What is Operational Due Diligence in PE fund selection?

Question

AcadiFi · Accepted Answer

Operational Due Diligence (ODD) evaluates the non-investment aspects of a PE firm — the 'can they run a shop' question, separate from the 'can they pick deals' question handled by investment DD.

Core ODD review areas:
1. **Firm governance** — ownership structure, decision-making authority, key-person provisions, succession planning.
2. **Back office and operations** — fund accounting (internal or third-party), valuation committee process, audit quality (Big Four preferred), cash management controls.
3. **Compliance and regulatory** — SEC/FCA registrations, ADV filings, code of ethics, personal trading policies, AML/KYC procedures, most recent regulatory exam findings.
4. **Technology and cyber** — data management, disaster recovery, cyber insurance, recent breach history.
5. **Service providers** — fund administrator, auditor, legal counsel, prime broker references and rotation cadence.
6. **Fund terms and structures** — parallel vehicles, management company expenses charged to fund vs borne by GP, LPAC composition.
7. **Expense allocation** — broken deal costs, co-investment expense treatment (Dell settlement era triggered scrutiny).
8. **Employee matters** — turnover of senior professionals, compensation structure, carry distribution within team.

Example: Meridian LP declined to invest in a 'top quartile' mid-market buyout GP after ODD found the CFO was the fund manager's spouse, audited financials had a qualified opinion two years running, and ten of twenty deal professionals had left in 18 months. Investment performance looked great; operational red flags killed it.

ODD typically takes 6-10 weeks and involves on-site visits, document review, reference checks, and scenario testing. Large LPs maintain dedicated ODD teams separate from investment staff.

What is Operational Due Diligence in PE fund selection?

Master Level III with our CFA Course

Related Questions

Practice Questions