Operational Due Diligence: What LPs Should Check Beyond Returns

When LPs evaluate a venture fund, most attention goes to the investment team, strategy and track record. But some of the most damaging fund failures have had little to do with investment skill. They came from weak controls, poor valuation practices, conflicts of interest, cyber fraud or, in rare cases, misappropriation of investor money.

Operational due diligence (ODD) examines how a fund manager runs its business: who controls the cash, who values the assets, who checks the numbers and what happens when something goes wrong. This guide covers what LPs should check, with extra attention for emerging managers, where operational infrastructure is often still being built.

1. Governance and Structure

• Legal structure of the fund and management company, and who controls decisions.
• Regulatory status. In the US, is the manager a registered investment adviser or an exempt reporting adviser, and what obligations follow?
• Advisory committee composition and role in approving conflicts and valuations.
• Key staff beyond investment professionals, such as finance, operations and compliance.

2. Cash Controls

• Who can move money? Look for dual authorisation on payments and segregation of duties.
• Bank accounts held in the fund's name, with clear separation from the management company.
• Capital call and distribution procedures, including verification of wiring instructions. See cybersecurity due diligence.
• Fund administrator involvement in payment approvals.

3. Service Providers

• Independent fund administrator handling accounting, investor reporting and capital accounts. See fund administration platforms compared and who does what.
• Reputable auditor issuing annual audited financial statements.
• Legal counsel with fund formation expertise.
• Tax advisers for fund and investor tax reporting.

Independent service providers act as a check on the manager. A fund that handles everything internally deserves closer scrutiny.

4. Valuation Policy

• A written valuation policy consistent with accounting standards and industry guidelines.
• Who values the portfolio, how often, and whether any independent review occurs.
• Consistency in applying the policy across companies and over time.

See how venture funds mark private holdings.

5. Compliance and Conflicts

• Compliance manual and officer, appropriate to the manager's size.
• Conflicts of interest: personal investments by partners, cross-fund investments, related-party transactions and fee arrangements.
• Allocation policy for deals across multiple funds or vehicles.
• Side letters and whether their terms affect other LPs. See side letters.

6. Technology and Continuity

• Cybersecurity controls, including multi-factor authentication and email security.
• Data protection for LP and portfolio information.
• Business continuity and key person arrangements. See key-person clauses.

7. Red Flags

• No independent administrator or auditor.
• A single person able to move fund money without approval.
• Reluctance to share policies or introduce service providers.
• Inconsistent or unexplained valuations.
• Undisclosed related-party transactions.
• Frequent turnover in finance or operations staff.

Frequently Asked Questions

Is operational due diligence necessary for small commitments?

Yes, at an appropriate depth. Basic checks on cash controls, administrator, auditor and valuation policy protect any investor.

What should emerging managers have in place?

At minimum, an independent administrator, auditor, fund counsel, clear cash controls and a written valuation policy. See raising a first venture fund.

Can LPs speak directly to service providers?

Often yes, with the manager's permission. Many LPs confirm relationships with the administrator and auditor directly.

Is a fail in ODD always a deal-breaker?

Not always. Some gaps can be fixed before closing, but serious control weaknesses should be resolved before committing capital.

The Bottom Line

Investment skill determines how well a fund performs; operational strength determines whether LPs' money is safe along the way. Checking governance, cash controls, service providers, valuation and compliance is a small effort compared with the losses weak operations can cause. See also becoming an LP.

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This article is general information, not legal or investment advice.