Interest in Private Equity and Venture Capital investments continues to grow.
Surveys show that many institutional investors and family offices are looking to increase allocations to the space. At the same time, new initiatives are underway to make private investments more broadly available to investment advisors and individual investors.
A thoughtful process is an important part of any investment approach, but it is especially crucial with private investing, given the illiquid nature of the investments, the multi-year commitment required, and the limited rights and transparency often afforded investors (Limited Partners – LPs) in a private investment fund.
Before even starting a private investment program, the following are high level questions to consider:
Do you have the time horizon and patience to make a long-term commitment?
Do you have confidence that a private investment fund manager will remain intact and strong over an extended period?
If an investor does proceed, it is important to build a diversified portfolio and understand the differences between investing in a fund-of-funds, single funds, co-investments, and direct investing.
Fund-of-funds offer professional management and diversification, but control over investments is reduced and investment management fees can be high due to the fee-on-fee nature of these pooled investment funds (a fee for underlying funds plus another fee for the selection and management of the funds).
When investing in a single private investment fund, co-investing with other investors, or directly investing in private companies, investors have greater control over portfolio construction and investment fees may be lower. The need for hands on management and diversification across industry sectors, entry point years or vintages, management styles, and geography is dramatically increased, though, and the costs (treasure and time) related to due diligence, tracking and oversight can be high.
Private investment due diligence questionnaires (DDQs) have been developed for institutional investors but they are often long and can be quite technical.
As a supplement to detailed institutional DDQs, the following is a summary of questions to consider when investing in private investment funds or companies. The list may still seem long, highlighting the unique nature of private investing, but hopefully the sections outlining various issues to keep in mind, and our attempt to simplify language, will increase transparency and be a useful template for both advisors and investors.
Links to more information can also be found at the end of this paper following our Conclusions under Related Reading and Resources.
General Overview and Firm Structure
Investment and Portfolio Structure
Capital Call and Cash Management
Governance and Conflict Management
Private fund managers hold assets that can be difficult to value, and reported valuations tend to be limited and can include many subjective inputs.
Managers often provide multiple forms of performance metrics that can be difficult to evaluate and compare to other types of investments. Examples include, but are not limited to, realized and total fund MOICs, TVPIs, DPIs, and IRRs, which can be influenced the timing of cash flows and lines of credit. Accordingly, a multi-dimensional analysis of performance is prudent.
The following are a list of additional issues to consider:
Terms and Fees
Private investment fund documents, disclosures, and terms can be complex and it is important to understand manager incentives.
Below are a list of questions related to the evaluation of management fees, expenses, and other costs.
Fund Document Review List
Additional Considerations for Funds of Funds
Additional Document List and Considerations for Direct Private Investments
Conclusions and Summary
No due diligence questionnaire can cover all issues or produce a definitive yes or no answer for an investment opportunity.
Beyond the considerations and questions listed above, it is also important to step back and balance any analysis with the emotion involved in any investment decision, keeping these thoughts in mind:
Is the desire to do a deal, or any prior connections with the individuals associated with the fund, potentially influencing anything uncovered during your due diligence process?
Have you taken enough time for due diligence?
Are you prepared to be a long-term partner with private fund managers (remember – time frames can be 10 or more years)?
Related to the last point, having a good understanding of who you are investing with, what makes them different, and what is driving them is important. The following are a few additional questions to consider along these lines, which we touched on to some extent, but want to emphasize:
Are the senior leaders of the fund solely focused on their funds with significant skin in the game in terms of time and treasure?
What is the culture and reputation of the firm – are they considered to be partners by other GPs and industry leaders?
Ultimately, due diligence is in part an emotional and human exercise, which can be based on limited information. It also does not end with the initial investment. Once an investor has committed to a private investment fund, it is only the beginning.
Many good private investment opportunities exist but they are not easy to find at the correct time. To increase the probability of success, it is important to have a good team, a thoughtful process, constantly examine assumptions, and to maintain a disciplined, diversified, long-term plan.
Special Thank You:
A special thank you to Victoria Ivashina, the Harvard Business School, Lovett-Learner Professor of Business Administration Head, Finance, who provided important edits and was especially generous with her time. Professor Ivahina’s book is first on our Related Reading and Resources list below for a reason. If you would like a copy of the book let us know and we will send you one.
Also, thank you to Brent Beshore, the CEO and Founder of Permanent Equity, Jim Kane, CFA, CAIA, CIPM, a Senior Pension Fund Specialist at the National Education Association, and Jeremy Heer, CFA, CAIA, a Senior Portfolio Manager at the University of Chicago Endowment. They offered valuable insights and contributed to our list of questions based on their industry experience.
Next, appreciation goes to Ludovic Phalippou, the head of the FAME Group at Said Business School at the University of Oxford, who was kind enough to spend time reviewing this piece. A link to his book on the subject can be found under Related Reading and Resources.
Finally, a continued thank you to members of our Research Roundtable, who always provide good insights and are valued partners.
Related Reading and Resources:
Patient Capital: The Challenges and Promises of Long-Term Investing – Ivashina and Lerner
Private Capital Investing Keys – Commonfund
The Variant Perception – Victoria Ivashina, Jason Zweig, and Michael Mauboussin – Greenwich Family Office Roundtable
Private Equity Laid Bare – Ludovic Phalippou