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Guide

Year-end audit preparation for a first fund: the PBC list, the timeline and what auditors ask for

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Quick answer

A first fund audit is a calendar problem before it is an accounting problem. The custody rule's audit route requires GAAP financial statements, audited by a firm registered with and inspected by the PCAOB, delivered to LPs within 120 days of fiscal year end; most LPAs copy that date. Work backwards from it: engage the auditor before year end, deliver the prepared-by-client list in January, close the valuations by early February, and leave the last month for the draft, the review and the partners' capital reconciliation.

Before you start

Read two documents before year end. The LPA's reporting clause tells you the audit deadline, which GAAP applies, whether the auditor must be a named firm or a firm of a stated size, and what LPs receive. The custody rule tells you the floor if the manager is a registered adviser relying on the audit route: financial statements prepared under GAAP, audited by an independent public accountant registered with and subject to regular inspection by the PCAOB, and distributed to all limited partners within 120 days of fiscal year end, with a final audit on liquidation. Most LPAs copy the 120 days even for exempt reporting advisers, so treat it as the date whatever your registration status.

Then engage the auditor, in writing, before December 31. A firm engaged in February is a firm that will be late, and the engagement letter is where you agree the fee, the timeline, who signs the representations, and which records the auditor gets from the administrator and which from you. Check the firm on the PCAOB's list of registered firms if the custody rule applies, and ask when it was last inspected.

The 120 days, worked backwards

Days after a December 31 year end. The deadline is the custody rule's and most LPAs copy it; everything before it is scheduled to make the last month boring.

Days after fiscal year end
Day -15Auditor engagedEngagement letter, PBC list agreed, planning call
Day 0Year endBooks close; valuations as of this date
Day 25PBC list deliveredLedger, bank, investments, capital accounts, documents
Day 45Valuations closedMarks approved under the valuation policy, support filed
Day 75Fieldwork doneOpen items cleared; draft statements to the manager
Day 100Draft reviewedDisclosures, partners' capital tie-out, representations letter
Day 120Audited statements to LPsThe custody rule's 120 days; LPAs copy it
Fieldwork
1234567
  1. 1Day -15Auditor engagedEngagement letter, PBC list agreed, planning call
  2. 2Day 0Year endBooks close; valuations as of this date
  3. 3Day 25PBC list deliveredLedger, bank, investments, capital accounts, documents
  4. 4Day 45Valuations closedMarks approved under the valuation policy, support filed
  5. 5Day 75Fieldwork doneOpen items cleared; draft statements to the manager
  6. 6Day 100Draft reviewedDisclosures, partners' capital tie-out, representations letter
  7. 7Day 120Audited statements to LPsThe custody rule's 120 days; LPAs copy it
Figure 1The GP Ledger

Step 1. Build the PBC list in December

The prepared-by-client list is the audit. Everything the auditor tests comes from it, and every late item on it moves the delivery date. Agree it with the auditor in December, assign an owner to each line, split between the administrator and the manager, and put a date on each that lands before the fieldwork start.

The PBC list for a first venture fund

What the auditor asks for, in the order they usually ask. The valuation support is the line that decides the timeline.

  1. 1General ledger and trial balanceFull year, with the closing entries and the year-end accruals
  2. 2Bank statements and reconciliationsEvery account, every month, reconciled to the ledger
  3. 3Investment schedule and valuation supportCost, fair value, method and the evidence for each position at year end
  4. 4Capital account roll-forwardsPer LP: opening, contributions, allocations, fees, distributions, closing
  5. 5Fee, carry and waterfall calculationsManagement fee by LP, accrued carry, the waterfall as applied to any distribution
  6. 6Fund documentsLPA, side letters, subscription agreements, investor register
  7. 7Notices and consentsCapital call and distribution notices, investment approvals, advisory committee minutes
  8. 8Legal and related-party itemsLegal letters, management company transactions, expense allocations
Figure 2The GP Ledger

Step 2. Close the valuations early

Fair value under ASC 820 is where a venture fund audit spends its hours. For every position the auditor wants the method the valuation policy prescribes, the inputs, the evidence (the last priced round, a calibration to it, secondary trades, the company's financials) and the approval. A position marked at the last round price with no calibration a year later draws a question; a position written up without a transaction draws several.

Close the marks as of year end, approve them in the valuation committee the policy names, and file the support with the approval. Do it in January, not when the auditor asks in March. Portfolio companies that have not sent year-end financials are the usual reason a mark cannot be supported, so ask them in December.

