Professional Documents
Culture Documents
iii
Contents
Figures and tables
vii
xi
Chapter three
Emerging managers: How to
analyse a first-time fund
19
SECTION I:
IN-DEPTH, INCISIVE CHAPTERS
Chapter one
Private equity fund manager due
diligence and selection
Chapter two
Track-record analysis as the
foundation of due diligence
Chapter four
Legal due diligence:
The ILPA Principles
3
3
4
4
4
8
8
29
29
30
Chapter five
Legal due diligence: a Q&A session
31
Introduction
The experts
The questions
31
31
31
Chapter six
Private equity benchmarks:
Methods and meaning
45
11
45
45
47
51
54
54
iv
CONTENTS
61
61
69
71
Chapter ten
Venture capital due diligence:
Issues of analysis
97
Chapter seven
Doing due diligence on the
next fund: The importance of
portfolio monitoring
73
Chapter eight
Regional due diligence:
A European perspective
By Katharina Lichtner, Capital Dynamics
Introduction
Team
Strategy and market
Processes
Quantitative analysis
Conclusion
Chapter nine
Due diligence in emerging private
equity markets
By Ernest J.F. Lambers, EMAlternatives, LLC
Introduction
The rise of the emerging markets
Key elements in the selection of
private equity managers
Conclusion
79
79
80
84
84
85
88
89
89
89
90
96
Introduction
Differences between venture capital and
private equity manager evaluation
Selection criteria and evaluation processes
Investment performance
Team
Investment strategy
Investment process
Portfolio management
Governance
Conclusion
Chapter eleven
Mezzanine funds: Risk, return
and the equity mix
By Matthias Unser
Overview of the mezzanine market
Different strategies of mezzanine funds
Risk and return of mezzanine investments
Due diligence for mezzanine fund managers
Conclusion and outlook
Chapter twelve
Sector-focused funds: Special
considerations on due diligence
By Jeffrey Mansukhani,
Cambridge Associates LLC
Introduction
Team
Strategy
Performance
Considerations for private equity industry
sector funds
97
98
98
99
100
101
102
103
104
105
107
107
110
114
117
126
129
129
129
130
131
134
CONTENTS
136
138
Chapter thirteen
Co-investment due diligence
139
Chapter fourteen
Private equity real estate:
Factors of analysis
By Hawkeye Partners, LP
Introduction
Real estate fund due diligence
Legal fund terms
Conclusion
Chapter fifteen
Infrastructure fund investing
By Nancy Duff Mangraviti and Scott Sinha,
RBC Global Asset Management
Introduction
Infrastructure fund diligence: Beware the
traps for the unwary
Back to basics: portfolio construction
Evaluating a managers infrastructure
investment strategy
First-time funds/emerging teams
Fund terms and structure warranting
special focus
Conclusion
139
139
140
143
148
149
149
152
152
157
159
159
159
160
160
163
164
165
Chapter sixteen
Secondary private equity
fund pricing
167
167
169
Chapter seventeen
Publicly traded private equity
vehicles: A different kind of model
179
Chapter eighteen
Investing in fund management
companies
By Andrew L. Turner, Northern Lights
Capital Group
Introduction
Asset management as a pure intellectual
capital activity
Evaluating investment fund managers and
investment strategies
170
171
171
174
176
176
177
177
179
180
181
183
185
189
189
189
191
vi
CONTENTS
Chapter nineteen
Staffing for success: The human
capital factor
By Erik Hirsch, Hamilton Lane,
with contributions from Michael Koenig
and Grant Saul
Introduction
Sourcing
Due diligence
Legal
Back office/reporting
Monitoring
Globalisation and private equity
Models for deploying human capital to
private equity
Advisory model
Separate account model
Fund of funds model
Hub-and-spoke model
Conclusion
193
194
196
197
210
213
216
217
219
220
221
SECTION III:
APPENDICES
197
197
197
198
200
201
201
201
202
202
203
204
205
SECTION II:
2010 PEI/PROBITAS PARTNERS
PRIVATE EQUITY FUND INVESTMENT
DUE DILIGENCE SURVEY
Conducted June/July 2010
209
Appendix I
225
Private Equity Investors Association
Recommended Due Diligence
Questionnaire
Appendix II
241
Private Equity Investors Association
Legal Due Diligence Checklist
SECTION IV:
FROM THE PEI ARCHIVES
Journalistic coverage of
due diligence
Year of the extension
Planes, trains and due diligence
Changing the equation
Tales from the fraudulent frontline
Who cares?
