Due diligence

Key takeaways

• Thorough due diligence is essential in private equity to identify risks, ensure accurate valuations and align investments with strategic objectives.
• Both GPs and LPs must perform rigorous due diligence, albeit with different focuses: GPs on the deal opportunity and LPs on the GPs.
• Moonfare's due diligence process is highly selective, with a 5% selection rate, ensuring only the most robust investment opportunities are made available to investors.¹
• Financial, operational, legal and market due diligence are the primary types, each addressing different aspects of the investment. However, DD encompasses everything from intellectual property, technology and increasingly environmental, social and governance (ESG).
• A comprehensive due diligence process enhances negotiation power and supports informed decision-making, leading to better investment outcomes.

What is due diligence in private equity?

Due diligence (DD) in private equity is the rigorous and comprehensive process of investigation, analysis and evaluation that both General Partners (GPs) and Limited Partners (LPs) undertake to assess the viability, risks and potential returns of an investment opportunity. This process is vital for ensuring that investments align with the strategic objectives, financial goals and risk tolerance of the stakeholders involved.

For GPs, due diligence is crucial when analysing potential deal opportunities, as it allows them to identify any hidden risks, understand the true value of the target company and develop a robust investment strategy. For LPs, due diligence is equally important as they assess the capabilities, track record and strategy of the GPs they are considering committing their capital to.

Key benefits of due diligence in private equity

1. Risk mitigation: Due diligence helps in identifying potential risks associated with an investment, such as financial liabilities, operational inefficiencies or market vulnerabilities. By understanding these risks, investors can make informed decisions and develop strategies to mitigate them.
2. Accurate valuation: Through detailed financial analysis, due diligence ensures that the valuation of the target company is based on realistic assumptions and accurate data, reducing the likelihood of overpaying for an investment.
3. Strategic alignment: DD helps ensure that the investment aligns with the strategic goals and investment thesis of the GP or LP, increasing the likelihood of achieving the desired returns.
4. Enhanced negotiation power: Armed with thorough due diligence, investors are in a stronger position to negotiate terms and conditions, potentially leading to more favourable deal structures.
5. Informed decision-making: By providing a comprehensive view of the target company or GP, due diligence enables investors to make decisions based on a holistic understanding of the opportunity.

Types of due diligence

Due diligence in private equity can be categorised into several key types, each focusing on a different aspect of the target investment. These ensure that every facet of the investment is thoroughly evaluated before a commitment is made.

Financial due diligence

Financial due diligence is the cornerstone of the DD process. It involves a deep dive into the target company's financial statements, including its balance sheet, income statement and cash flow statement. The goal is to verify the accuracy of the financial data, assess the company's financial health and understand the drivers of its revenue and profitability.

Operational due diligence

Operational due diligence focuses on evaluating the target company's business operations and management practices. This type of DD aims to identify operational risks, inefficiencies and opportunities for improvement. It can cover assessments of everything from supply chain management to the quality of the workforce and human resources practices.

Legal due diligence

Legal due diligence involves a thorough review of the legal aspects of the target. This includes examining contracts, litigation history and compliance with laws and regulations. The purpose is to identify any legal risks or obligations that could impact the value or viability of the investment.

Market due diligence

Market due diligence focuses on the external environment in which the target company operates. It involves analysing the industry, competitive landscape, customer base and market trends to assess the company's growth potential and market position.

Moonfare’s method

At Moonfare, due diligence is at the heart of our investment process. Our method is designed to rigorously evaluate private equity funds and fund managers, ensuring that only the highest-quality opportunities are presented to our investors. Our approach is characterised by its selectivity and thoroughness, with a focus on delivering superior potential investment outcomes. 

We scrutinise hundreds of private market funds annually, yet only a small minority meet our stringent standards. This selectivity ensures that our investors have access to only the most promising opportunities in the private capital space.

Fund managers evaluation

Our due diligence process starts with a thorough evaluation of the fund managers. We assess their experience, track record and investment philosophy to ensure they have a history of strong performance across various market conditions. Additionally, we prioritise transparency and alignment of interests between the fund managers and LPs, ensuring that the terms are fair and conducive to long-term success.

Investment strategy assessment

We carefully scrutinise the investment strategy of each fund, ensuring it is both sound and well-aligned with current market opportunities. This assessment includes an in-depth analysis of the fund's target sectors, geographic focus, and approach to sourcing deals. We also evaluate the fund’s value creation plans, including how they intend to drive operational improvements and achieve successful exits.

Team structure analysis

The strength and cohesion of a fund’s team are critical to its success. In our due diligence process, we closely examine the team's structure, expertise, and working dynamics. We assess whether the team has the necessary skills and experience to execute the investment strategy effectively and whether they have a track record of collaboration and talent retention.

Performance overview

A detailed review of the fund's historical performance is another key component of our due diligence. We focus on key metrics such as distributed to paid-in capital (DPI), internal rate of return (IRR) and multiple on invested capital (MOIC) to assess the fund’s ability to consistently deliver strong returns. This performance analysis helps us select funds with a proven track record of success.

Fund approval process

Moonfare’s fund approval process is highly selective, with only about 5% of reviewed funds being approved for our platform.²  This rigorous process includes multiple layers of review, involving both our internal investment committee and external experts. Our goal is to ensure that each fund meets the highest standards of quality and offers a compelling opportunity for our investors.

Due diligence is an indispensable part of the private equity investment process, providing both GPs and LPs with the insights and confidence needed to make informed decisions. Whether it's evaluating a potential deal or choosing the right fund manager, thorough due diligence is essential for mitigating risks, ensuring alignment with strategic goals and ultimately achieving successful investment outcomes. 

At Moonfare, our meticulous due diligence process ensures that we consistently deliver high-quality investment opportunities to our investors, underpinned by our commitment to selectivity and excellence.