Due Diligence Best Practices: A Checklist

Is your organization looking to invest in a private equity fund, hedge funds, or some other alternative investment? Before you invest, you must undertake operational due diligence (ODD).

ODD is an investor-initiated process for assessing the operational infrastructure of investment managers and funds to both detect and mitigate potential operational risks associated with the investment.

That said, ODD often relies on numerous manual steps, long due diligence questionnaires (DDQ), confusing workflows, and scattered documentation.

Moreover, ODD practitioners often have to track and monitor the status of multiple requests over multiple emails.

All these elements are challenging to manage and optimize. They also bog down the ODD process, cause frustration and rework, and impact the quality of investment decisions.

Fortunately, there’s good news for ODD practitioners.

You can take advantage of advancements in cloud storage, software-as-a-service, predictive analytics, and ODD automation solutions like ODD360 to minimize complexity, improve effectiveness, achieve scalability, and ultimately make the best investment decisions possible.

In addition to leveraging these modern solutions, it’s also helpful to follow tested and proven ODD best practices. With that in mind, we’ve created a five-step checklist based on our experience working with allocators.

But first, let’s quickly recap why executing ODD is so critical.

The Importance of an Operational Due Diligence Process

In recent times, operational due diligence has become vital for alternative investments.

Developing questionnaires, reviewing documents, conducting interviews with investment managers, and managing issues and risks are essential aspects of ODD. Done well, risk can be limited and ROI maximized.

If neglected, you may find yourself burdened with unexpected liabilities and significant operational risks that weaken your rate of return, invite regulatory trouble, and even damage your reputation.

Now that we have highlighted the need for ODD let’s explore some effective best practices.

Best Practice #1: Digitize your Due Diligence Processes

Old-school ODD processes were often hampered by disjointed, manual activities, paper-based questionnaires, inefficient risk reporting, and a never-ending loop of emails, Word documents and Excel spreadsheets.

But today, there’s no need for manual activities or paper questionnaires in the due diligence process. When you adopt digitization and ODD software, you won’t have to wade through an assortment of confusing documents, information requests, or communication channels.

You can step out of the email rabbit hole with centralized documentation, collaboration, and reporting. Digitization automates many aspects of ODD to streamline workflows, minimize complexity, and improve effectiveness.

With a single integrated platform like ODD360, your ODD team can easily access all the customizable templates and questionnaires they need in a collaborative, centralized environment.

You can improve risk scoring, track compliance with detailed analytics, and eliminate unnecessary back-and-forth interactions. Digitization can also help you prepare for audits and significantly mitigate operational risk to your investment.

Best Practice #2: Use a Multi-Party Platform

Today, it is critical for Investors and Managers to provide a superior Operational Due Diligence process experience. The best way to do this is to bring all parties together to complete the ODD process.

Using a multi-party platform like ODD360 will bring all parties into the same environment, which will allow recipients to assign questions internally, collaborate, set up approval workflows, and access audit trails.

The shared environment will also eliminate the need for multiple emails, document formats, and communication channels, further simplifying workflows and boosting collaboration for better overall best results.

Best Practice #3: Conduct Detailed Assessments

A detailed assessment process is a crucial part of every due diligence process. And yet, many frequently overlook it. Don’t make this mistake.

A thorough assessment provides essential insights to guide your evaluation and analysis processes and guide investment decisions. However, when done manually, this extensive process can quickly become unmanageable.

By digitizing your assessment process with a platform like ODD360, ODD professionals are empowered to:

• Anticipate the needs of the firm;
• Assign specific answers or questions to relevant team members;
• Create a standardized evaluation process; and
• Automate the scoring removing the possibility of human error.

Best Practice #4: Collect All Relevant Documents

Two of the most critical steps in any ODD process are:

• Developing questionnaires
• Collecting and reviewing the necessary documentation

The documents reviewed during ODD can provide crucial inputs that you will need to start due diligence, prepare necessary reports, and confirm that the investment is viable and meets all necessary criteria.

However, simply collecting documents is not enough because you may end up missing some red flags in the operational infrastructure that can cause problems later. Also, make sure you review all documents carefully to get the maximum value from them.

These include documents related to:

• Due diligence questionnaire (DDQ)
• Fund offering memorandum
• Fund audited financial statements
• Cash and liquidity internal controls
• Independent pricing and asset valuation policies
• Compliance policies and manuals
• Regulatory filings such as the SEC’s ADV
• Operational policy and procedure documents
• Marketing presentations and any other documents that can guide your ODD activities.

Best Practice #5: Conduct On-site Visits

But don’t stop with document review. Conduct onsite visits with crucial operational staff to ensure that all the provided information can be independently verified.

Visits will also reveal any potential gaps in the process and bring the transparency required to create a fuller picture of the investment manager. Ongoing monitoring is also essential to assess changes that might affect maintaining an ongoing investment.

Ask managers questions about the following:

• Company culture
• Operational systems
• Staff qualifications
• Segregation of duties
• Culture of compliance
• IT infrastructure and cybersecurity systems to prevent data breaches
• Business Continuity Planning (BCP) and Disaster Recovery
• Risk management (including counterparty risk management)

As stated earlier, a qualitative assessment is an integral part of the due diligence process, and the best way to conduct it is with onsite visits.

Conclusion

Operational due diligence is more critical than ever. Robust due diligence can help you effectively assess investment risk, increase transparency, and ensure that a potential investment is an excellent strategic fit for your organization.

Fortunately, you don’t have to continue with old-fashioned manual steps, a spreadsheet-driven DDQ process, or scattered documents to perform effective and beneficial due diligence.

Disparate information sources, low visibility into activity status, and poor audit readiness are also a thing of the past – with automated, multi-party ODD platforms like ODD360.

ODD360 provides automated workflows, auto-scoring, rich analytics, and user-friendly visual reports. The platform is ideal for investors, consultants, and fund managers looking for a centralized source of truth available in real-time in the cloud.

Take advantage of its automated RFI and DDQ workflows, a centralized document and data repository, and customizable templates and questionnaires to streamline the ODD process.

With ODD360, our clients have been able to increase the efficiency of their ODD workflows by up to 50% and achieve an average cost savings of 30-40%.

To try ODD360, ask us for a free, no-obligation demo. Click here to get started.