Due diligence: How to vet companies and investors

As a result of ongoing market instability, dealmakers have shifted their approach from a growth-at-all-costs mindset to increased scrutiny—focusing on protecting valuations and investment strategies. Exits and fundraising activity continue to diminish compared to COVID-19 levels as LPs (limited partners) closely analyze allocations to VC and PE, and dealmakers are holding out for more favorable conditions.

The importance of investment vetting in risk management

In the private market landscape, where data is harder to come by, conducting thorough and comprehensive due diligence can make a significant difference in investment outcomes. Though due diligence largely involves examining financial and legal specifics, it also includes validating potential targets or confirming that an investor is a good fit before reaching out or pursuing a deal.

With timely, accurate data on deals, funds, and valuations, PitchBook helps dealmakers detect and identify potential issues with a target or investor early, saving valuable time and money. Ultimately, more sophisticated due diligence tools—and more data—enable professionals to optimize investment vetting for companies and investors.

How to vet a company

Thorough company due diligence involves looking at revenue figures, cap tables, financing history, and similar companies. Doing so can surface important insights regarding available equity and potential value. Beyond company data, it can be equally important to get a sense of an executive team’s track record to ensure they have the right experience to grow a business. This kind of insight can help determine which opportunities to pursue and whom to work with based on the big picture—not just a snapshot.

What questions should investors consider as they evaluate investments?

• What does the company’s financial performance and condition look like?
• Do you have insight into the executive team’s past performance?
• Are there any unique challenges in the company’s industry or vertical?
• How does the company stack up against current and expected market trends?
• What is the company’s growth potential within its market?
• Is the company in compliance from a legal and regulatory standpoint?

How to vet investors

With a better understanding of an investor’s past performance, you can better judge its likelihood for future success. A traditional benchmark can provide a general sense of fund performance. A better approach to benchmarking would compare funds based on strategy and portfolio construction to provide insight into the true value of a financial sponsor. Looking at the performance of a firm’s investments, the deals specific fund managers have led, the co-investors they’ve partnered with and the institutional investors they’ve raised money from can shed more light on an investor’s experience and track record.

Investment risk management for limited partners and general partners

As negotiating terms and fees shift when markets swing, limited partners (LPs) and general partners (GPs) should carefully evaluate each other to ensure a mutually beneficial partnership for years to come. Below we outline some key questions and considerations each party must be able to answer as part of their investment risk management.

What do LPs look for in GPs?

Limited partners invest in venture capital funds, private equity, real estate, and other alternative assets classes. A few major types of LPs include large institutional investors such as pension funds and endowments and family offices or high-net-worth individuals. Before committing capital, LPs must be able to answer these questions of potential GPs:

• What is the GPs past financial performance? This analysis includes examining their investment capacities, exits, and generated returns.
• What is the GPs industry knowledge, and is it compatible with your investment strategy?
• What are the annual terms and fees of the GP?
• What is their approach to sourcing investments and co-investors?
• Is their fund size, industry, VC stage, and geography in alignment with your strategy?

What do GPs look for in LPs?

General partners (GPs) are venture capital funds, private equity firms, commodities, real estate, and private debt funds that invest capital on behalf of LPs. Top of mind for GPs, especially emerging managers or those raising a first-time fund, is how to position their fund and pitch in a fiercely competitive market landscape. Articulating and refining fund strategy is informed by thorough investor due diligence and a portfolio review on LPs. Here are some top considerations when it comes to investor due diligence:

• What is the LP’s strategy and investment preference, including asset classes, risk tolerance, and anticipated return on investment?
• What is the LP’s investment track record, encompassing investment returns and exits?
• What are their target allocations and historic investment allocations across asset classes?
• What kind of knowledge and expertise do they have in specific industries?
• What is the LP’s legal and regulatory history?

What questions should companies consider as they evaluate investors?

• What is the firm’s fund performance and investment track record?
• How does the firm compare to its competitors?
• What value can the investor add beyond funding related to industry knowledge and network?
• Have I done enough fund manager due diligence?
• What is the investor’s financial positioning?
• What deals has the fund manager led?
• What firms have they co-invested with?
• Does their strategy align with your long-term vision?

The right tool for due diligence

PitchBook’s detailed data on companies and investors across private equity and venture capital enables its users to better evaluate potential investments and funds. With access to information on past investments, fund performance, and fund manager experience, users can identify the right investors to work with and expand their network to connect with future prospects in an evolving financing landscape. In addition, PitchBook offers custom benchmarking, where users can choose a peer group based on portfolio construction and industry focus. Similarly, PitchBook’s comprehensive company data helps investors find targets that best match their investment criteria. Dealmakers can also leverage our custom benchmarks tool to conduct more precise due diligence on historic fund performance and fund managers, informed by specific strategies, sectors, geographies, and more.