Private Fund Audits: What Happens and How to Prepare

A fund audit is an independent examination of a private fund's annual financial statements by a certified public accounting firm, ending in an opinion on whether those statements are fairly presented under the applicable framework, usually U.S. GAAP. For venture and private equity funds, auditors focus on the existence and fair value of portfolio investments, capital activity, partner capital allocations and fees. Most funds are audited annually because LPs require it and because SEC-registered advisers commonly use audits to satisfy the custody rule.

Why private funds are audited#

There are three main drivers.

1. LP requirements. Nearly every LPA requires annual audited financial statements delivered within a set period. Institutional LPs rely on them for their own reporting.
2. The SEC custody rule. Rule 206(4)-2 under the Investment Advisers Act requires registered advisers with custody of client assets to meet certain safeguards. For pooled vehicles, an adviser can satisfy key requirements by having the fund audited annually by an independent public accountant that is registered with, and subject to regular inspection by, the PCAOB, and distributing the audited statements to investors within 120 days of fiscal year-end (180 days for a fund of funds, with a longer period for certain top-tier funds of funds).
3. Credibility. Audited statements support fundraising, lender requirements for credit facilities, and secondary transactions.

The SEC's 2023 Private Fund Adviser Rules would have added a separate mandatory audit requirement, but those rules were vacated by the Fifth Circuit in June 2024. The pre-existing custody rule framework continues to apply. Exempt reporting advisers are not subject to the custody rule in the same way, but their LPs usually still require audits.

Who is involved#

• The audit firm: partner, manager and field staff, plus valuation specialists for complex investments.
• The fund CFO or controller: owns the financial statements and management's representations.
• The fund administrator, if any: prepares many of the schedules and responds to detailed requests.
• The deal team: supports valuation conclusions and provides portfolio company information.
• Legal counsel: responds to legal letters on litigation and contingencies.

The audit timeline#

For a calendar-year fund, a typical sequence looks like this:

Funds of funds, or funds that invest in other funds, often run later because they depend on underlying fund audits.

What auditors test#

Investments and valuation#

This is the core of most private fund audits. Auditors will:

• Confirm existence and ownership, through deal documents, capitalization tables, share certificates or confirmations with portfolio companies.
• Test fair value by reviewing the fund's valuation policy, methodology, inputs and comparable companies, often with their own valuation specialists.
• Assess consistency with prior periods and with subsequent events, such as a priced round or exit shortly after year-end.
• Review disclosures for the fair value hierarchy, Level 3 roll-forward and significant unobservable inputs.

Venture funds see particular scrutiny on marks based on the last round price, especially when the round included preferred terms, when the round is stale, or when the company's performance has changed since.

Capital activity and partner capital#

• Confirmations sent to a sample of LPs to verify commitments, contributions and distributions.
• Recalculation of capital calls and distributions against the LPA.
• Testing allocation of income, expenses and gains across partners.
• Recalculation of accrued carried interest using the distribution waterfall.

Fees and expenses#

• Recalculation of management fees and any offsets.
• Testing that fund expenses are permitted under the LPA and correctly allocated between the fund, parallel vehicles and the management company.
• Review of related-party transactions.

Cash and liabilities#

• Bank confirmations and reconciliations.
• Credit facility confirmations, interest and covenant compliance.
• Search for unrecorded liabilities after year-end.

Materiality and findings#

Auditors set an overall materiality, often derived from net assets for investment funds, and smaller thresholds for specific areas. Misstatements found during the audit are classified as corrected (adjusting entries) or uncorrected (summarized for management and governance).

At the end, the firm issues its opinion. An unmodified (clean) opinion is the expected outcome. Auditors may also issue a management letter noting control observations that are not severe enough to affect the opinion but should be fixed.

How to prepare: a practical checklist#

1. Agree the PBC list early and assign an owner and due date to each item.
2. Close the books on time with reconciled cash, investments and capital accounts.
3. Finalize valuations with full support: memos, models, comparable sets, board materials and subsequent-event analysis.
4. Reconcile capital to the investor register and to every notice issued.
5. Prepare a waterfall file that ties to the LPA, with inputs and outputs documented.
6. Schedule fees and expenses with invoices, approvals and allocation logic.
7. Pre-draft the financial statements and disclosures rather than waiting for the auditor.
8. Keep an index. A logical folder structure, named consistently, saves days of back-and-forth.

Hypothetical example of where time goes#

Assume a fund expects a six-week fieldwork window. If valuation support arrives two weeks late, capital confirmations reveal three LP addresses are stale, and two expense invoices cannot be located, each issue triggers follow-up requests, additional sampling and partner review. None of them is complex; together they can push sign-off past the delivery deadline. The fix is preparation, not negotiation.

Common audit findings in private funds#

• Expense allocation errors, for example management company costs charged to the fund.
• Fee calculation errors, especially around offsets and step-downs after the investment period.
• Stale or unsupported marks on Level 3 investments.
• Cutoff errors on capital activity near year-end.
• Weak change controls over spreadsheets that drive allocations.

A strong audit trail addresses several of these at once, because auditors can follow each figure back to its source and see who changed what.

The representation letter and governance communications#

Near the end of the audit, management signs a representation letter confirming, among other things, that it has provided all relevant information, that the financial statements are its responsibility, and that there are no undisclosed related-party transactions, litigation or subsequent events. The fund CFO and an appropriate senior person at the GP usually sign. Treat it seriously: it is a statement of fact by management, not a formality.

Auditors also communicate significant matters to those charged with governance, typically the GP's principals or an advisory committee where one exists. These communications cover significant accounting policies and estimates, difficulties encountered, uncorrected misstatements and any disagreements with management. LPs sometimes ask whether such matters arose; a clean, uneventful audit is itself a useful data point in due diligence.

First-year audits#

A fund's first audit takes more effort than later ones. The auditor must understand the structure, read the LPA and side letters, document processes from scratch and test opening balances such as organizational costs and initial capital. Emerging managers should engage the auditor before the first close where possible, so that chart of accounts, fee calculations and expense policies are set up in a way the auditor will accept. Fixing an accounting policy after a year of transactions costs far more than getting it right at the start.

How Privatis helps#

Privatis keeps each fund's double-entry general ledger, capital activity, waterfall calculations and portfolio valuations in one system, with period close and locking. Capital account statements and documents are available through the LP portal, and the audit trail records every change, so auditors can trace balances to their source.

Custody rule obligations depend on your registration status and facts; confirm specifics with counsel.