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Private Equity Operational Due Diligence: Tools to Evaluate Liquidity, Valuation, and Documentation by Jason A. Scharfman

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CHAPTER 6

Legal Due Diligence

Early on in the history of private equity, investors did not perform much, if any, operational due diligence. In recent years, in part driven by losses due to poor operations in funds and outright fraud in others, investors have begun to recognize the benefits of operational risk assessment in private equity funds. These moments of enlightenment, whether driven by a true desire to actually make more informed investment decisions or driven by a once bitten, twice shy reaction caused by bad experiences with poor operational infrastructures in the past, is a positive development for both private equity investors and fund managers alike. As Justice Louis Brandeis once famously said, “Sunlight is the best disinfectant,” and with the increased transparency that is required by a well-developed and properly implemented operational due diligence program, private equity investors will hopefully make better-informed operational choices when selecting a private equity fund.

OPERATIONAL DUE DILIGENCE SPECIALISTS VERSUS GENERALISTS

While increased acceptance of operational due diligence is commendable, it presents investors and private equity allocators, such as private equity funds-of-funds and consultants, with a series of challenges. In addition to carrying out the actual review and monitoring work entailed in a private equity operational due diligence program, professional allocators in particular must now make certain decisions as to the structure and resources ...

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