Practical strategies and solutions to safeguard private equity firms and asset managers

Background Checks, Due Diligence, Employee Training, ESG, External Threats, Governance, Insider Threats, Internal Threats, Portfolio Management, Private Equity, Risk Management, Risk Mitigation, Threat Intelligence

February 10, 2023
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In this white paper, we share state-of-the-art strategies for private equity firms to mitigate deal execution risk, enhance governance, and protect funds and managers against internal and external threats. A high concentration of capital in the hands of a small number of people puts private equity firms under the same pressure as larger investment organizations with a higher headcount.

Key Takeaways

An effective organization will stick to several important principles:

  • They place great importance on governance and all its aspects, like oversight, review, and enforcement.
  • They take great care in setting policies for all areas of their own firm and its portfolio.
  • They perceive accountability and oversight as a diligent, never-ending task that needs regular attention and refinement.
  • They make strategic investments into safeguarding their firm and its funds, increasing health and longevity.
  • They rely on an expert partner to co-design, implement, and enforce their policies.
  • They encourage participation from all team members in developing and implementing guidelines.

Download the PDF version of our white paper "Best practices for safeguarding private equity firms"

Best practices for safeguarding private equity firms

A 5 minute read, this white paper lists the state-of-the-art strategies to mitigate deal execution risk, enhance governance, and protect funds and managers against internal and external threats.

Click the button below for a direct download.

Context and Challenges for Private Equity firms

Private equity is among the most attractive asset classes, and assets under management continue to rise rapidly. However, like every other investor, private equity managers face geopolitical risks, uncertain inflation, higher interest rates, and economic turbulence.

Record levels of dry powder and limited partner (LP) expectations continue to put pressure on transaction valuations and the realization of required rates of return. In that environment, private equity firms face unique internal challenges and external threats.

Private equity managers must continuously manage the expectations of asset allocators and investment targets alike. In addition, recent environmental, social, and governance (ESG) forces create another layer of considerations for operations, transparency in communication, team conduct, and the firm’s positioning in the marketplace.

The following five strategies have contributed significantly to the overall health of private equity firms. Accordingly, they should be a starting point for improving the firm’s operations.

private equity

1. Conduct People Due Diligence just as Thoroughly as the Financial One

With record amounts under management, record levels of dry powder available, and an unbroken need to deliver returns, it is inevitable that the investment appetite is as big as ever. This might lead to opportunities and teams being considered for investment that would not pass in different circumstances. Unfortunately, it is also high time for con men and deception schemes. Of course, investment activities will inevitably yield different perspectives within the firm on the future success of the investee company and team. Every private equity firm must pay attention to early warning signs, and every orange flag must be examined. Every opportunity must be taken to vet individuals and make background checks a standard part of the due diligence process. Often these simple efforts can yield valuable results that benefit the fund in the long term by possibly systemically averting catastrophic consequences, like complete loss or an impaired reputation.

How Falcone International can help with this: Falcone International regularly performs motivation audits,  in-depth interviews, and advanced background checks with existing or prospective investment targets’ founders and managers to identify discrepancies and allow them to be repaired. Organizations drawing on these measures report higher levels of financial health, lower levels of write-offs, and higher levels of trust among key people on both sides.

Because of their funds’ vintages, PE firms must harmonize near-term exit ambitions and long-term high levels of success by hardwiring their ethos and philosophies into guidelines.

2. Acknowledge, Track, and Correct Mistakes Decisively and Timely

Mistakes will be made within the private equity firm and its portfolio in day-to-day and long-term management. It is essential to acknowledge them, discuss them openly and freely, systematically track them, and eventually take corrective action. As asset managers, private equity managers are asset protectors and should not hesitate to intervene and get involved with all their heft. Time is a critical factor in most cases, and swiftly mounting an effective countermeasure is crucial to avert further loss. Equally, private equity firms must ensure that they create an environment in which mistakes or wrongdoing can be safely reported in the first place. Regardless of team size, a private equity firm can also benefit from setting up its own whistleblower program to learn of suspicious activities within its portfolio companies.

How Falcone International can help: Falcone International regularly performs audits and investigations for investors. If something goes wrong, we thoroughly investigate the circumstances and people to offer our clients an impartial, unbiased third-party view on the case. Organizations drawing on these investigations report higher effectiveness in solving issues, preventing further losses, and more confidence in rectifying internal and external wrongdoing.

