Investment Manager Due Diligence Process

Investment Manager Due Diligence Process

Due Diligence on an Operator/Sponsor

We want to invest our money with organizations and individuals that are trustworthy and reliable. It’s just common sense. But how do we know if a fund operator or sponsor is trustworthy? Through Investment Manager Due Diligence Process of course.

By taking on the work of due diligence you will gain insight into the investment, the organization, and the people responsible for running the company. For some investors, private equity investments are new. So, a proper due diligence process before putting money down is essential.

You want to work with a sponsor who is transparent and accountable.

investment manager due diligence process


Fund Manager, Heather Dreves

Heather is passionate about the power of transparency in creating a win-win for both sides of an investment. Whether you conduct due diligence yourself or use a third-party monitoring provider, Heather’s guide will help you ask the right questions and gather the right data to better protect your hard-earned capital.

Heather Dreves - Secured Investment Corp Fund Manager
Heather Dreves speaking at the National Lending Experts Conference

As the Fund Manager for Secured Investment Corp (SIC), Heather has been responsible for the sale of over 75 million dollars in trust deed mortgages and raised more than 10 million in SIC’s High Yield Equity Funds.

Heather has worked in the private money industry for over 15 years and is one of a handful of women fund managers in the U.S.

She speaks frequently at financial and lending conferences and financial mastermind groups. She was featured in the June 2021 edition of the Originate Report magazine and is a published author with her first book titled, Money Multiplied – Generate Passive Income as a Private Money Lender.

As a regular guest on real estate, financial, and investing podcasts, Heather speaks about passive investing using Private Equity Funds and Mortgage Notes.

A Definition of Due Diligence

Due diligence is the practice of scrutinizing an investment before venturing into it.

By focusing on a consistent due diligence process, investors can understand the scope and management of an investment before entering any type of agreement.

The Need for a Investment Manager Due Diligence Process on a Fund Operator and Sponsors

When you are vetting potential investments, it is important to understand the background and experience of the fund operator or sponsor. This includes:

  • Historical performance
  • Current and former investors
  • What products do they offer
  • What services do they provide

Ask About the Team

You should also ask about the team behind the fund.

  • What are their backgrounds and qualifications?
  • Do they have experience in the industry you are investing in?
  • How large is their team and what is their performance record look like?

Closely Examine the Fund’s Offering

  • What are the terms of the investment?
  • What is the expected return?
  • What are the risks involved?
  • How does this investment fit into your overall financial strategy?

Understanding the Regulatory Environment in Which the Fund is Operating

  • What are the specific regulations that apply to this investment?
  • What are the risks and potential rewards?

Finally, it is important to understand the fund’s accounting and financial reporting. How often do they report to investors?

What are the Benefits of Doing Due Diligence on a Fund Operator or Sponsor?

By following a due diligence process, you can ensure that you are fully aware of the risks and rewards involved in any investment. You can also assess the quality of the fund operator or sponsor and their team. This is important for protecting your capital and ensuring that you are making wise decisions with your money.

Third-Party Due Diligence

Working with a third-party due diligence provider can also be helpful. They can provide an objective assessment of the fund and its operators, as well as help you gather the information you need to make an informed decision.

The investment manager due diligence process is an important part of any investment process and should not be taken lightly. By taking the time to ask the right questions and gather the right data, you can protect your capital and maximize growth.

10 Reasons Why You Should do Your Due Diligence on a Fund Operator

  1.  To assess the financial condition of the operator and its ability to continue to meet its obligations to you as an investor.
  2.  To understand the business model of the fund and how it works.
  3.  To review the investment strategy of the fund and how it performs.
  4.  To read through the fund’s offering memorandum and understand the risks associated with investing.
  5.  To review the fund’s Limited Partnership Agreement (LPA) and guidelines.
  6.  To research the experience and performance of the management team of the fund.
  7.  To understand the ownership structure of the fund and who stands to benefit.
  8.  To check the regulatory filings of the fund with the relevant authorities.
  9.  To review any complaints or lawsuits that have been filed against the fund or its operator.
  10.  To get input from industry professionals, such as lawyers and accountants, who can provide an objective overview of the fund and its operator.

When performing due diligence on a fund operator, make sure the operator and organization fit your needs as an investor. To do that, focus on Three Core Areas.

Three Core Areas of Focus

When conducting your due diligence process, there are Three Core Areas to focus on. These are:

  1.  Sponsor/Operator Due Diligence (the people)
  2.  Investment Due Diligence (the fund)
  3.  Investment Monitoring (the administration)

Conducting Sponsor/Operator Due Diligence

Begin by collecting some general information. This includes names and positions of principles and executives working in the company. Starting here gives an investor a lot of background, with information gleaned from company websites and publications.

