A Key Private Equity Job: Due Diligence

May 10, 2010

Financial Advisor Magazine had an interesting glimpse into the extent of the due diligence that big institutional investors go through before taking a chance on a private equity deal.  If you work in private equity, better get ready for people peering into your private life. And if you’re thinking of getting into the business, it may just reveal another private equity career opportunity.

The article quoted Tom Connelly, president of Versant Capital Management of Phoenix. Connelly manages assets for ultra-high-net-worth investors as well as serving as chairman of the investment committee for the Arizona state employee pension fund. When they get interested in a private equity deal, they’ll spend tens of thousands of dollars researching it first.

Allan Martin, a managing partner and senior consultant at NEPC LLC, which performs due diligence for some of the nation’s largest pension funds, says that big institutional investors conduct extensive background checks on the managers of these PE funds. They search through public records, specialized databases, even the divorce filings of managers to try to uncover anything suspicious. In addition, due-diligence consultants review the books. Accountants pour over returns and verify that securities do exist.

The process is both time-consuming and, as you can imagine, expensive. Most PE firms have between 15 and 20 employees, whose credentials must be picked through carefully at a cost of $1,000 per employee. Vetting an investment can take three to four months or 50 to 100 person-hours at about $400 per hour.

Due diligence consultants typically charge fees ranging from 10 to 20 basis points on the amount of assets being committed to a particular asset class. Given that the typical pension fund might make a $50 to $75 million PE investment, this can translate into fees of $150,000 a year or more.

It’s one reason, according to the Financial Advisor Magazine article, that few people other than big institutions have the resources to truly check out these deals. And why others who take short cuts can fall victim to swindlers like Bernie Madoff.

What do you think? Does the due diligence process make it prohibitive for anyone but a large institution to invest in private equity? Add your comments below.

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