The downfall of The Abraaj Group has, since the unraveling began in February, provided much for private equity professionals to ponder. But the most pertinent question has always been: “What does this mean for the wider industry?”
As we have noted before, one reaction must be an enhancement of operational due diligence practices.
This week we got some detailed insight into this very matter from an Abraaj insider. Ahmed Badreldin was until recently a partner and head of the MENA region for Abraaj, a firm which has collapsed under the weight of its debts and amid allegations that investor capital from a number of its funds was misused.
Badreldin wanted to put forward some practical steps that LPs can take to protect themselves when investing in “emerging managers and smaller GPs.” While he is understandably careful not to identify any specific situation, his observations carry weight given what he must have witnessed over the past year.
The former Abraaj exec has some very specific ideas about protecting investors, such as ensuring that the limited partner advisory committee has the power to demand a forensic fund audit and access to the fund’s bank statements. He also recommends that third party fund administrators be empowered to question the GP’s instructions (“lest it become a rubber stamp”), or better still, bear legal liability as directors in the GP as “this increases the focus and attention to detail.”
He also suggests that administrators’ work should be periodically reviewed by a third party, “as not all fund administrators are equal.”
What comes through loud and clear from Badreldin’s article is that, in what is still regarded as a people business, a huge part of investment due diligence is based on trust and human instinct. If an investment process for an LP takes between six and 12 months, then “emotional investment potentially gets in the way” of the skepticism that is a necessary part of due diligence.
Part of overcoming this involves doubling down on what one might view as traditional due diligence: properly getting under the bonnet of the firm. “Flushing out inconsistencies from one-on-one interviews, historic churn of GP professionals and interviewing the internal auditor (including specifically what has been excluded from the internal audit cycle) are some of the approaches,” he writes. “Bottom line here is: slides may be perfect, but it can’t be all rosy.”
Abraaj is an emerging markets-focused investor headquartered in the Middle East, but its investors were global. So too will be the fallout. Investors are already getting more granular in terms of the volume and type of data they require. GPs should not be surprised if they start being more prescriptive about fund governance and controls too.
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