 199
Operational Due Diligence Specialists versus Generalistsp. 199
Common Private Equity Fund Structuresp. 201
Understanding the Private Placement Memorandump. 201
Common Document Risk Assignment Termsp. 206
Exculpation and Indemnityp. 206
Trends in Indemnification and Exculpation Clausesp. 217
Other Legal Documents Considerationsp. 227
Conclusionp. 228
Notesp. 228
Financial Statement Due Diligencep. 233
Audit Standardsp. 233
Accounting Standardsp. 235
Other Financial Statement Formatsp. 237
Considerations That Are Unique to Private Equity and Real Estate Financial Statementsp. 241
Understanding Financial Statement Sectionsp. 244
Other Financial Statement Sectionsp. 245
Understanding FAS 157p. 251
Conclusionp. 254
Notesp. 254
Distinguishing the Assets Class: Real Estate-Specific Concernsp. 257
Real Estate Trade Flow Processp. 257
Sample Real Estate Processp. 258
Real Estate Valuationp. 262
Monitoring Conflicts of Interestp. 266
Fraud Considerations: Mortgage Fraud and Straw-Man Borrowersp. 269
Understanding Real Estate Fund Feesp. 270
Property Holdings Legal Considerationsp. 271
Conclusionp. 272
Notep. 273
Putting It All Together: Asset Allocation and Ongoing Monitoringp. 275
Incorporating the Results of Operational Due Diligence into Asset Allocationp. 276
Evolution of Minimum Operational Risk Regime (MORR)p. 283
Operational Risk Correlations to Portfolio Transactions Frequencyp. 285
Operational Lift-to-Drag Ratiop. 286
Negotiating Private Equity Side Lettersp. 290
Ongoing Monitoring: Operational Due Diligence Monitoring for Private Equity Fundsp. 292
Conclusionp. 296
Mathematical Conceptsp. 297
The Derivativep. 297
The Chain Rulep. 298
The Second Partial Derivative Testp. 299
Notesp. 300
Boards, Committees, and Activismp. 301
Private Equity Fund Advisory Boardsp. 301
Different Types of Advisory Boards: Limited Partners versus Pure Advisorsp. 302
Ongoing Operational Due Diligence Monitoring Advisory Benefitsp. 303
Balancing the Role of Inner Circle versus Broadly Representative Advisory Boardsp. 305
Advisory Board Criticisms: Crowding Out, Power Aggregation, and Redundant Board Layersp. 306
Information Flow Considerations from Underlying Portfolio General Partner to Limited Partnersp. 307
Limited Partner Due Diligence Considerations for a Private Equity Fund of Fundsp. 308
Additional Private Equity Advisory Board Considerationsp. 311
Conclusionp. 313
Notesp. 313
Case Studies and Scenariosp. 315
Case Studiesp. 315
Hypothetical Scenariosp. 326
Notesp. 335
Trends and Future Developmentsp. 341
Use of Third-Party Administratorsp. 341
Increased Focus on Material Nonpublic Information in the United Statesp. 345
Increased Reliance on Audit-Type Certificationsp. 348
Increased Use of Operational Due Diligence Consultantsp. 350
Pooling Operational Due Diligence Resources among Multiple LPsp. 352
Operational Benchmarkingp. 353
ILPA Guidelinesp. 354
From Self-Regulation to Mandatory Registrationp. 355
Impact of Dodd-Frank on Operational Due Diligencep. 356
Conclusionp. 357
Notesp. 358
About the Authorp. 359
About the Websitep. 361
Indexp. 363
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