3. Formulate Clear Philosophies and Guidelines Across all Activities

Despite the fixed time horizon of their individual funds, private equity managers can achieve high levels of consistency and success by hardwiring their philosophies into guidelines. Not all eventualities are entirely predictable, so it is helpful to set out a general philosophy that every member of the fund management team can get behind. These philosophies can then be transposed into guidelines with more operational terms and even passed on to portfolio companies either as part of the investment commitment or post-investment as a best practice demanded by the investor. The more precise these guidelines are, the easier adherence and enforcement can be. This is especially relevant for private equity managers as their actions, in turn, will be examined by either their limited partners (LPs) or the press if one of the portfolio companies is found to be involved in something untoward. Interestingly, in most cases of fraud, most perpetrators have higher levels of authority. Thus, all definitions of roles and responsibilities should also include a framework for top management in which their actions can be reviewed by an investor team or the company’s board, for example.

How Falcone International can help: Falcone International regularly performs reviews of all guidelines, probes for internal compliance, test internal policies and philosophies, and facilitates internal participation in reviewing guidelines and standards. Organizations utilizing these tools report higher efficiency and lower costs. Being in compliance is made more accessible, and the firm has a more solid basis for any action brought against non-compliance. In addition, management and staff report that they find it easier to operate in an environment with clear rules. 

The pressures on private equity firms are mounting. Major investment firms regularly draw on business intelligence resources to make better-informed decisions and proactively manage risk.

private equity

4. Make Portfolio Companies Think of their Stakeholders and as Being One of your ‘Family Members’

Often conflict arises from the misalignment of expectations. A clear definition of a company’s standards can mitigate these risks. Companies use policies like a ‘Supplier Code of Conduct’ or other publicly available statements (against Tax Evasion, Slavery, Child Labor, etc.) to publish their aspiration on different issues. A publicly or privately available policy incentivizes stakeholders and portfolio companies to comply. Often, reputational damage can arise from a supplier or external stakeholder misconduct, which all related parties are dragged into. By proactively communicating and enforcing the organizations’ ethos and ethics and then effectively monitoring and enforcing them, a public track record can serve as evidence and a tool for safeguarding the organization. Private equity managers can efficiently ensure compliance with new written and unwritten environmental, social, and governance (ESG) rules in their portfolio companies by implementing them in their firm first and then leading by example and expecting portfolio companies to follow suit.

How Falcone International can help: Falcone International regularly performs overt and covert in-depth reviews with clients’ key stakeholders like suppliers or customers to check for compliance with rules and regulations or act upon specific findings and tips from within. Organizations utilizing these services report higher efficiency through higher levels of trust in their key stakeholders. Other effects include lower insurance premiums and avoiding costly conflicts like lawsuits or public relations issues.

Regular high-level and in-depth reviews are crucial for private equity firms and can deter untoward activity.

5. Establish Perpetual Accountability through Process and Mindset in the Private Equity firm

Like muscles in sporting activities, a one-time effort is reasonable, but only a powerful habit is excellent. Making accountability functions like internal audits and governance and an ongoing effort with regular high-level and in-depth reviews is crucial for private equity firms. Supervising the firm and its portfolio continuously can be a great exercise. Equally, it will deter any untoward activity geared towards a long-running scheme. Most fraud in business has a surprisingly long runtime. Asset misappropriations can go undetected for years. In addition, regular reviews make detecting anomalies in financial statements or management reports easier.

How Falcone International can help: Falcone International regularly performs in-depth reviews concurrently with internal financial reviews to enrich the analysis of internal findings. Upon detection of anomalies, Falcone International can take further action by investigating the results, securing evidence, assisting with recovery, and complementing possible litigation efforts through in-house or external counsel. As a result, organizations utilizing these reviews report higher levels of confidence in their internal processes and higher efficiency in keeping their own rules and processes current and timely.

Download the PDF version of our white paper "Best practices for safeguarding private equity firms"

Best practices for safeguarding private equity firms

A 5 minute read, this white paper lists the state-of-the-art strategies to mitigate deal execution risk, enhance governance, and protect funds and managers against internal and external threats.

Click the button below for a direct download.

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