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

Book Description

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.

Note: The ebook version does not provide access to the companion files.

Table of Contents

  1. Cover
  2. Series
  3. Title Page
  4. Copyright
  5. Dedication
  6. Preface
  7. CHAPTER 1: Introduction to Private Equity Operational Risk
    1. INTRODUCTION TO OPERATIONAL RISK
    2. OPERATIONAL RISK COMPARED TO OPERATIONAL DUE DILIGENCE
    3. WHAT IS OPERATIONAL DUE DILIGENCE?
    4. OPERATIONAL DUE DILIGENCE IN THE FIELD OF PRIVATE EQUITY
    5. OPERATIONAL DUE DILIGENCE AS DISTINGUISHED FROM OPERATIONAL MANAGEMENT OF PORTFOLIO COMPANIES
    6. TIMING OF OPERATIONAL DUE DILIGENCE IN THE INVESTING PROCESS
    7. OPERATIONAL DUE DILIGENCE PROCESS
    8. HISTORICAL PERSPECTIVES OF PRIVATE EQUITY OPERATIONAL RISK
    9. ITEMS TYPICALLY COVERED DURING THE OPERATIONAL DUE DILIGENCE PROCESS
    10. CORE VERSUS EXPANDED OPERATIONAL DUE DILIGENCE REVIEWS
    11. SHARED COMMONALITIES BETWEEN PRIVATE EQUITY AND REAL ESTATE OPERATIONS RISK
    12. DIFFERENCES IN OPERATIONAL RISK FACTORS BETWEEN PRIVATE EQUITY AND REAL ESTATE
    13. COUNTRY- AND INDUSTRY-SPECIFIC RISK CONSIDERATIONS
    14. INVESTMENT AND OPERATIONAL DUE DILIGENCE: NEXUS OR BLURRED LINES?
    15. DIFFERENCES AND SIMILARITIES WITH HEDGE FUND OPERATIONAL DUE DILIGENCE
  8. CHAPTER 2: Importance of Operational Due Diligence for Private Equity Funds
    1. UNDERSTANDING THE GOALS OF THE OPERATIONAL DUE DILIGENCE PROCESS
    2. COMMON ARGUMENTS AGAINST OPERATIONAL REVIEWS OF PRIVATE EQUITY FUNDS
    3. COMMON ARGUMENTS IN FAVOR OF PERFORMING OPERATIONAL REVIEWS OF PRIVATE EQUITY FUNDS
    4. CONCLUSION
  9. CHAPTER 3: Beginning the Operational Due Diligence Review: Core Issues
    1. GOAL SELF-ASSESSMENT
    2. DESIGNING AN OPERATIONAL DUE DILIGENCE PROGRAM FOR PRIVATE EQUITY
    3. WHEN DOES THE OPERATIONAL DUE DILIGENCE PROCESS BEGIN?
    4. SIGNALING EFFECTS OF OPERATIONAL FLAGS
    5. REQUESTING AND COLLECTING DOCUMENTATION
    6. NONDISCLOSURE AND CONFIDENTIALITY AGREEMENTS
    7. DOCUMENT COLLECTION: WHAT DOCUMENTS SHOULD INVESTORS REQUEST?
    8. DOCUMENT COLLECTION NEGOTIATION TECHNIQUES: AVOIDING A PASS-THE-BUCK ENVIRONMENT
    9. DOCUMENT COLLECTION: HARD COPY OR ELECTRONIC?
    10. FUND MANAGER ON-SITE DUE DILIGENCE CONSIDERATIONS
    11. KEY RISK CONSIDERATION AREAS TO COVER
    12. CONCLUSION
  10. CHAPTER 4: Additional Operational Due Diligence Considerations: An Expanded Analysis
    1. CORE ISSUES VERSUS EXPANDED ANALYSIS
    2. COMPENSATION STRUCTURES
    3. INTRODUCTION TO PRIVATE EQUITY FUND FEES
    4. MANAGER INVESTMENT IN FUNDS
    5. EVALUATING SERVICE PROVIDERS
    6. ADDITIONAL ON-SITE VISIT CONSIDERATIONS: NEGATIVE OPERATIONAL DUE DILIGENCE
    7. ADDITIONAL ON-SITE VISIT CONSIDERATIONS: INTERVIEW TECHNIQUES AND QUESTION DESIGN
    8. ASSET RAISING AND THE USE OF PLACEMENT AGENTS AND THIRD-PARTY MARKETERS
    9. CASH MANAGEMENT AND CONTROLS
    10. BUSINESS CONTINUITY AND DISASTER RECOVERY
    11. UNDERSTANDING THE TRADE LIFE CYCLE PROCESS
    12. LEGAL, COMPLIANCE, AND REGULATORY RISKS
    13. INSURANCE
    14. TECHNOLOGY AND SYSTEMS
    15. TAX PRACTICES
    16. DIAGNOSING AND MITIGATING REPUTATIONAL RISK
    17. CONCLUSION
  11. CHAPTER 5: Valuation Techniques, Methodologies, and Standards
    1. LIMITED PARTNER DISTINCTION BETWEEN FUND LEVEL AND PORTFOLIO COMPANY VALUATION APPROACHES
    2. VALUATION CONSIDERATIONS FOR NEWLY FORMED FUNDS