The winds of change
Lots of appetite, little follow-through
Manager selection key for Asian PE
249
250
252
253
257
258
259
263
268
vii
Figures
Figure 1.1:
Figure 1.2:
Figure 2.1:
Figure 2.2:
Figure 4.1:
Figure 6.1:
Figure 6.2:
Figure 6.3:
Figure 6.4:
Figure 6.5:
Figure 8.1:
Figure 8.2:
Figure 8.3:
Figure 8.4:
Figure 8.5:
Figure 8.6:
Figure 9.1:
Figure 9.2:
Figure 10.1:
Figure 10.2:
Figure 11.1:
Figure 11.2:
Figure 11.3:
Figure 11.4:
Figure 11.5:
Figure 11.6:
Figure 12.1:
Figure 12.2:
Figure 12.3:
Figure 12.4:
Figure 12.5:
Figure 12.6:
Figure 14.1:
Figure 14.2:
Figure 15.1:
Figure 16.1:
Figure 17.1:
viii
F I G U R E S A N D TA B L E S
Figure
Figure
Figure
Figure
17.2:
19.1:
19.2:
19.3:
Survey figures
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
Figure
1:
2:
3:
4:
5:
6:
7:
8:
9:
10:
11:
12:
13:
14:
15:
16:
17:
18:
19:
20:
21:
Profile of respondents
Respondent firm headquarters
Private equity investment experience
Primary investment sector focus
Primary investment geographic focus
Interest in the secondary market
Interest in directs and co-investments
Due diligence staffing
Key factors in due diligence
Fund performance benchmarks utilised
Attitude towards terms and conditions
Attitude towards the ILPA Private Equity Principles
Terms and conditions deal-breakers
Due diligence on-site GP visits
Due diligence on-site selected portfolio company visits
Require the completion of a detailed due diligence questionnaire
Require track-record data in electronic format
Attitude towards first-time funds
Key factors with first-time funds
Attitude towards sponsored funds
Position on sponsored funds
Tables
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
2.1:
3.1:
3.2:
6.1:
6.2:
6.3:
6.4:
6.5:
6.6:
6.7:
6.8:
6.9:
F I G U R E S A N D TA B L E S
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
Table
6.10:
6.11:
6.12:
11.1:
11.2:
11.3:
12.1:
14.1:
15.1:
15.2:
16.1:
16.2:
16.3:
16.4:
17.1:
19.1:
19.2:
ix
xi
CHAPTER ONE
Introduction
This chapter tackles the subject of private equity
fund manager due diligence and is divided into
three parts. First of all, we examine why manager
selection is so critical in private equity. We go on
to describe the challenges of conducting due diligence and constructing a well-diversified private
equity portfolio, and discuss a typical due diligence
process. Finally, we highlight the changes in this
process over the past five years, since the first edition of this guide was published, and in the aftermath of the credit crunch.
15
Upper: 14.5%
10
5
Median:
3.6%
0
-5
Upper: 15.0%
Median:
6.6%
Median:
6.2%
Upper: 3.3%
Lower: -0.4%
Median:
-2.2%
Lower: -2.7%
Lower: -3.1%
Lower: -8.0%
-10
US venture
US buyout
Europe venture
Europe buyout
P R I V AT E E Q U I T Y F U N D M A N A G E R D U E D I L I G E N C E A N D S E L E C T I O N
Industry
relationships
Research
Intermediaries
Fund
relationships
Monitor and
oversight
Exit and
distribution
management
Deal sourcing
Preliminary
analysis
Due diligence
Investment
committee
approval
Negotiation and
legal review
Commitment
Source: Pantheon.
