By Danielle St. Luce, Investment Associate, Cogent Consulting PBC
The last few years have seen new organizations and emerging funds use racial equity as part of their thesis, with most of the leadership of these organizations lacking sufficient investment or business experience. This isn’t to say they’re not worth investment; instead, it highlights the importance of nontraditional due diligence. The Due Diligence 2.0 Commitment, of which Cogent Consulting PBC is a signatory, lays out a framework that allows for proper assessment of emerging fund managers and can be adapted to other organizations[i].
While Cogent uses the Due Diligence 2.0 framework in all our diligence work, our approach differs from traditional investment analysts. Our due diligence is adapted to our clients’ needs, with many investing in nontraditional organizations with models that don’t directly correlate to the Due Diligence 2.0 framework. We also adapt Due Diligence 2.0 based on our lived experience and professional expertise working with diverse business owners and fund managers.
Below is a “Cogent take“, providing context to the nine required shifts to the traditional due diligence process.
- Consider Track Record Alternatives. Most emerging managers need more experience, with many needing more relevant experience for their stated goals. When conducting due diligence, we primarily focus on managers’ responses to that lack of track record. Those that provide a clear roadmap to hiring the right team members or partnering with the right firms consistently score higher than those without a plan. We always respect people who are confident in what they do know, and what they don’t. That’s the mark of a leader who is aware they can’t do it all.
- Expand What It Means to Work Together. When we find managers’ experience and roadmap needing amplification, we connect them to other organizations supporting their growth. This may look like recommending them to an industry-specific training program or introductions to organizations that can provide a capacity-building grant.
- Reassess Assets Under Management as A Risk Metric. When assessing a fund’s size, our primary concern is that the proposed value directly correlates to the market need. Smaller funds do not equate to a riskier investment. However, fund sizing that doesn’t reflect the realities of their chosen industry is a major red flag. A larger fund only exacerbates that risk.
- Respect BIPOC Time. Cogent has created a simple method to respect managers’ time in which we don’t jump into full due diligence but complete it in three stages. Subsequent stages require more information and time from the managers. We require client feedback on their appetite for investment before moving forward to the next stage, allowing us to engage managers without wasting their time. Often, we only engage with managers once they pass our clients’ first stage.
- Contextualize Fees. Emerging funds, especially smaller funds with less than $50 million in assets under management, will need higher fees or additional sources of capital to subsidize their costs. While we don’t advocate for either route, our focus when conducting due diligence is for the proposed structure to make sense. Funds with multiple entities, various owners, and unclear profit-sharing structures require more due diligence but are not immediately dismissed.
- Include Historically Unrecognized Risks. While Due Diligence 2.0 advocates for including social unrest, climate migration, and economic underperformance in risk assessment, we include harder-to-quantify factors such as community involvement, social capital, historic investment, or lack thereof, in the proposed geographic area, and more. Our clients are impact-focused, allowing us to leverage nontraditional risk assessments in our due diligence.
- Be Willing to Go First. While a lack of fundraising momentum can be seen as a red flag, we see it as an opportunity for fund managers to assess their offerings. A capacity-building grant, tied to reasonable deliverables, is sometimes needed instead of an investment. Reaching the stage in the due diligence process where we can recommend this alternative form of support is a positive sign that our clients are willing to make a small investment in the fund manager in the hope that they can meet their minimum investment threshold.
- Offer Transparency About Remaining Hurdles. If we discover information that presents a challenge for our clients during diligence, we communicate as clearly and efficiently as possible with fund managers. This can be a sticky subject as some hurdles are caused by managers’ lack of experience, such as disclosing pertinent information upfront that can be easily found during a background check. Determining whether a challenge warrants passing on a potential investment becomes more complicated when managers make “rookie mistakes”.
- Provide Detailed Feedback. As best we can, we support emerging fund managers through our feedback. When providing feedback, we are proactive with solutions to observed problems. For us, feedback isn’t limited to notes about their pitch deck or offering. We also support managers by introducing them to organizations and individuals in our network who can be helpful to their goals.
Due Diligence 2.0, especially Cogent’s take on it, can be difficult to do well. However, with the growth in racial equity-focused investment vehicles and managers coupled with billions in financial commitments made in recent years, nontraditional due diligence is more important than ever.
If you have any questions or are interested in working with Cogent, feel free to connect with our team at https://www.cogentconsulting.net/contact/.
[i] Gray, T., Davies, E. S., Kessel, B., & Robasciottie, R. J. (2020). Due diligence 2.0 commitment. Due Diligence 2.0 Commitment. Retrieved January 31, 2023, from https://www.duediligencecommitment.com/