There is no shortage of private equity fund managers and they’re always on the lookout for sources of new investments. The challenge is in finding the best indication that a fund will have future success. Private equity firms have a tall order in doing due diligence to ensure that funds are being invested wisely and with some sound reasoning behind their decisions. For those who’ve been in the business a long time and know what they’re looking for, there are key indicators of funds that will likely perform well. They also need to be aware of indicators that signal red flags.

Good governance plays a part in the selection process, and there are clear negative monetary outcomes associated with bad governance. Teams must move with speed and agility during the bidding process while maintaining the highest standards of security and confidentiality.

Key Issues Around Due Diligence for Private Equity Firms 

One of the main concerns for private equity firms concerns how likely it is that a fund will meet its fundraising target. If the fundraising target is unattainable in the first place, the potential performance is irrelevant.

Investors look for firms that have experience and expertise with fund strategy. The lack of a demonstrable track record sends up a red flag. Experienced investors will know whether the fund requires greater investigation or whether they should pass on it. Investors are likely to consider whether a fund has a returning investor base. They will also be interested in knowing if a fund has a successful performance track record at the firm level, which is a key indication that it will achieve its fundraising target.

In addition, investors will be looking to see if a fund has a successful performance track record at the team level. Investors feel that a good team is more important than the firm’s track record as an indicator that a fund will meet its fundraising target. Funds that are struggling to meet their targets for current investors will not likely attract new investors.

Another factor that investors look for is whether the fund is likely to outperform its peers. The risk profile comes into play here. Once the risk is determined, investors will want to deliver the best performance. If a team leaves the firm for any reason, their track record at the previous firm becomes meaningless. Investors might give a firm a second look if they’ve since hired professionals or team members who have a good track record of managing a fund.

The lack of a track record at a firm isn’t as much of a red flag when a team’s track record has a positive history of fund or portfolio management. First-time funds will be able to produce individual team member track records for investors to consider in due diligence.

Still another factor is the experience and expertise with the fund strategy that’s being employed in the current fund. Investors also need to account for strategy drift.

What Are Best Practices for Investors Trying to Access Top-Tier Fund Managers?

It’s a bit more challenging to access top-tier fund managers. To be successful in this endeavor, investors will need to have a willingness to make a sizeable commitment to a fund. It won’t help for investors to be too demanding with fund terms and conditions, which are the greatest barriers to gaining access to top-tier funds.

Service providers are of the belief that top-tier managers prefer to accept commitments from investors that are interested in being long-term partners.

Is There A Connection Between Good Governance and Due Diligence?

Good governance may not create value for a company on its own, but companies that practice high governance standards are associated with value creation. Good governance practices allow for early detection of poor performance and identify issues before they escalate into a crisis.

Private equity teams must move with speed and agility during the bidding process. What makes that challenging is that they must simultaneously maintain the highest standards of security and confidentiality.

Firms must create favorable targets for investment. Companies that benefit from having high standards of governance are likely to attract more interest from investors, as it’s easier for outside parties such as investors and underwriters to access information and understand the company’s approach to the market. Good governance also goes a long way toward building the company’s reputation and credibility.

Institutional investors are increasingly talking about their desire to see improvements in governance, as they pave the way for increased transparency and accountability. Good governance sets a foundation for good conversations with current and prospective investors.

If a company in a firm’s portfolio becomes involved in a governance scandal, the firm’s reputation will suffer and investors will avoid investing in it in the future, even if the firm’s own governance is acceptable.

Today’s marketplace demands that firms adopt more secure, efficient and collaborative processes as they grow into new geographies, assets classes and the number of funds. Informal processes are giving way to digital processes that keep things on track to produce favorable outcomes.

Regulators are increasingly interested in greater transparency, and they desire insight into a firm’s structure and related company information. Managing legal entity and fund data requires diligence on the part of legal, compliance and tax teams. Mistakes can be pricey from a compliance standpoint and from a business perspective where companies risk wasting time and resources, as well as facing hold-ups in their processes or delays due to regulatory investigations.

Good governance is a positive thing for investors, private equity firms, shareholders and stakeholders. Private equity firms need digital tools to assist them in upholding good governance and in keeping their communications and collaborations highly secure. Diligent Corporation is an industry leader in board management software programs. Governance Cloud is comprised of a fully integrated suite of governance tools that cover essentially every aspect of good governance, which paves the way for due diligence for private equity firms.