What it is
Fund due diligence is a structured review of a private fund before someone decides whether to participate. It generally looks at the manager, the strategy, the legal documents, the fees and the way the fund is run day to day.
Three areas come up most often. Document review covers the private placement memorandum (PPM), the subscription documents and the fund's governing agreement. Operational due diligence looks at the back office: who holds the assets, who administers the fund, who audits it, and how risks and conflicts are handled. Fee and terms review looks at management fees, performance-based compensation, expenses, lockups, redemption or distribution rules and reporting.
Due diligence is not a guarantee of any outcome. It is a way to understand what you are being asked to agree to. Private offerings are made only by the issuer through its own offering documents, and nothing here is an offer or a solicitation to buy any security.
How it’s traditionally been approached
Traditionally, people have approached due diligence with a checklist and a series of conversations. They read the offering documents closely, ask the manager written and live questions, and request background information about the team, service providers and past regulatory or legal history.
Many people involve their own licensed advisers. An attorney may review the legal documents, an accountant may look at tax reporting such as K-1s and how tax treatment could apply, and a financial adviser may consider how a fund fits into the person's wider situation. Tax treatment, including anything related to QSBS (Section 1202), depends on individual circumstances.
Eligibility is part of the process too. Many private funds are offered under SEC Rule 506(b), which does not allow general solicitation, or Rule 506(c), which allows general solicitation but requires that all purchasers be accredited and that the issuer take reasonable steps to verify. Under Rule 501(a), accredited-investor categories include certain income or net worth tests, holders in good standing of Series 7, 65 or 82 licenses, knowledgeable employees of the fund, spousal equivalents, entities and family offices with over $5 million in investments or assets, and registered investment advisers and exempt reporting advisers, following the August 2020 amendments.
How the right fund manager may help
The right fund manager or due diligence professional may help you organize the review, so that you know which questions matter and where to find the answers in the documents. They may also explain unfamiliar terms in plain English and point out areas that merit a closer look with your own attorney or accountant.
A first conversation is generally an exchange of information. You might be asked about your goals, your experience, your timeline and your need for access to your money. Helpful questions to bring include: How are fees calculated and when are they charged? What are the lockup and redemption or distribution terms? Who administers and audits the fund? How often will I receive reports, and what will they include? What conflicts of interest exist, and how are they managed?
It can also help to ask what happens if things do not go as planned, how decisions are communicated, and what risks the manager considers most significant. A good conversation leaves you better informed, whether or not you decide to go forward. Past performance does not guarantee future results, and a thorough review cannot remove risk.
The bigger picture
Big financial decisions can bring stress, second-guessing and sleepless nights. Taking time to understand the documents and terms may help you feel more settled, because you are choosing with clear eyes rather than under pressure. Giving yourself room to say no, or not yet, is a healthy part of the process.
Money decisions also affect relationships, daily routines and long-term plans. Some people find it useful to talk things over with family, a trusted adviser or a wellbeing professional, and Providers.plus can help you find support for the personal side of financial stress. No approach is right for everyone, and every method of reviewing a fund has its place.
Keep in mind
- Private fund investments are speculative and illiquid and can lose all of their value.
- Past performance does not guarantee future results, and due diligence does not eliminate risk.
- The Hastings Fund is an independent directory, not a broker-dealer, funding portal or investment adviser, and it does not recommend, endorse or rank investments.
- Consult your own licensed investment, legal and tax advisers, since tax treatment and suitability depend on individual circumstances.
Fund managers
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Frequently asked questions
What is fund due diligence?
Fund due diligence is the process of researching a private fund and its manager before committing capital. It usually covers the offering documents, operations, fees, terms and reporting. It helps you understand what you are agreeing to, but it does not guarantee any result.
What should I ask a private fund manager?
Common questions cover the strategy, the team's background, how fees are charged, lockup and redemption or distribution terms, who the service providers are, and how often you will receive reports. You can also ask about conflicts of interest and the main risks. Your own attorney or adviser can help tailor the list to your situation.
What is a PPM and why does it matter?
A PPM, or private placement memorandum, is a document that describes a private offering, including its strategy, risks, terms, fees and conflicts of interest. It matters because it is where the issuer sets out the details of the offering. Reading it with a licensed attorney can help you understand the obligations and risks involved.
What is operational due diligence?
Operational due diligence is a review of how a fund actually runs, apart from its strategy. It often looks at who administers the fund, who holds assets, who audits the books, and what controls and compliance practices are in place. It aims to help you understand operational risks, though it cannot remove them.
How do I review fund fees and lockups?
Start by finding the fee and redemption sections of the offering documents, then list each fee, when it is charged and how it is calculated. Check how long your money may be locked up and what limits apply to withdrawals or distributions. Ask the manager to explain anything unclear, and have your own adviser review the terms.
Do I need to be an accredited investor for fund due diligence?
You can learn about due diligence without being accredited, but many private funds are limited to accredited investors under SEC Rule 501(a). Rule 506(c) offerings require all purchasers to be accredited and the issuer to take reasonable steps to verify, while Rule 506(b) offerings do not allow general solicitation. Ask your own licensed adviser how these rules apply to you.
Educational resource. The Hastings Fund shares general information and connects people with independent fund managers. It is not professional advice. Talk with a qualified professional about your own situation.