Increasing operational due diligence on PE fund managers

According to Invest Europe’s latest data for 2017, European private equity fundraising saw a tremendous increase, growing by almost 40% to the highest level recorded since 2008. This clearly demonstrates that it is an asset class in high demand. 

Pension funds directly accounted for over a third of the money raised, which is clearly driven by their firm belief that investing in the asset class will outperform public equity in the future. This is not far from the truth, as highlighted in the 2016 BVCA Private Equity and Venture Capital Performance Measurement Survey, according to which UK private equity funds – many of which invest on a pan-European basis – generated returns of 11% over a 10-year period, compared to 5.6% returns for the FTSE All-Share index.

The success of the private equity asset class has given rise to new challenges. Strong fundraising has put the industry in a position in which it has a record amount of dry powder. Deal exits tend to be favourable under such market conditions; however, it does put pressure on GPs when trying to acquire business at attractive prices, and this could have an impact on returns from the investment being made. In addition to finding the right deals, GPs have to deal with an increasingly changing regulatory and tax environment and ensure that they have the right operational set-up to deal with it on an ongoing basis.

While it is flagged as an alternative asset class within the European financial regulatory framework, the numbers tend to indicate that it is increasingly becoming mainstream. As the investor base diversifies with an increase in appetite for this asset, there is also a focus on the need for increased due diligence on PE houses. In recent years, the focus on both operational and investment due diligence has sharpened. While large international PE houses are familiar with such due diligence requests from their investor base and are better prepared, smaller firms and firms expanding into new markets may face an increased administrative burden and costs in meeting these investor requests.

Similar to any other due diligence exercise, the focus is usually on the investment team, deal sourcing, value-creation proposition, operations, systems, controls, risk management, compliance and governance in place to protect investors’ long-term interests. However, in recent years there has been a shift towards more transparency around cost and charge disclosure, valuation, ESG issues and operational set-up at holding-company level. PE houses are increasingly offering multiple strategies (buyout to credit), and it is important that conflicts of interest be properly managed. This is where the investment process and the level of involvement of PE firms in the management of the portfolio companies becomes crucial.

It is important that PE firms pay attention to their internal set-up at all levels, in order to continue raising more funds, drive growth in the portfolio companies, retain the existing investor base and attract new investors. For LPs, it is essential to find the right GPs in which to invest by asking the right questions and performing due diligence on them. PwC Luxembourg has over 250 dedicated experts in the private equity industry, covering a diverse range of topics (regulatory and tax, technology, operations, risk management, ESG, substance needs) to help both GPs and LPs meet their needs.

Contact us

Benjamin Gauthier

Partner, PwC Luxembourg

Tel: +352 49 48 48 4137

Prasanta Mandal

Manager, PwC Luxembourg

Tel: +352 49 48 48 5928

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