Begin with the basics for sponsor due diligence:

  • Sponsor name
  • Principal names
  • Year founded
  • Current investor capital managed
  • Background checks on principals
  • Typical K-1 delivery date on existing
  • Past deals review
  • Example investor reporting package
  • Review offering material for past opportunities (e.g. PPM, OM, Executive Summary)
  • Contact investor references

Review list of key employees:

  • Head of Acquisitions
  • Head of Investment Committee
  • Head of Asset Management
  • Head of Investor Relations

Confirm service providers:

  • Securities Counsel
  • Real Estate Attorney
  • Property Manager
  • Loan Servicer

Other areas for review:

  • Review List of Affiliated Entities / Companies (should be listed in their PPM)
  • Review Track Record / Asset List Verify Asset Existence
  • Confirm Performance Metrics (IRR/MOIC)

Investment performance history Historical activity inside an investment
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Six Introductory Questions for Sponsors

Sponsors and Fund Operators understand peoples’ need to know when it comes to the company and the investments under management. Fielding questions is part of the job of a sponsor.

Questions you can ask a sponsor, include:

  • How did you get into real estate? What is the origin story for the Sponsor Firm?
  • What is your asset acquisition strategy? How do you source new opportunities?
  • What key markets do you operate in and why do you operate in them?
  • What is your investing philosophy? How do you determine whether a deal is worth doing?
  • How do you generate value once you’ve invested? What is done to ensure a return on capital? What are some ways that you mitigate inherent risks?
  • Who are the key players involved that allow you to execute your acquisition and asset management strategy?

Conducting the Investment Manager Due Diligence Process

  • Name of entity
  • Reporting frequency
  • Report delivery due dates
  • Distribution frequency quarterly
  • Anticipated date of first distribution
  • Minimum investment amount
  • Debt or preferred equity
  • Property type(s) multi-family
  • Review conflicts of interest
  • Review operating agreement
  • Income (loss) allocation
  • Fees payable to GP or an affiliate 2% asset management fee
  • Allowable partnership expenses
  • Preferred return?
  • Catch-up?
  • Profit split (LP/GP)?

Fund Administrator Due Diligence Questionnaire

We’ve made it easy for you to conduct your own investment manager due diligence process.  Click the link below to download our Fund Manager Due Diligence Checklist today.

Assess the Financial Condition of the Operator and Their Ability to Continue to Meet its Obligations to Investors.

When doing due diligence on a fund operator, one of the key things you want to look at is their financial condition. This includes their current assets and liabilities, as well as their historical financial performance. You want to make sure that the operator can meet its obligations to you as an investor now and in the future.

You can also look at the operator’s credit rating to get a sense of their overall financial health. A low credit rating can be a sign that the operator is struggling financially and may not be able to meet their obligations in the future.

Another thing you want to look at is the operator’s debt-to-equity ratio. This will give you an idea of how leveraged the operator is. A high debt-to-equity ratio can be a sign of financial distress and may lead to problems down the road.

Finally, you want to make sure that the operator has a healthy cash flow. This will ensure that they have the resources they need to continue operating their business.

When assessing the financial condition of a fund operator, it’s important to look at all aspects of their financial health. By doing so, you can ensure that you are making a wise investment decision.

Understand the Business Model of the Fund and How it Works

When engaging in the investment manager due diligence process, it’s important to understand their business model. This includes:

  • How the fund works.
  • What types of investments does it make.
  • Demonstrated history of success.
  • Compliance with all applicable laws and regulations.
  • What are the fees? You will pay for these so make sure your net returns are solid.

Review the Investment Strategy of the Fund and How it has Performed in the Past

Fund Strategy and Distribution

Another area to understand would be the operator’s fund strategy. How are the operator’s investments distributed and how heavily leveraged in any one single industry or market?

This will give you an idea of how the fund plans to achieve its objectives.

Past Performance

You also want to look at the past performance of the investment strategy. Has it been successful in the past? Or has it resulted in losses for investors?

By reviewing the investing strategy and performance of a fund, you can better understand the risk level of the investment.

Past performance is a strong indicator of future gains or losses. Make an informed decision about whether or not to invest by understanding the history of the company and the fund manager’s performance during their tenure.

Read the Fund’s Offering Memorandum and Understand the Risks

One key thing you do not want to overlook is the fund’s offering memorandum. This document will outline all the risks associated with investing.