    3. INTRODUCTION TO VALUATION
    4. GIPS STATEMENT ON PRIVATE EQUITY
    5. IPEV GUIDELINES
    6. FAS 157
    7. USE OF THIRD-PARTY VALUATION CONSULTANTS
    8. VALUATION OUTPUT PROCESS DOCUMENTATION
    9. VALUATION COMMITTEE REVIEW SCOPE
    10. ADDITIONAL LIMITED PARTNER VALUATION CONSIDERATIONS
    11. CONCLUSION
  12. CHAPTER 6: Legal Due Diligence
    1. OPERATIONAL DUE DILIGENCE SPECIALISTS VERSUS GENERALISTS
    2. COMMON PRIVATE EQUITY FUND STRUCTURES
    3. UNDERSTANDING THE PRIVATE PLACEMENT MEMORANDUM
    4. COMMON DOCUMENT RISK ASSIGNMENT TERMS
    5. EXCULPATION AND INDEMNITY
    6. TRENDS IN INDEMNIFICATION AND EXCULPATION CLAUSES
    7. OTHER LEGAL DOCUMENTS CONSIDERATIONS
    8. CONCLUSION
  13. CHAPTER 7: Financial Statement Due Diligence
    1. AUDIT STANDARDS
    2. ACCOUNTING STANDARDS
    3. OTHER FINANCIAL STATEMENT FORMATS
    4. CONSIDERATIONS THAT ARE UNIQUE TO PRIVATE EQUITY AND REAL ESTATE FINANCIAL STATEMENTS
    5. UNDERSTANDING FINANCIAL STATEMENT SECTIONS
    6. OTHER FINANCIAL STATEMENT SECTIONS
    7. UNDERSTANDING FAS 157
    8. CONCLUSION
  14. CHAPTER 8: Distinguishing the Assets Class: Real Estate–Specific Concerns
    1. REAL ESTATE TRADE FLOW PROCESS
    2. SAMPLE REAL ESTATE PROCESS
    3. REAL ESTATE VALUATION
    4. MONITORING CONFLICTS OF INTEREST
    5. FRAUD CONSIDERATIONS: MORTGAGE FRAUD AND STRAW-MAN BORROWERS
    6. UNDERSTANDING REAL ESTATE FUND FEES
    7. PROPERTY HOLDINGS LEGAL CONSIDERATIONS
    8. CONCLUSION
  15. CHAPTER 9: Putting It All Together: Asset Allocation and Ongoing Monitoring
    1. INCORPORATING THE RESULTS OF OPERATIONAL DUE DILIGENCE INTO ASSET ALLOCATION
    2. EVOLUTION OF MINIMUM OPERATIONAL RISK REGIME (MORR)
    3. OPERATIONAL RISK CORRELATIONS TO PORTFOLIO TRANSACTION FREQUENCY
    4. OPERATIONAL LIFT-TO-DRAG RATIO
    5. NEGOTIATING PRIVATE EQUITY SIDE LETTERS
    6. ONGOING MONITORING: OPERATIONAL DUE DILIGENCE MONITORING FOR PRIVATE EQUITY FUNDS
    7. CONCLUSION
    8. APPENDIX 9A: Mathematical Concepts
    9. THE DERIVATIVE
    10. THE CHAIN RULE
    11. THE SECOND PARTIAL DERIVATIVE TEST
  16. CHAPTER 10: Boards, Committees, and Activism
    1. PRIVATE EQUITY FUND ADVISORY BOARDS
    2. DIFFERENT TYPES OF ADVISORY BOARDS: LIMITED PARTNERS VERSUS PURE ADVISORS
    3. ONGOING OPERATIONAL DUE DILIGENCE MONITORING ADVISORY BENEFITS
    4. BALANCING THE ROLE OF INNER CIRCLE VERSUS BROADLY REPRESENTATIVE ADVISORY BOARDS
    5. ADVISORY BOARD CRITICISMS: CROWDING OUT, POWER AGGREGATION, AND REDUNDANT BOARD LAYERS
    6. INFORMATION FLOW CONSIDERATIONS FROM UNDERLYING PORTFOLIO GENERAL PARTNER TO LIMITED PARTNERS
    7. LIMITED PARTNER DUE DILIGENCE CONSIDERATIONS FOR A PRIVATE EQUITY FUND OF FUNDS
    8. ADDITIONAL PRIVATE EQUITY ADVISORY BOARD CONSIDERATIONS
    9. CONCLUSION
  17. CHAPTER 11: Case Studies and Scenarios
    1. CASE STUDIES
    2. HYPOTHETICAL SCENARIOS
  18. CHAPTER 12: Trends and Future Developments
    1. USE OF THIRD-PARTY ADMINISTRATORS
    2. INCREASED FOCUS ON MATERIAL NONPUBLIC INFORMATION IN THE UNITED STATES
    3. INCREASED RELIANCE ON AUDIT-TYPE CERTIFICATIONS
    4. INCREASED USE OF OPERATIONAL DUE DILIGENCE CONSULTANTS
    5. POOLING OPERATIONAL DUE DILIGENCE RESOURCES AMONG MULTIPLE LPS
    6. OPERATIONAL BENCHMARKING
    7. ILPA GUIDELINES
    8. FROM SELF-REGULATION TO MANDATORY REGISTRATION
    9. IMPACT OF DODD-FRANK ON OPERATIONAL DUE DILIGENCE
    10. CONCLUSION
  19. About the Author
  20. About the Website
  21. Index