Private Equity Due Diligence: Strategic Guide

This guide covers due diligence by investors on private equity funds: how to judge a manager's track record, read the performance numbers in a pitch book, understand the fees and legal terms, and check the firm's operations before committing money for ten years or more. Diligence that a fund carries out on a company it plans to buy, including quality of earnings and working capital, is covered in our M&A due diligence guide.

The environment in 2026 raises the stakes on one number in particular. Bain & Company's 2026 private equity report counted about 32,000 unsold buyout-backed companies worth $3.8 trillion, found holding periods had stretched to around seven years, and put distributions at 14% of net asset value in 2025, the fourth straight year below 15% (Bain). Paper gains are plentiful. Cash returned is not.

The four numbers in every pitch book

• IRR, the internal rate of return, is the annualized return implied by the timing and size of cash flows, with unsold holdings counted at their reported value.
• TVPI, total value to paid-in, is distributions plus remaining net asset value divided by capital paid in.
• DPI, distributions to paid-in, counts only cash actually returned.
• RVPI, residual value to paid-in, is the unrealized part: TVPI minus DPI.

A young fund showing a 20% IRR and 1.4x TVPI with 0.1x DPI has returned almost nothing; its performance is the manager's estimate of what its companies are worth. For older funds in a track record, look at DPI first, then ask how the remaining NAV is valued and when it was last tested by a sale.

Ask for both gross returns (at the deal level, before fees and carried interest) and net returns (what investors received). An illustration with hypothetical numbers: a fund turns $100 of invested capital into $180, a 1.80x gross multiple. Investors also paid $14.50 of management fees over the fund's life, so they put in $114.50. The manager takes 20% of the $65.50 profit, or $13.10, leaving investors $166.90. Net TVPI is 1.46x. A gap of that size between gross and net is normal; a larger one points to high fees, expenses charged to the fund, or a fund too small for its cost base.

Subscription lines and IRR

Most funds now use subscription credit lines: they borrow against investors' commitments to buy companies, then call capital later to repay the loan. That is convenient administratively, and it also raises IRR, because IRR rewards shorter holding periods for investors' money.

An illustration with hypothetical numbers: a fund buys a company for $100 and sells it five years later for $180.

The company performed the same in all three rows. Investors ended up with less money in the second and third rows, while the IRR went up.

The SEC's 2023 private fund adviser rules would have required quarterly statements showing performance with and without subscription lines, but the Fifth Circuit vacated the rules in full on June 5, 2024 (SEC). The Institutional Limited Partners Association has filled part of the gap with voluntary templates released in January 2025. Its updated Reporting Template, first delivered for the first quarter of 2026, breaks out expenses charged by the manager and its affiliates, and its Performance Template reports IRR and TVPI with and without subscription lines for funds that started operations on or after January 1, 2026 (ILPA). Ask whether the manager has adopted both, and ask for the unlevered figures on earlier funds even if they are not in the template.

Comparing with public markets

An IRR on its own does not say whether investors would have done better in an index fund. The public market equivalent (PME) answers that by discounting each capital call and distribution by an index's return over the same period. In the Kaplan-Schoar version, the PME is the index-adjusted value of distributions (plus remaining NAV) divided by the index-adjusted value of capital calls; above 1.0 means the fund beat the index.

An illustration with hypothetical cash flows: a fund calls $50 in year 0 and $50 in year 1, then distributes $40, $60, and $70 in years 4, 5, and 6. Its IRR is 12.07% and its TVPI 1.70x.

The fund's cash flows are identical in both rows. Whether a 12% IRR was good depends on what the market did while the money was tied up.

Recent benchmarks show why this matters. Cambridge Associates reported that its US Private Equity Index returned 8.7% in 2025, with buyouts at 7.6% and growth equity at 11.9%, while its venture index returned 21.1%. It noted that comparisons over most periods shorter than ten years favored public markets, with private equity beating the Russell 2000 more often than the S&P 500 (Cambridge Associates). Ask the manager for PMEs against an index that matches the fund's strategy, such as small-cap stocks for a lower-middle-market buyout fund.

Does a top-quartile record predict the next fund?

The industry habit is to back managers whose previous funds were top quartile. The evidence for buyouts is weaker than that habit suggests. Harris, Jenkinson, Kaplan, and Stucke, using Burgiss cash-flow data from institutional investors, confirmed persistence when funds are judged on final returns. When they used only the performance an investor could have seen when the next fund was being raised, they found little or no persistence for buyout funds overall or after 2000. What persistence remained came from poor performers staying poor. Venture capital showed persistence even on information available at fundraising (NBER).