CHAPTER FIVE
31
Introduction
A thorough review of the terms and conditions of
the partnership agreement is a vital part of the
due diligence that any investor considering investing in a private equity or venture capital fund
should undertake. As the financial crisis has
slowed down the fundraising process and limited
the amount of capital available for investment, the
due diligence process has become more important as investors re-evaluate relationships and
reconsider investment programmes. Examining
the details of the partnership agreement, and
negotiating with the general partner (GP) where
necessary, is as much a step in the due diligence
process as analysing the GPs track record or taking references.
In order to examine the area of legal due diligence
in depth, PEI Media asked a group of distinguished
fund formation experts to comment on a number
of issues, ranging from whether investors were
paying more attention to legal due diligence,
through whether there are substantial differences
between different classes of investors, to those
areas that are causing concern to limited partners
(LPs). Their responses are included below in a
Q&A format.
The experts
Our group consists of leading legal private equity
and venture capital fund formation attorneys from
the US, the UK, Germany and Asia. Between
them, they have many years of experience in
structuring funds and drafting terms and conditions
in limited partnership agreements globally. Their
experience relates to all types of private equity and
+ Partners, Berlin
Dean Collins and Lawrence Sussman of
OMelveny & Myers, Singapore and Beijing,
respectively
Craig Dauchy of Cooley LLP, Palo Alto
Robin Painter of Proskauer Rose LLP, Boston
Duncan Woollard of SJ Berwin, London
The questions
Given the turmoil of the last couple of
years, are investors in general paying
more attention to legal due diligence?
Have they become more sophisticated in
this arena?
Uwe Brenz (UB) and Tarek Mardini (TM): Yes,
investors (even smaller investors such as family
offices) have become more sophisticated over the
last few years and spend more time and energy on
analysing and negotiating legal terms as part of
their increased overall due diligence. This is both a
result and sign of the fact that private equity has
matured as an asset class. While it is true that
investor-friendly legal terms do not automatically
make successful fund investments, the financial
crisis has made investors aware that good fund
governance is important as a downside protection
of investors assets and can help prevent an
unsuccessful investment from becoming a catastrophic one.
Dean Collins (DC) and Larry Sussman (LS): There
has undoubtedly been a greater emphasis among
institutional investors on risk management generally
32
CHAPTER SIX
45
What is a benchmark?
Before the advent of modern power tools, craftsmen resorted to tradecraft to precisely build furniture. At the time, without accurate rulers or
measuring tapes, they used trade tools such as
story sticks and for measurement would make
marks on their workbenches as points of reference. For example, these benchmarks might be
used to make sure that all legs for a table were
the same length.
Thus, a benchmark is a point of reference.
In investments the term has evolved to mean
the use of indexes and other return statistics
to evaluate the performance of financial securities. There is a large body of knowledge regarding
the use of indexes as benchmarks in the
public securities markets and an entire performance measurement industry has evolved for
the express purpose of creating and using a
bewildering variety of benchmarks. Benchmarks
range from the trivial (for example, what was
the return last year or I want a 10 percent
real return) to the extremely complicated (for
example, a set of heuristics and algorithms that
can be used to evaluate a complicated investment structure).
46
For a relevant example in the private equity industry, take a buyout fund of funds manager who
must make two critical investment decisions:
which vintage years to invest in (a temporal allocation decision); and, within those vintage years,
which buyout managers to invest in (a series of
manager selection decisions).
This manager forms a buyout fund of funds in
2001 and invests in underlying funds with vintage
years 2001, 2003, 2004 and 2006. Note that the
manager chose not to invest in 2002 and 2005.
There are two different benchmarks for these two
different decisions. The first benchmark would
exactly mirror the managers temporal allocation
decision by using return data from the exact same
vintage years in which the manager chose to
invest. The only difference between the managers
series of investment selection decisions and the
benchmark would be the relative performance of
the funds the manager selected versus the performance of the funds in the benchmark. This
direct comparison benchmark would measure only
the managers selection prowess.
Alternatively, the manager could select a composite
benchmark made up of all the vintage years in the
investment period, from 2001 through 2006. The
managers decision not to invest in 2002 and 2005
should provide superior results when compared to
Direct benchmark
Opportunity benchmark
X
X
2002
2003
2004
X
X
2005
2006