Private Equity Due Diligence (LP Evaluation Guide)
Private equity due diligence is the process of testing whether a fund fits your investment goals and whether its manager, results, terms, and controls stand up to scrutiny. Before committing, define your mandate, verify claims against primary records, model costs and risks, review legal documents with specialists, and document both your decision and follow-up plan.
A disciplined review can save time and money. It helps you avoid spending heavily on a fund that does not fit your mandate, and it can focus legal, tax, and operational reviews on the issues that matter most. No checklist can guarantee returns. The goal is to identify what you know, what remains uncertain, and whether the risks are acceptable.
The ILPA Principles and Due Diligence Questionnaire (DDQ) can provide useful frameworks for reviewing fund terms and manager practices. They are not regulatory approval, proof of quality, or a substitute for your own review. The steps below are designed for LPs, investment teams, and finance professionals assessing a commitment.
Set the LP mandate and confirm eligibility
A mandate defines what an LP needs from an investment before it considers a specific fund. Write down the desired allocation, time horizon, liquidity limits, risk tolerance, diversification needs, and return objectives. Then confirm that the fund’s structure and investor requirements allow you to participate. Eligibility rules depend on the offering and its legal basis.
Start with your investment policy and decision process. Identify who can approve a commitment, what documents they need, and whether the proposed fund fits existing limits on private investments, geography, industry, or manager exposure. Private equity can tie up capital for years, and fund interests are not usually as easy to sell as publicly traded securities. Your liquidity plan should account for that.
Ask the manager or counsel to explain the offering’s exemption and investor criteria. For example, a fund relying on Investment Company Act §3(c)(7) generally limits ownership to qualified purchasers. The statutory test for an individual generally requires at least $5 million in investments. That is not a universal threshold for private equity investing; other structures and exemptions have different rules. Confirm your status with qualified counsel.
Screen the manager before commissioning a costly review. Compare its strategy, team, fund size, sourcing approach, and prior-fund record with your mandate. Review the manager’s current Form ADV and available firm, registration, and disciplinary information through the SEC’s Investment Adviser Public Disclosure (IAPD) system. Check relevant filings and disclosures directly. A pitchbook or third-party database is not a substitute for primary records.
Mandate checklist – Maximum commitment and share of your total private-market allocation – Expected capital-call pace and ability to meet calls – Strategy, sector, geography, and fund-vintage limits – Required approvals, legal review, and reporting needs – Reasons to decline, such as an unverified claim or a material mismatch
Test performance, terms, and operations
Due diligence means checking a manager’s claims against evidence and assessing how the fund works in practice. Review investment performance, economics, governance, and controls as connected issues: a strong reported result can mean less if it relies on unusual leverage, unclear valuation methods, or terms that do not fit your needs.
Reconcile the track record
Track record analysis compares reported results with fund documents, audited financial statements, cash-flow records, and deal-level support. Request both net and gross performance, realized and unrealized values, and the timing of contributions and distributions. Confirm which deals are included, how results are attributed to the current team, and whether predecessor-firm results are presented.
Do not treat a headline internal rate of return (IRR) or investment multiple as proof of quality. IRR reflects the timing of cash flows; a multiple compares value with invested capital. They answer different questions. Subscription-line borrowing can change the timing used in an IRR calculation, and unrealized valuations are estimates rather than cash proceeds. Ask for results both with and without material subscription-line effects where available.
There is no single IRR or multiple that establishes whether a fund is suitable. Compare funds with care, including by vintage, strategy, leverage, and the share of value that has been realized. Investigate gaps between gross and net results, losses, write-offs, and any material difference between the manager’s presentation and audited records.
Model fund economics and governance
The limited partnership agreement (LPA) sets core rights and obligations. Read it with the subscription documents and any side letter, not as a standalone summary. Model how management fees, carried interest, the preferred return, fund expenses, and timing of distributions could affect your net proceeds.
Also review recycling, subscription facilities, clawback provisions, investment-period extensions, key-person terms, and LP advisory committee rights. A clawback may require the manager to return excess carried interest under stated conditions; the specific rules depend on the LPA. Confirm how expenses are allocated between the fund, manager, and portfolio companies. Ask counsel to explain provisions that are unclear or differ from the manager’s verbal description.
| Review item | Evidence to request | Diligence question |
|---|---|---|
| Net performance | Audited statements and cash-flow records | Do reported figures reconcile to cash flows and audited values? |
| Subscription facility | Facility terms and performance calculations | How does borrowing affect reported IRR and call timing? |
| Fund expenses | LPA, budgets, and expense reporting | Which costs can be charged to the fund, and how are they allocated? |
| Clawback and carry | LPA and worked examples from the manager | What happens if early gains are followed by later losses? |
| Key-person terms | LPA and team information | What event can pause investment activity, and what rights follow? |
Check operations and conflicts
Operational diligence tests whether the fund can safeguard assets, produce reliable reports, and manage risks. Review the valuation policy, fund administrator, audit arrangements, custody and cash controls, cybersecurity practices, borrowing, and conflicts of interest. Ask who performs each task, how often controls are tested, and what evidence supports the answer.
