What LPs care about most when performing due diligence

Research suggests that when limited partners assess a private equity fund, the old saw of “culture eats strategy for breakfast” is not always the case.

Just 61 percent of LPs say a general partner’s culture plays a major role in their due diligence, with the remainder saying it forms only a minor part of the process, according to Private Equity International’s LP Perspectives 2019, which surveyed 101 institutional investors across private equity, private real estate, infrastructure and private debt.

The gender pay gap, itself something of a cultural indicator, is ignored by 57 percent of LPs during the due diligence process.

By way of comparison, track record is a major consideration for 98 percent of LPs and a GP’s team size and investment capacity is crucial for 92 percent. Almost 90 percent say the same of a firm’s investment thesis and propensity for style drift.

However, a firm’s culture is “essential”, Jean-François Le Ruyet, a London-based partner at fund of funds Quilvest Private Equity, told PEI.

“Culture determines where the GP is going to be different from others, so it’s the number one factor I’d look at. Recent events and scandals have made operations and compliance, which is tied to culture, so important,” he added.

Succession planning and retention programmes, which play an integral role in determining a firm’s culture, were cited by 58 percent of LPs as forming a major part of due diligence. Just over 40 percent said it was of minor importance and a further 1 percent do not include it in their due diligence.

“With everyone moving to European waterfalls with short-term valuation reviews it’s a long time before people get profit share and compensation models have altered quite significantly, so retention programmes that worked for people before aren’t necessarily as attractive these days,” said Mounir Guen, founder and chief executive of placement agency MVision Private Equity Advisors.

“Succession is an extremely critical component of a GP, and that’s something that goes back to the nuance of the culture.”

That not all LPs consider succession a crucial factor in their decision-making may be surprising given the potential consequences. DH Private Equity Partners, previously known as Doughty Hanson after its two founders, cancelled its fundraise last month and began winding down after Dick Hanson decided he could not commit to another 10 years at the firm.

GPs are often careful to negotiate a gradual leadership transition. In August sister publication Secondaries Investor reported that Stephen Can, co-head and a senior managing director at Blackstone’s Strategic Partners, would stand aside from the day-to-day running of the business, assuming the role of executive chairman in February before stepping down from the firm in the next few years.

This was followed by news that co-chief executive Philip Hammarskjold would be handing over the reins at Hellman & Friedman in January 2019, also taking up an executive chairman position.

“At the end of the day we’re investing money with a team of individuals for 12 years,” Le Ruyet added. “It’s a connection to people, which is why artificial intelligence and robots can’t perform due diligence.”