Answering the same question once

Anyone wondering how serious institutional investors have become about due diligence should take a look at the 100-plus-item questionnaires now sent GPs’ way during fundraising.

A lot of time and effort (on the part of both manager and investor) goes into creating and processing these due diligence questionnaires, yet when it comes to basic firm information, they all tend to capture the same details. The result is a ton of redundant paperwork for the CFOs and COOs responsible for filling out various questionnaires that come in different styles and templates. If there was a way to standardize some of the process, the reduced administrative burden would be serious cause for celebration.

Over the past few months the Institutional Limited Partners Association has been working to do exactly that. Speaking with GPs, LPs, placement agents and consultants, the LP trade body feels that it’s created a standard list of due diligence questions that will be met with industry-wide approval. ILPA hopes to post its final questionnaire on its website sometime in October, PE Manager has learned.

ILPA expects the outcome to benefit all stakeholders. GPs would like to streamline the process of filling out DDQs, which should also benefit their LPs. And there's also a perk in that newer entrants to the private equity asset class, who may not be aware of the level of transparency and detail provided by their more veteran counterparts, will have a model to follow from the outset.

But similar to the limits of standardized reporting templates, it's a tall order for a standard questionnaire to meet every LP’s wants and needs. Institutional investors are a heterogeneous bunch that come with different priorities when selecting a fund manager. Some for instance may have many more questions about a firm’s ESG policies, others its policy on co-investments or perhaps operating capabilities. It's hard to see how large, established institutional investors with complex policies of their own would be able to throw out their existing questionnaires in favor of a standardized form.

We asked ILPA managing director Mike Elio, who is spearheading the initiative, how an ILPA-created DDQ can really fit all LPs' needs. His answer? It isn't supposed to.

“It’s really a tool that creates a common framework for GPs to begin answering LPs’ due diligence questions,” says Elio. “If everyone adopted our DDQ, and only added one extra page of questions not already answered in the template, then we’ve achieved greater efficiency in processing them.”  

Getting LPs to adopt and accept the template won't be the only challenge; GPs will need convincing, too. In pre-marketing and during fundraising periods, many GPs try to anticipate investors' FAQs by uploading their own DDQs with answered questions into shared datarooms. Doing so provides GPs greater control over what information is readily available to prospective investors, and prevents data fishers – who are not actually serious about making a commitment – from easily accessing sensitive performance figures or budget information. Some fund managers might worry about releasing all the answers on a standardized form in this fashion, but Elio says a solution would be allowing GPs control over the timing of delivery of their answers. “Perhaps 80 percent of questions in the template are answered in a round one of due diligence, and the remaining 20 percent of more sensitive questions are answered to more serious investors in round two.”

A last challenge for ILPA may be the strong use of yes or no questions in its draft questionnaire – 58 of the 155 items in the questionnaire are in this format and do not allow for explanation. That goes against convention to some extent; when filling out a DDQ, GPs often like to include lengthy explanations around answers they fear may lose points with investors, or which are too nuanced to address under a check-the-box approach. But Elio argues LPs are sophisticated investors who understand that there are often legitimate reasons behind a ‘No’ answer. “And they’re annoyed by having to read 10 paragraphs of spin before receiving a direct answer to what they feel is a simple question.”

What's your view on standardizing due diligence? ILPA will continue soliciting feedback until the end of September. Email ilpaprinciples@ilpa.org to join the conversation.