Starting a Private Fund? We're Answering Your Questions About Audits.

Posted by John Braun on Jun 9, 2021 11:38:53 AM

We often have conversations with portfolio managers who have experience managing a portfolio in a large shop and decide to break away and start their own investment advisory business. Many of these managers have an interest in launching their own pooled investment vehicle, often a product that they have been working “on the side.”

Because start-up and emerging managers often have been insulated from the administrative process in their experience as a portfolio manager with a larger shop, we find that they have many questions about working with an accounting firm.  As would be expected, many of our conversations with start-up and emerging managers involve a step-by-step review of the audit process for private funds.  
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Below we have outlined certain important highlights and considerations of the audit process for start-up and emerging managers. We address them as the Five Ws. 

The Why (Do I need an audit?)

There are two major reasons why a start-up private fund would need an audit:

  1. An audit is specifically required in the private fund’s offering documents
  2. The advisor is registered with the Securities and Exchange Commission and is therefore required by Rule 206(4)-2 (Custody Rule) to either have a pooled investment vehicle audited (in order to apply an exemption within the Rule) or undergo a surprise examination of securities held on behalf of investors

Aside from the reasons specifically noted above, many managers decide to have their financial statements audited as a matter of practice and with the intent of providing comfort to existing and potential investors as to the validity of their performance and balance sheet.

The When (Timing of selection of auditor and audit timeline)

Most advisors select an auditor (and tax preparer) prior to commencement of the private fund and have them named in the offering documents. Aside from the comfort factor described above resulting from including an audit firm in the offering documents, your audit firm will also often review the offering documents as part of the initial set up of the fund and provide comments and considerations, if requested.

Regarding the timing of the audit, private funds are generally December fiscal year-ends. In most cases, it is not an audit deadline that is the focus of the advisor but rather the distribution of K-1s. It makes sense that the most important item to the investor (getting their K-1 timely to be able to file their individual tax return) in turn becomes the focus of the advisor, which in turn becomes the focus of the audit/tax firm.

So, while there may be a deadline in the offering documents and most private funds managed by advisors registered with the SEC have a 120-day deadline, the true deadline for most private funds based on the expectation and need of investors is more likely 90 days.

The challenge is that in order for the audit/tax firm to have comfort to prepare the tax numbers and the resulting K-1s, they must have comfort with the book numbers, which requires the audit to be substantially complete.

The What (Audit process)

Generally, the audit process can be summarized as follows:

Planning/Risk Assessment

During the early stages of the audit, the audit team will review documents and have discussions with management and those charged with governance to gain an understanding of the private fund, its investments and operations, and its control environment. Those areas of higher risk of misstatement will be identified, and an audit plan will be tailored accordingly.

Substantive/Analytic Procedures

During this stage of the audit, the auditor is focused on testing to gain comfort with balances as of the balance sheet date and for the fiscal period ended. Most of the interaction is with the administrator or accounting agent and management, to the extent that there are fair valued investments. For a private fund, areas of focus are normally the existence and valuation of investments. Additional areas of concentration might include investor capital allocations, due to the calculations involved with incentive fees and investor specific allocations.

Financial Reporting/Communication

The final stage of the audit is primarily focused on the auditor’s review of the financial statements to ensure they are presented in accordance with Generally Accepted Accounting Principles in the United States for Investment Companies. The auditor is also responsible for communicating the results of the audit to those charged with governance, through the issuance of a report on the financial statements and other communications regarding any findings.

The Who (Audit Firm)

While there is no shortage of auditors who serve private funds, critical factors to consider when selecting an audit and tax firm are their expertise relative to investment companies, the quality of the firm’s work, and the level of service you are likely to expect.

Investment Company Experience – There are specific audit, financial reporting and tax considerations for the investment company industry. Significant investment company experience should be a baseline requirement when considering an audit and tax firm.

Audit Quality – In addition to investment company expertise, you should consider the quality of the audits the firm performs as well. There are a number of important measurable indicators of audit quality.

Certainly, any audit firm you consider should have a track record of clean peer review inspections and reports as part of the American Institute of Certified Public Accountants firm peer review process.

Additionally, you should consider an audit firm that is both registered with and inspected by the Public Company Accounting Oversight Board (PCAOB). The PCAOB is a private-sector, not-for-profit corporation, created by the Sarbanes-Oxley Act of 2002, to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports. It’s important for advisors of private funds to note that, as detailed above, the SEC’s Custody Rule allows for an exception from the surprise examination requirement for advisers to pooled investment vehicles, as long as the pooled investment vehicle is audited by an independent public accountant both registered with, and subject to regular inspection by, the PCAOB. Advisors to pooled investment vehicles relying on the audit exception to satisfy the Custody Rule must use an auditor regularly receiving PCAOB inspections. The sphere of accounting firms offering audit services for private funds is vast, but not all of those firms are regularly inspected by the PCAOB. The results of PCAOB inspections are available at You should ask any audit firm you consider about their history of PCAOB inspections.

Client Service Philosophy – Once you have comfort that you have a good short-list of qualified firms, it’s important to gain an understanding of the firm’s client service philosophy. While audit professionals are required to be independent to express a meaningful opinion on a fund’s financial statements, your audit and tax firm also should be focused on collaboration with you and adding value to your growing business. Especially as a start-up or emerging manager, you need a good partner who will be collaborative with you right from the start. Will you be able to call the firm with questions and have your calls returned and questions answered in a timely manner? Will the firm charge fees for questions throughout the year? How important will you be to the firm? These are all important questions to ask.

The Where (Does the audit firm come on-site?)

Most audits today can be performed remotely. There are no professional standards requiring on-site visits, so there should not be a need for the auditor to camp out in your office for weeks at a time. In fact, most private funds make use of service providers to divide the back-office work required, and so there is not one location for the documents and personnel. There are times, however, where the auditor and those charged with governance of the audit would prefer an on-location interview or a day or two on-site to engage individually with management and personnel.


Many of the above concepts are actual discussion topics that have taken place with our clients and prospects. While not overly complex, they are important in understanding the audit process when considering a start-up private fund. The above list is, however, by no means meant to be comprehensive. Are you starting a private fund? Please contact us with your questions.  We are available as a resource for you.

Stay tuned for our upcoming post, where we will address tax considerations for start-up and emerging private fund managers.

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