When it comes to manager due diligence, what are investors actually looking for? This was the question put to a panel of experienced private funds professionals at Home House in London, on May 15. It's a pretty important question, I think you'll agree.
The event was part of MJ Hudson's continued efforts to demystify the process of investing into private funds. In parallel with a series of events, we'll soon be launching our latest edition of the private equity fund terms report ( last edition available here) and you can read all about the risks associated with investing in private equity from an LP perspective in our investment advisory team's excellent and aptly named report " Key Risks in Private Equity Investing".
Anyway – back to the breakfast panel...
Joanne Job, Managing Director and Head of Research and I represented MJ Hudson and we were delighted to welcome some distinguished guest speakers: Louise Corner, Partner and Head of IR and Portfolio Performance at Phoenix Equity Partners and Gabbie Joseph, Principal, Head of Due Diligence at Rede. Will Roxburgh, Director in MJ Hudson's Fund Management Solutions team moderated the discussion with pertinent questions and no small degree of charm.
The audience comprised 80 or so fund managers and their advisers from across the private funds spectrum.
DD in the spotlight
In the aftermath of Abraaj, the panellists agreed that due diligence, and operational due diligence in particular, had become increasingly important to investors. Investor due diligence was most noticeably focussed on governance, including, most relevantly for the Abraaj situation, governance structures of the fund and its manager (including segregation of functions and processes). This extended to ESG (environmental, social and governance factors), wherein focus on governance, including legal compliance, outweighed the interest in environmental and social factors.
Whereas investment due diligence and legal due diligence are certain to remain core tasks for any investor into private equity, the rise in importance of operational due diligence should not be underestimated.
Show thyself and all thy blemishes
With that, in mind, let us turn to the process of due diligence, itself. First and foremost, GPs need to be an open book. As Joanne Job explained: "Being transparent is a prerequisite for due diligence."
I bored the room a little by wittering on about the importance of providing information on where things went wrong and how to deal with "portfolio problems", historic and current (ask me for more details if you are interested). Some heads were nodding, but they could have just been dozing off.
In essence, I reminded the room that any bad news had better come straight from the horse's mouth and preparing sensible answers that focus on lessons learned and adaptations to strategy and governance are the way to go. "it was Dave's fault so we fired him" won't wash with investors any more (why did you hire Dave? Why was he able to do this? Why can't you take responsibility for your own failings?...)
I'll tell you what I want, what I really, really want...
Louise Corner, went straight to the heart of the matter. Explaining how she sees her role, as a GP, she put it thus:
What is the key question that the LP is getting at, and how can I help them answer that?
In essence, a successful due diligence process is all about preparation and listening. And you need both.
It's all very well preparing volumes of information for a dataroom (and you DO need to do this, of course), but your prospective LPs will tell you (if only you will listen!) what they actually WANT to see. Make sure you provide enough data to cover every eventuality, but also direct your investors to where they can find the answers they seek. Make sure everything is organised in a sensible way, so that information can be found without your help, if you are not available to assist. A data room is a library and every library needs a good librarian, but the equivalent of the Dewey Decimal System can do a good job for self-directed readers. Additionally, it is important to bear in mind that while the dataroom information is important, it is only the first step of any good due diligence process, which would entail onsite visits, meetings with key staff and verification of the information provided.
Show off your plumage
Of course, it's not just about how you present your information – the content, itself, is crucial.
As a GP, you need to demonstrate that you tick all of the boxes, but also that you are compellingly different. "You need to demonstrate how you are better than the others", explained Joanne Job.
A team's track record, and history with a strategy was seen as crucial evidence to engender investor confidence. It is ideal for a team to be able to demonstrate that they have executed their strategy over the course of multiple market cycles. "People are very focussed on managers that stick to their knitting", Louise Corner explained. She is right, of course.
In addition to experience, culture was identified as crucial to the success of a team, and it was seen as important for firms to identify, and nurture the culture that they want. As I was keen to point out, differentiation isn't easy and if your culture is GENUINELY unique, this can be a good way to show how you are different (as long as it is not the ONLY way). What is the personality of your firm?
Whilst every firm needs a USP, many firms, in seeking to stand out, end up making the same claims as their peers. I've written on this topic before... Linked to this was the point that a fund should not look to please all investors; instead it should show that it can follow through on its strategy, and do this well, even though it will mean that some investors will no longer be interested. Better to wow 10% of the room and leave the rest cold, than merely avoid offending everyone.
A note of thanks
Thanks to all of the panellists and the participants from the floor for making this such an engaging morning. Thanks also to Matthew Williamson from our Fund Management Solutions team for taking the thorough notes on which I based this piece.
We will be sending a few slides to the event attendees, outlining some of the talking points and also featuring a summary of some of the results from recently published research from Rede Partners, provided by Gabbie Joseph. This looks at liquidity and also at how ESG issues factor into LP decision making. Interesting reading! Let us know if you would like to receive a copy of the slides and I will send them to you when they are distributed.
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