As defined by Investopedia:

An offering memorandum is a legal document that states the objectives, risks, and terms of an investment involved with a private placement

Carefully read through this document. Memorandums are a great help in understanding the investment and the company’s mission.

Risk Awareness

Some of the risks that may be included in the offering memorandum include:

  • The risk of losing some or all of your investment
  • The risk of not getting back your original investment
  • The risk of not receiving future distributions
  • The risk of being subject to restrictions on how you can sell your investment
  • The risk of being subject to penalties if you sell your investment before a certain date

Always be aware of the risks before investing your money.

Review the Fund’s Limited Partnership Agreement (LPA) and Guidelines

When doing due diligence on a fund operator, you also want to review the fund’s Limited Partnership Agreement (LPA) and guidelines. This will give you more information about how the fund operates and the types of investments it makes.

It’s important to familiarize yourself with the LPA and investing guidelines before investing in a fund.

Some of the things you can expect to find in the LPA and guidelines include:

  • The name of the fund manager
  • The type of investments the fund will make
  • The minimum and maximum investment amount
  • The fees associated with the investment
  • The terms and conditions of the investment

Research the Experience and Historical Performance of the Management Team of the Fund

When doing due diligence on a fund operator, it’s important to research the experience and performance of the management team. This will give you a sense of how qualified they are to manage the fund.

You can look at their experience and record to see if they have a history of success. Or, if they have any bankruptcies or convictions related to their work in the financial industry.

Understanding their history gives you a better idea of the experience level of the team and possible risks to investing if there are character questions.

Understand the Ownership Structure of the Fund and Who Stands to Benefit

When doing due diligence on a fund operator, it’s important to understand the ownership structure of the fund. This will help you determine who stands to benefit from the investment.

The ownership structure of a fund can be complex. But, by taking the time to understand it, you can get a better idea of who is in control of the investment.

Some things you can look for in the ownership structure include:

  • The name of the company that owns the fund
  • The name of the company that operates the fund
  • The name of any company that has a financial interest in the fund
  • The name of any company that has an advisory role with the fund

By understanding the ownership structure of a fund, you can get a better idea of who is in control and who stands to benefit from the investment.

Research the Regulatory Environment of the Fund

When doing due diligence on a fund operator, it’s important to research the regulatory environment of the fund. This will help you understand the laws and regulations that are in place to protect investors.

You can research the regulatory environment of a fund by looking at the following:

  • The financial regulator that oversees the fund
  • The type of investment the fund is making
  • The country where the fund is located
  • The company that created the fund

Ongoing Monitoring

After you’ve invested, keep close tabs on how things are going. Since you aren’t involved in the day-to-day operations, you will need to rely on the information provided by the Sponsor.

Assuming that you only decided to invest with a Sponsor that checked most of the boxes on the Sponsor Checklist and Investment Due Diligence Checklist, you should have what you need to complete a monitoring review. This review should happen every quarter at a minimum.

Report Delivery

When receiving reports from a Sponsor, check that they delivered the reports on the deadline.

If they were late—by how much? In a perfect world, they would meet or beat the deadline every time.

If they miss their deadline for two consecutive periods, you should probably contact the Investor Relations person and ask about the cause of the delay.

Reporting Information:

  • Sponsor Name of Entity
  • Invested into Investment Date
  • Your Investment Amount ($)
  • Reporting Period
  • Delivery Due Date
  • Report Delivery Date

 Review the Income Statement (Part of Reporting Package)

  • Total Income
  • Property Management Fees
  • Loan Servicing Fees
  • Total Expenses
  • Net Operating Income (NOI)
  • Interest Expense
  • Depreciation
  • Unrealized Gain (Loss)
  • Management Fees Net Income

Review investment income statements

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Filter Based on Your Real Estate Investment Criteria

Find verified sponsors who operate in industries or businesses that you are interested in. Also, social causes can come into play. Are the fund’s investments part of a larger philanthropic effort? If yes, do these align with your values?

Other areas of consideration, include:

  • Targeted geography
  • Strategy
  • Property type
  • Risk profile

Focus on the People and Sponsor

  • Focus on the who
  • Focus on the deal
  • Focusing on the people and only then search real estate deals that meet your objectives

Due Diligence Before Taking Action

By completing an investment manager due diligence process, you can feel confident that you’re making a well-informed decision. This process is critical to protecting your financial interests and should be done before any money exchanges hands.

If you have questions about the steps involved in due diligence or want help conducting this research for an upcoming investment, our team at Heather’s company is happy to assist. Contact us today to get started!

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