conducting-secondary-due-diligence

# 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]