This white paper covers deal execution risk, governance, and protecting funds and managers against internal and external threats. Private equity concentrates a great deal of capital in the hands of very few people, which produces the scrutiny of a large institution without the staff of one — and that mismatch is where most of the exposure sits.
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"
A 5 minute read on reducing deal execution risk, tightening governance, and protecting 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.
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: we review guidelines, test internal policies against actual practice, and involve the people bound by the rules in revising them. Clients report that clear rules make compliance cheaper to maintain and give the firm firmer ground if non-compliance is ever alleged. Staff generally report the same thing in plainer terms: it is easier to work somewhere the rules are unambiguous.
Pressure on private equity continues to rise. Most major investment firms now treat business intelligence as a standing input to decisions rather than something commissioned once a problem appears.
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: we run reviews with key stakeholders — suppliers, customers — both openly and discreetly, to test compliance or to act on a specific finding or internal tip. Clients report better-founded trust in those relationships, and secondary effects that include lower insurance premiums and conflicts that never became lawsuits or press stories.
Reviews that happen on a schedule deter conduct that depends on nobody looking. That deterrent effect is worth as much as the findings.
5. Establish Perpetual Accountability through Process and Mindset in the Private Equity firm
A single review establishes a baseline; only a repeating one detects drift. This matters more than it sounds, because most business fraud runs for a surprisingly long time — asset misappropriation regularly goes undetected for years, not months. Schemes of that duration depend on the assumption that nobody will look twice at the same thing. Regular internal audit and governance review removes that assumption, and makes anomalies in financial statements or management reports far easier to see.
How Falcone International can help: we run reviews alongside internal financial review, which gives the internal findings a second, independent reading. Where an anomaly surfaces we can carry it forward — investigating, securing evidence, supporting recovery, and working with in-house or external counsel if it goes to litigation. The reported benefit is mostly confidence: knowing the internal processes hold, because somebody outside them checked.
Download the PDF version of our white paper "Best practices for safeguarding private equity firms"
A 5 minute read on reducing deal execution risk, tightening governance, and protecting funds and managers against internal and external threats.
Click the button below for a direct download.
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