The "Four P's" of Due Diligence (2024)

In the private equity and venture capital industries, due diligence is essential to uncovering the highest quality managers and reducing risk. After all, the top-quartile managers return more than 22% annualized returns, while the bottom-quartile barely beat inflation.

But with more than 18,000 private equity funds, it can be tough to know where to start. A few tangible principles can help guide the way, including people, performance, philosophy, and process. Four less tangible principles can also play a role in manager selection: passion, perspective, purpose, and progress.

Among various other elements, Gridline’s due diligence process focuses on these “four P’s” to identify the best possible managers for our clients. We make access to these managers available via Thematic Portfolios for a targeted investment thesis or vehicle that provides access to funds typically reserved for insiders.

People

When it comes to people, we want to know about the quality, depth, and experience of the fund’s investment team.

The team’s pedigree is important, but so is diversity. Studies show that diverse PE funds outperform their non-diverse counterparts. Additionally, relying solely on a star manager can be dangerous, so we also want to see a deep bench of talent. After all, emerging managers outperform established managers.

Performance

Key measures when it comes to performance include internal rate of return (IRR), multiple of invested capital (MOIC), and public market equivalent (PME).

IRR is a capital-weighted return providing a single cumulative figure that is useful for comparing different sizes and durations of investments. Unlike IRR, which measures the “when” of the return, MOIC measures the “how much” by dividing total proceeds by total capital invested. This is a key ratio for understanding how much value a manager has created.

PME compares private capital fund performance to public indices and is a useful metric for understanding whether a manager is truly adding value or if they are simply riding the wave of a bull market.

Philosophy

Value-creation is the primary focus of private capital, so it’s important to align with a manager who shares that philosophy. A long-term orientation toward investments and a willingness to actively work with portfolio companies are key.

Exploiting market inefficiencies is another key part of the private capital investment philosophy, so we also look for managers who deeply understand their chosen market or industry. This allows them to identify opportunities that others may miss.

Process

A manager’s investment process should be clear, repeatable, and well-documented. A disciplined approach to research and decision-making, as well as a focus on continuous improvement, is vital.

Additionally, it’s important to know how positions or themes are added to the portfolio, monitored, and removed. A good investment process will help ensure that the portfolio is well-constructed and managed to minimize risk.

Intangible Factors

In addition to the four key principles of people, performance, philosophy, and process, four intangible factors can also play a role in manager selection: passion, perspective, purpose, and progress.

Passionate managers are those who are truly dedicated to their work and have a genuine interest in making a difference. They should also be able to articulate their vision for the future and inspire others to buy into it. Diversity of perspective is also important to avoid groupthink and generate new ideas. That’s why we look for open-minded managers embracing diverse views.

Private capital managers should have a clear purpose beyond simply making money. They should be motivated by creating value and positively impacting the world. Finally, we want to see evidence of progress.

Gridline’s due diligence process includes these “four P’s” to identify the best possible managers for our clients. This allows our clients to invest confidently, knowing they are aligned with some of the top talents in the industry.

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