LP due diligence guide

Welcome back and happy Thursday!

I didn’t come to appreciate all the things I learned about due diligence until I left an SVP role at a Public REIT (more on that experience here).

The truth is that there are four related but quite different aspects to diligence:

• What to ask (usually people are most sensitive to this one)

• When to ask

• How to ask

• What happens if the answers aren’t complete?

Today I’d like to dive into each of these to help you on your due diligence journey.

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First, some general principles that I’ve learned over the years:

• If you’re asking about anything related to transparency or honesty twice, you should probably just pass

• When you’re conducting pre-investment diligence don’t forget that you’re in the middle of a sales process - the dinners and smiles are always appreciated, but don’t let it get in the way of the facts

• Similar to you not being able to you not being able to eat IRR, the dinners won’t help with your IRR either

I recently wrote on the extent to which due diligence matters (hint: it depends on your experience levels) and I recommend you start there. It’s hard to understand the importance of doing due diligence without the framework I set up there (and the meme in there isn’t bad either - hope you’ll enjoy).

Alright, let’s dive into it:

• What to ask (usually people are most sensitive to this one)

• The goal here should be to compile a “laundry list” of questions as you’re going through each slide and anything else you have

• This is actually the easiest thing to answer in my opinion, since it’s fact based

• Biggest articles I’d send your way here are:

• Track Record Audit

• Top 15 Syndication Mistakes

• 26 questions to ask your GP

• Top 15 Syndication Mistakes

• Minimum Viable Due Diligence

• You can see the “Pre Investment Diligence” section of the Q1 2025 index for more

• When to ask

• This requires a deeper level of thinking, because you’re forced to prioritize your questions

• You’ll hear many LPs say “I don’t care to prioritize.. I’m just going to send it all at once” and I have two thoughts on this approach

• You might not care, but good GPs typically have more and less sophisticated LPs and it’s much easier (long term) to do business with the sophisticated LP

• While we’re on this topic, I’ll mention that doing business with the unsophisticated LP is easier in the short term because they don’t know what to ask … but it’s almost always a long term foolish for both sides

• While it’s true that you shouldn’t invest before all of your questions are answered, there’s also some sensitivity in asking questions that are irrelevant until you get to the “next” stage of due diligence

• The more questions you send, the more time it’ll take to answer them - whether you like it or not, good deals fill up faster than you’d like at times and getting a quick question to quickly decide whether you want to dig further is really helpful to you while also being more respectful to the GP (and better for the long term relationship)

• Example:

• You’re looking at a deal and you have 10 different questions across track record, valuation, rent comps, the proforma, the design of the deck (that was a joke - just checking if you’re still with me), etc.

• At the same time, you notice right before you’re about to finish doing diligence (ideally this would come earlier in the process, but that takes experience and deal flow) that one of the 6 reasons to put down a deck is in the deal!

• So do you include your entire laundry list of questions now? Of course not - you won’t even look at them … you’ll just look at the answer to the most important question

• For some thoughts on this topic in even more intricate/sensitive situations such as distress, see my deal is distressed, now what. Here’s an excerpt:

• “I think you first need to understand that the GP is busy and answering a lengthy question list might not be the top priority. Thus, you should try to prioritize your questions to a few that have the most impact to your overall understanding of the situation.”

• Another slightly different way of thinking about this concept (which appears a lot on the GP side when you’re doing diligence on any investment to be candid) is that you can usually only ask so many questions ... so if you could only ask 3-5, what would they be to increase your chances of a successful investment?

• One question might have a 1-2% (i.e. immaterial) impact in your decision, while another might be a true catalyst and move your opinion significantly once you hear back from the GP

• See #2 in Minimum Viable Due Diligence for more on the concept of catalysts in due diligence

• How to ask

• I wrote on this at length in 6 lessons on the perils of quick advice, but the same thing holds on the perils of wrong questions - your questions have to be carefully worded otherwise they won’t help you

• Also, take a look at the section on bad question forms in 26 questions to ask your GP (most important part pasted below)

• “As a general rule, you should always shy away from asking questions that can be answered with a simple number or a yes/no. The questions should always require detail that allow you to verify that your original assumptions were correct. A good rule to keep in mind, especially when you’re just starting to get to know the other party: verify, and only then trust.”

• What happens if the answers aren’t complete?

• What happens if you don’t hear back or maybe the GP didn’t answer all of your questions?! What’s next?

• The short answer by the way, is that you have to make a decision with what you have!

• In some cases that’s actually still a “yes” when you’re in the GP seat, but the deal better be really good and have room for error…

• In the LP seat I think a “yes” will be less common since there’s information asymmetry between you and the GP and the only way for you to get closer to their knowledge is asking questions

• You’re in the middle of a sales process (let’s be honest) and if they can’t be transparent up front then what makes you think they’ll be transparent later?

• This is a tough one by the way, because if you send 100 questions you’ll likely not hear back - at the end of the day a GP is in the business of working with reasonable people and that’s where prioritization comes in

• What’s common (or uncommon) should (at some point) become irrelevant to you in a sense … because you should develop your own standards for underwriting after a lot of experience and if the GP is not willing to share that information you simply pass ... there are plenty of places to put your money, and making 5% risk free isn’t the worst “worst case” scenario either, so don’t rush.

I hope this helps and have a wonderful weekend!

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