Financial Audits for GP-Stakes Funds: Management Company Valuation Testing, Investment Accounting, and Distribution Verification

GP-stakes fund audits focus on management company investment valuation testing given reliance on discounted cash flow models and judgment-intensive assumptions, investment accounting review ensuring proper cost basis tracking and fair value adjustments, distribution verification confirming management fee and carried interest receipts, and related party transaction testing given potential affiliate relationships. Auditors must understand private capital economics, management company business models, and valuation methodologies for fee-based businesses.

Valuation Methodology Review

Management company investments require regular fair value determination. Auditors test valuation approaches examining DCF models used for valuations, assessing key assumptions including AUM growth rates, management fee projections, carried interest expectations, operating margin assumptions, and discount rates, comparing assumptions to portfolio GP business performance and market benchmarks, reviewing valuation specialist work when external experts are engaged, and testing mathematical accuracy of calculations. Material valuation changes require explanation supported by business developments, market condition changes, or assumption updates. Auditors pay particular attention to assumption reasonableness given significant judgment involved in projecting long-term fee streams and carry realization.

Investment Accounting and Cost Basis

Proper investment accounting requires auditor verification of initial purchase accounting including acquisition price and transaction costs establishing basis, ownership percentage calculation determining economic rights, subsequent capital contributions or distributions adjusting basis, and fair value adjustments reflecting valuation changes. Auditors obtain purchase agreements and closing statements, verify cash movements confirming consideration paid, test ownership calculations ensuring accurate participation percentages, and review subsequent transaction history including follow-on investments or partial sales. Accurate basis tracking is essential for determining gains or losses upon eventual disposition.

Distribution Testing and Verification

Cash receipts from portfolio GPs require audit verification. Auditors confirm distributions by obtaining bank statements showing receipts, reviewing portfolio GP distribution notices explaining amounts and character, testing allocation to investors per fund terms including preferred returns or tiered structures, and verifying tax characterization matching reporting. Confirmation procedures may include direct communication with portfolio GP administrators when significant. Distribution testing provides assurance that reported receipts are accurate and properly allocated to fund investors.

Key Takeaways

• Valuation requires significant judgment: DCF models with long-term projections and discount rates involve assumptions requiring auditor scrutiny and support.
• AUM growth assumptions drive value: Projections of management company growth through fundraising success substantially impact valuations requiring careful testing.
• Distribution verification confirms cash flows: Testing management fee and carry receipts provides assurance of reported investment returns and cash generation.
• Related party considerations are common: Affiliate relationships between GP-stakes funds and portfolio GPs require transaction testing and disclosure.