Where practical, seek independent confirmation from service providers. Review how the manager handles transactions involving affiliated firms, allocation of investment opportunities, co-investments, and fees paid by portfolio companies. Ask how valuation changes are approved and documented. A polished policy is useful only if actual practice matches it.
Illustrative diligence cases
- A manager presents a high gross IRR. The LP finds that much of the value is unrealized and that a subscription line affects cash-flow timing. The next step is to reconcile net returns, deal records, and calculations with and without the facility, then assess the remaining uncertainty.
- A fund’s LPA permits a broad range of expenses. The manager says in a meeting that charges will be limited. The LP asks for written clarification, compares it with the LPA and side letter, and has counsel assess whether the documents provide the expected protection.
These are hypothetical examples, not reports of actual funds. They show why document-level verification matters more than a verbal assurance.
Run diligence, make a decision, and monitor
A sound process assigns owners, sets evidence standards, and records open questions. Diligence should move from mandate fit to screening, full review, and an approval decision. Keep a written record of the rationale, key risks, follow-up items, and any conditions that must be met before the commitment.
1. Screen. Confirm strategy fit, eligibility, team stability, sourcing and investment process, prior-fund evidence, and public disclosures. Log each claim that lacks support or conflicts with another source.
2. Investigate. Reconcile performance and cash flows. Review the LPA, subscription documents, side letters, operations, conflicts, and portfolio exposure. Assign investment, legal, tax, compliance, and operations specialists to the questions within their scope.
3. Test the decision. Model likely capital-call pacing, fees, liquidity needs, and downside scenarios. Consider how the fund would affect concentration by manager, strategy, industry, and vintage. Do not assume that a planned exit will occur on schedule or at a stated value.
4. Approve and document. Record the expected role of the fund in the portfolio, main risks, unresolved issues, and approval conditions. Negotiate permissible terms through counsel. Complete legal and operational onboarding before sending capital.
After commitment, track capital calls, distributions, valuations, fees, portfolio concentration, key-person events, and changes in strategy or team. Compare updates with the original mandate and review cadence. A capital call must be met under the fund documents, so maintain a liquidity plan rather than relying on expected distributions.
Assess portfolio exposure and liquidity
Portfolio diligence examines what the fund owns, how it may create value, and what could delay or reduce returns. An LP should look beyond the manager’s target number of companies. Review concentration, sector exposure, leverage, follow-on reserves, and the fund’s dependence on a small number of exits.
Ask how the manager expects to realize value: a sale, public listing, refinancing, or another route. These are possible pathways, not promises. Review the fund’s assumptions about holding periods and exit conditions, then consider what happens if financing markets weaken or a buyer is not available. Private equity fund interests can have limited transfer options, so secondary sales should not be treated as a certain liquidity plan.
The relevance of a result depends on your own objective. A fund with attractive deal-level outcomes may still create too much concentration, require capital sooner than expected, or rely on assumptions that your investment policy does not accept. Compare the portfolio’s likely role with other holdings and your ability to fund calls through the full investment period.
Decision record – What portfolio role will this fund serve? – Which risks could cause a loss or delay liquidity? – What is the expected capital-call and distribution pattern? – Which results are realized, and which depend on manager valuations? – What evidence or event would trigger a follow-up review?
Frequently asked questions
What should an LP review first?
Start with mandate fit, eligibility, strategy, team, and verified performance. This early screen can reveal a basic mismatch before you spend time and money on a full legal, tax, and operational review.
Is a high IRR enough to choose a private equity fund?
No. IRR reflects cash-flow timing and may be affected by subscription-line use. Review net results, multiples, realized value, deal attribution, and audited records, then compare funds with similar strategies and vintages where possible.
What is the difference between gross and net returns?
Gross returns generally show investment results before fund-level fees and expenses. Net returns reflect costs charged to the fund or investor under the stated method. Check the manager’s definitions and calculations before comparing figures.
How do I verify a manager’s regulatory information?
Review the manager’s current Form ADV and available information in the SEC’s IAPD system. Check relevant filings and disclosures directly, and ask qualified counsel about issues that may affect your investment or the offering.
Does every private equity investor need $5 million in investments?
No. That threshold generally relates to the individual qualified-purchaser test for certain funds relying on Investment Company Act §3(c)(7). Other structures and exemptions have different requirements. Confirm eligibility with counsel.
What fund documents should I review?
Review the LPA, subscription documents, side letters, offering materials, and relevant financial and operational records. Have counsel compare written terms with the manager’s explanations and identify provisions that need clarification.
Why do subscription facilities matter?
A subscription facility lets a fund borrow against investor commitments, subject to its terms. It can affect capital-call timing and reported IRR. Ask how use of the facility is disclosed and reflected in performance calculations.
What should I monitor after committing?
Track capital calls, distributions, fees, valuations, portfolio concentration, team changes, and key-person events. Compare updates with the original mandate and maintain enough liquidity to meet obligations under the fund documents.
A defensible LP decision does not depend on one score or benchmark. It links the mandate to verified evidence, clear legal terms, a realistic liquidity plan, and ongoing oversight. If key claims remain unverified or the fund does not fit your constraints, document that result and pause before committing.
(This article was written by one of our staff writers, James Holloway. Visit our Meet the Team page.)