Part of the reason is that interim returns at fundraising are only moderately correlated with final returns, and managers tend to raise money when interim numbers look good. For due diligence, that means:

• Rank the prior funds on DPI and PME, not on interim IRR.
• Break returns down by deal. If one exit produced most of the profit, ask whether the person who led it is still at the firm and whether the new fund can make a similar deal.
• Look at the loss ratio: the share of invested capital in deals returned below cost.
• Check whether the new fund is larger, pursues a different strategy, or relies on a different team. Each weakens the link to past results.
• Treat a bottom-half record as a real warning. That is the part of the evidence that has held up.

Fees and legal terms

Read the limited partnership agreement, not just the summary of terms. The items that move net returns most:

• Management fee: its rate during the investment period, what it is charged on afterward (commitments, invested capital, or NAV), and when it steps down.
• Fee offsets: whether transaction, monitoring, and director fees charged to portfolio companies reduce the management fee, and by how much.
• Carried interest: the rate, the preferred return, whether there is a catch-up, and whether the waterfall is European (whole fund) or American (deal by deal). Deal-by-deal carry needs a strong clawback, ideally with escrow or guarantees.
• Fund expenses: what the fund pays for, including legal, broken-deal, and compliance costs, and whether any are shared with co-investors.
• GP commitment: how much of their own money the partners invest, and whether it is cash or waived fees.
• Key person, no-fault removal, and fund term extensions: what happens if named partners leave, whether investors can replace the manager, and how many one-year extensions the manager can take on its own.

Enforcement cases show how these terms get tested. In 2015, three Blackstone advisers agreed to pay nearly $39 million after the SEC found they had not adequately disclosed accelerated monitoring fees taken before portfolio company exits and a legal fee discount that benefited the firm more than the funds (SEC). The same year KKR agreed to pay nearly $30 million over more than $17 million of broken-deal expenses charged to its flagship funds rather than shared with co-investors (SEC).

Operational due diligence

A good track record does not protect against poor controls, so check the firm as well as the funds:

• Registration and history: read Form ADV Parts 1 and 2A on the SEC's Investment Adviser Public Disclosure site for conflicts, fees, and disciplinary events.
• Valuation: who values unsold companies, how often, using what methods, whether a third party reviews the marks, and how past marks compared with eventual sale prices.
• Service providers: the auditor, fund administrator, and legal counsel, and whether they are firms other investors recognize.
• Allocation: how the firm divides deals and co-investment between funds and investors, and how it handles conflicts in continuation vehicles, where a manager sells a company from one of its funds to another fund it manages. Bain reported continuation vehicle volume up 62% in 2025, so expect the question to come up.
• Reporting: whether the firm provides ILPA-format statements, capital account detail, and portfolio company data on request.
• Team: turnover, succession plans, how carried interest is shared among partners, and whether junior partners have reason to stay.

For individual investors

Individuals increasingly reach private equity through evergreen funds and feeder funds rather than traditional ten-year partnerships. The same questions apply, with more weight on how NAV is set, how redemptions are limited, and how many layers of fees sit between the investor and the underlying funds. Our private equity for individuals guide covers those structures, and our alternative investments guide covers who can invest.

A due diligence checklist

1. Prior funds' net IRR, TVPI, and DPI, with and without subscription lines, and PME against a suitable index.
2. Deal-level attribution and loss ratio for each prior fund.
3. Team changes since the prior funds were invested, and who leads the new strategy.
4. Full LPA, side letter terms offered to others (and whether you get most-favored-nation rights), and the fee and expense schedule.
5. Form ADV, regulatory and litigation history, and reference calls with existing investors.
6. Valuation policy and a comparison of past marks with realized exit values.
7. How the fund fits your commitments across vintage years; our portfolio rebalancing guide covers keeping illiquid holdings in proportion.

For how buyout funds make money, see our guides to leveraged buyouts and private equity value creation.

This guide is for general information and is not investment, legal, or tax advice. Private equity funds are illiquid, carry a risk of loss, and are generally limited to accredited investors or qualified purchasers. The illustrations use hypothetical numbers. Consult qualified advisers before committing to a fund.