Conducting Secondary Due Diligence

Structures buy-side DD for secondary transactions — LP interest purchases, GP-led continuations, strip sales, and structured secondaries — covering underlying fund analysis, manager assessment, and portfolio-level risk evaluation.

When To Use

• Evaluating an LP portfolio or single fund interest offered on the secondary market
• Conducting buy-side DD on a GP-led continuation vehicle or tender offer
• Assessing a manager's track record and operational infrastructure before committing capital
• Building an investment memo for an IC submission on a secondary transaction
• Stress-testing NAV marks and pricing assumptions prior to bid submission

Inputs To Gather

• Fund documents: LPA (including amendments/side letters), PPM, subscription agreements, financial statements (audited), capital account statements
• GP materials: quarterly reports, annual meeting presentations, co-investment track record, prior fund performance data (DPI, TVPI, IRR by vintage)
• Portfolio company data: revenue/EBITDA schedules, cap tables, board decks, management financials (if available via data room)
• Transaction specifics: seller's ask price, transfer restrictions, ROFR/consent provisions, stapled commitment obligations, any escrow or holdback terms
• Market context: recent secondary pricing benchmarks (e.g., Greenhill, Jefferies secondary market reports), comparable fund multiples, relevant sector indices

Workflow

1. Scope the transaction structure

   • Classify as LP interest, GP-led (single-asset vs. multi-asset continuation), strip sale, or preferred equity
   • Identify whether the transfer triggers ROFR, requires GP consent, or involves tag-along/drag-along rights [VERIFY against LPA]
   • Map stapled commitments, unfunded obligations, and any management fee offsets

2. Assess the GP/manager

   • Evaluate track record across prior funds: net IRR, DPI, TVPI, loss ratios by vintage
   • Analyze team stability — key person departures, succession planning, compensation structure
   • Review operational infrastructure: fund admin, auditor, legal counsel, compliance framework
   • Check for any regulatory actions, litigation, or LP disputes [VERIFY via ADV filings and public records]
   • For GP-led transactions, assess alignment and potential conflicts (carry crystallization, fee resets, rollover percentage)

3. Analyze underlying portfolio

   • Obtain and scrub the latest NAV report; reconcile GP-reported NAV against audited financials
   • For each material holding (typically top 10–15 positions by NAV weight):
     • Review revenue growth, EBITDA margins, leverage (net debt/EBITDA), and cash flow trajectory
     • Assess entry multiples vs. current marks vs. comparable public/private multiples
     • Identify exit pathway and expected timing (IPO, strategic sale, sponsor-to-sponsor, dividend recap)
   • Flag concentration risk: single-position NAV weight >20%, sector clustering, geographic overlap
   • Evaluate foreign currency exposure and hedging posture

4. Model pricing and returns

   • Build a bottom-up NAV model using company-level assumptions (exit multiples, hold periods, growth rates)
   • Derive a bid price as a % of NAV; sensitize to downside cases (–20% NAV markdown, 12-month exit delay)
   • Calculate projected gross/net IRR and MOIC at bid price under base, upside, and stress scenarios
   • Factor in J-curve dynamics: unfunded commitments draw schedule vs. distribution timing
   • Compare risk-adjusted returns to alternative deployment (primary commitments, co-investments, direct secondaries)

5. Evaluate legal and structural risks

   • Review transfer provisions in the LPA: consent mechanics, timing, permitted transferee definitions [VERIFY]
   • Identify tax structuring considerations: UBTI exposure for tax-exempt buyers, withholding obligations, blocker structures
   • Assess indemnification scope in the purchase agreement — representations on NAV, known liabilities, pending litigation
   • For GP-led deals, review the continuation vehicle LPA terms: fee/carry step-up, LP advisory committee composition, liquidity options

6. Compile DD findings and recommendation

   • Summarize key risks with severity ratings (high/medium/low) and mitigants
   • Present pricing recommendation with supporting sensitivity tables
   • Highlight open items requiring GP clarification or additional data room access
   • Draft the IC memo sections: transaction overview, manager assessment, portfolio analysis, pricing rationale, risk factors

Output

• DD Summary Memo: Structured findings organized by manager, portfolio, pricing, and legal/structural sections
• NAV Bridge / Pricing Model: Bottom-up build with scenario analysis and sensitivity tables
• Risk Matrix: Itemized risks (manager, portfolio, structural, market) with likelihood, impact, and mitigants
• IC Recommendation: Go/no-go with proposed bid range, key conditions, and post-closing monitoring triggers

Quality Checks

• NAV figures reconcile between GP quarterly reports and audited financials; discrepancies are flagged
• Track record metrics (IRR, DPI, TVPI) are sourced from audited data, not GP marketing materials
• Every assumption in the pricing model has a stated basis (comparable, management guidance, or historical trend)
• Transfer mechanics and consent requirements are confirmed against the actual LPA, not summaries [VERIFY]
• Conflict-of-interest analysis is completed for GP-led transactions (fee economics, rollover terms, information asymmetry)
• All [VERIFY] items are tracked in an open-items log with assigned owners and deadlines
• Tax structuring review covers buyer-specific considerations (tax-exempt, non-US, fund-of-funds) [VERIFY with tax counsel]