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Operational Due Diligence: Navigating the Pitfalls with Prospective Investors

As the operational due diligence process (“ODD”) has become more important and complex, both fund managers and investors need to safeguard they are thoroughly prepared to ensure the process is as smooth as possible.  


At this month’s EisnerAmper breakfast series for fund managers and investors, a quartet of panelists shared their perspective on the ODD process and how firms can have a concrete plan in place. The panelists explicitly stated some concerns that would deter managers from receiving allocations, and how they can overcome these hurdles.

  1. ODD preparation begins prior to the meeting and there are several things both allocators and managers need to do throughout the process:  
    1. Managers should provide the allocator with a prior net-asset-value (“NAV”) packet for review before the meeting so the investor can thoroughly review it and have questions ready.
    2. Human capital is essential to the ODD process. Having dedicated ODD personnel, both on the allocator side and manager side, will allow the ODD analyst to provide feedback to managers about their process and how they can improve going forward. 
    3. If managers provide a dedicated operational due diligence questionnaire (“DDQ”) addressing corporate governance, valuations, cash transfers, and ODD components, among other things, they will be more prepared in the eyes of the investor. 
    4. Of course, how extensive the ODD process ultimately ends up being is contingent upon a firm’s investment strategy and the complexity of the assets.
     
  2. The panelists also revealed a number of their biggest concerns during the ODD process and how firms can alleviate them:
    1. Managers failing to comply with background checks is one of the biggest hurdles. Allocators should not only conduct them prior to the investment but also every few years throughout their investment partnership.
    2. If managers have an unclear succession plan, that is also a red flag. Firms need to have one in place to demonstrate to investors that they have a plan for when the firm’s founder(s) step aside.
    3. If firms give different investors preferential liquidity, that is also a cause for concern. Therefore, managers need to treat all investors fairly.
    4. Too often managers “wear too many hats,” most commonly COOs or CFOs having a dual role as CCOs. Firms should have a dedicated compliance plan, whether an outsourced provider or human capital, dedicated to compliance.
     

EisnerAmper would like to thank the panelists for their time and insights they shared at the breakfast:

  • Leighton Strader, Managing Director, Virginia Ventures
  • Lance Fraser, Managing Director, Alternatives, Merrill Lynch Wealth Management
  • Eric Lazear, COO, CCO, Head of Operational Due Diligence, International Asset Management
  • Michael Merrigan, Founder, Shadmoor Advisors


Stay tuned for the next breakfast September 10 on “Institutional Investor Outlook on Alternative Investments.”

Frank Napolitani, Director, Financial Services Group has nearly 20 years of experience working with organizations including a fund of funds, family office and prime brokerage firms, and providing consulting to investment fund managers.

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