Financial statement audits and assurance for GP-Stakes fund structures
Auditing GP-Stakes funds involves assurance procedures tailored to the unique characteristics of investments in asset management firms. The audit addresses fund-level financial statements while grappling with valuation complexity, multi-component investments, and reliance on information from portfolio companies. Auditors must understand GP-Stakes economics to design appropriate procedures and evaluate management's assertions.
GP-Stakes funds structured as private investment funds typically require annual audited financial statements delivered to investors within specified timeframes, often 90 or 120 days after fiscal year end. These audits provide assurance that financial statements present fairly, in all material respects, the fund's financial position and results of operations in accordance with applicable accounting standards.
The SEC's custody rule and investor expectations generally drive audit requirements for funds with institutional investor bases. Even when not technically required, audited financials represent market standard for sophisticated investors and support fundraising for successor funds.
Investment valuations represent the most significant audit area for GP-Stakes funds given the illiquidity of portfolio company interests and the judgment involved in fair value determinations. Auditors evaluate management's valuation methodologies, test key assumptions, and assess whether valuations are reasonable and consistently applied.
For GP-Stakes investments, this involves understanding how management values management company interests separately from carried interest interests, reviewing the revenue multiples or other methods applied to fee-based businesses, and evaluating the approaches used to estimate the present value of future carry distributions. Third-party valuation reports, when obtained, provide additional support but do not substitute for the auditor's independent evaluation.
GP-Stakes audits often rely on information from portfolio companies, including audited financial statements, performance data, and organizational information supporting valuations. Auditors evaluate the reliability of this information and may perform procedures to gain comfort over data received from portfolio GPs.
When portfolio companies have their own audits, the GP-Stakes fund auditor may obtain and evaluate those audit reports. However, the portfolio company audit scope may differ from what the GP-Stakes fund auditor needs, requiring supplemental procedures or inquiries. Coordination between the fund auditor and portfolio company auditors may be necessary in some cases.
GP-Stakes funds recognize income from portfolio companies as distributions are received or accrued based on underlying fund performance. Auditors test revenue recognition to ensure income is properly categorized between management fee income and carried interest, recorded in the correct period, and accurately reflected in partner capital accounts.
The timing of revenue recognition may involve estimates, particularly for carried interest accruals where the amount depends on underlying fund valuations that may not be finalized when the GP-Stakes fund's audit occurs. Auditors evaluate the reasonableness of estimates and subsequent events that might affect recorded amounts.
GP-Stakes fund financial statements must accurately allocate income, expenses, gains, and losses among partners according to partnership agreement provisions. Auditors test these allocations to ensure compliance with governing documents, including preferred return calculations, carried interest distributions, and expense allocations.
Given the complexity of some GP-Stakes fund waterfalls and the extended period over which allocations accumulate, thorough testing of allocation methodologies protects against errors that could compound over time or create disputes with investors.
The GP-Stakes fund's management company may also require annual audited financial statements, particularly if investors request visibility into management company financial health. Management company audits address expense recognition, fee calculations, employee compensation including carried interest allocations, and compliance with organizational documents.
Some managers combine fund and management company audits with the same firm to achieve efficiency and consistency. Others maintain separate audit relationships for different reasons. The scope of management company audit work should align with investor expectations and regulatory requirements.
Selecting auditors for GP-Stakes funds involves evaluating firms' experience with alternative asset fund structures, understanding of asset management business valuation, and capacity to serve the engagement appropriately. Major accounting firms and specialized fund audit practices both serve the GP-Stakes market.
Auditor independence requirements must be satisfied, and any non-audit services should be evaluated for potential conflicts. Establishing clear engagement terms, including expected timing and deliverables, sets appropriate expectations for the audit process.
Some GP-Stakes funds have audit committees or advisory committees with audit oversight responsibilities. These bodies may approve auditor selection, review audit plans, receive audit findings, and provide governance oversight. Even without formal audit committees, management should maintain appropriate oversight of the audit process and relationship.
A well-coordinated audit process supports timely delivery of quality financial statements that meet investor expectations and regulatory requirements. Planning for valuation documentation, portfolio company information needs, and timeline dependencies helps ensure smooth audit execution.