Step 3. Reconcile before fieldwork

Three reconciliations must hold before the auditor arrives, and holding them is cheaper than explaining them: the bank balance to the ledger for every account at year end; the sum of every LP's capital account to partners' capital on the balance sheet, to the cent; and the investment schedule to the general ledger at cost and at fair value. If an administrator keeps the books, ask for all three in writing with the PBC list. A capital account that drifts from the bank is how a first audit goes long.

Step 4. Model the fees, the carry and the waterfall

The auditor recomputes the management fee by LP against the LPA, including side-letter discounts and offsets, and recomputes the accrued carry as if the fund were liquidated at fair value on the balance sheet date. For a fund that has distributed, the waterfall as applied to the distribution is tested against the LPA tier by tier. Have the model, the LPA clause references and the side letter register ready as one bundle; the question is never whether carry was accrued but whether the LPA says what the model assumed.

Step 5. Read the draft like an LP

The draft statements arrive with the disclosures: the valuation hierarchy, the fee and carry terms, commitments, related parties, subsequent events. Read them as the most careful LP will. Tie partners' capital on the balance sheet to the capital account statements already sent. Check the fund's description, the fiscal year, the LPA terms and the subsequent events against what actually happened. Then sign the representations letter, which is the manager's statement that the records are complete and that nothing is left out; it is not a formality, and the auditor cannot issue without it.

Step 6. Deliver and file

Send the audited statements to every LP through the portal within the deadline, with the capital account statements that tie to them. File the statements, the representations letter, the PBC bundle and the valuation approvals together; the next year's auditor, and the LP's operational due diligence team, will ask for the set. If the deadline will be missed, say so to LPs before it passes, with a date.

The mistakes that make a first audit late

  • Engaging the auditor after year end. The firm plans its season in the autumn; a February engagement joins the back of the queue.
  • Valuation support assembled on request. Marks approved in January with the evidence filed take hours in fieldwork; marks defended in March take weeks.
  • An administrator and a manager who both think the other owns the PBC list. Write the split into the administration agreement.
  • Side letters outside the fee model. The auditor finds the discount the model missed, and the capital accounts have to be restated.
  • Treating the representations letter as paperwork. It is the document the manager signs; read every line.

Frequently asked questions

Does a first venture fund have to be audited?
Not by law in every case. An exempt reporting adviser is outside the custody rule, so the obligation comes from the LPA, which almost always requires an annual audit, and from LPs, who expect one. A registered adviser relying on the custody rule's audit route must deliver GAAP statements audited by a PCAOB-registered and inspected firm within 120 days of fiscal year end.
What is a PBC list?
Prepared by client: the schedule of documents the auditor needs from the fund before fieldwork, with an owner and a due date for each. The general ledger and trial balance, bank statements and reconciliations, the investment schedule with valuation support, capital account roll-forwards, fee and carry calculations, the LPA and side letters, subscription documents, capital call and distribution notices, and the minutes or consents behind each investment.
How long does a first fund audit take?
Plan on the full 120 days from year end, and more if the fund holds other funds or late-reporting portfolio companies. The long poles are valuation support for private positions and the first-time setup of the auditor's understanding of the fund, both of which can start before year end.
What does the auditor test in a venture fund?
Existence and ownership of the investments, their fair value under ASC 820 and the fund's valuation policy, the completeness of cash and capital transactions, the arithmetic of fees, carry and the waterfall against the LPA, the allocation of profit and loss to partners' capital, and the disclosures. Fair value takes most of the hours.
Can the administrator run the audit for me?
The administrator prepares the books and most of the PBC list and answers the auditor's questions about them. The manager still owns the valuations, the related-party disclosures, the representations letter and the sign-off. Agree in the administration agreement who delivers what, and by when.

Sources

  1. Rule 206(4)-2, custody of client funds or securities (Cornell LII)www.law.cornell.edu/cfr/text/17/275.206(4)-2
  2. PCAOB registered firmspcaobus.org/oversight/registration
  3. ILPA reporting guidance and templatesilpa.org/industry-guidance/templates-standards-model-documents/ilpa-templates-hub/

Terms used in this article

  • Fund audit A fund audit is the annual examination of a private fund's financial statements by an independent accounting firm, which issues an opinion on whether the statements, including the schedule of investments at fair value and the partners' capital, are fairly presented.
  • Custody rule The custody rule is Advisers Act Rule 206(4)-2, which requires a registered adviser with custody of client assets to keep them with a qualified custodian and submit to independent checks.
  • Valuation policy A valuation policy is the written document, adopted by the general partner and usually referenced in the LPA, that sets out how a fund determines the fair value of each investment at each reporting date: the methods used, the inputs and their hierarchy, who prepares and approves the marks, how often they are reviewed and how conflicts of interest are handled.
  • Fair value Fair value is the price that would be received to sell an investment in an orderly transaction between market participants at the measurement date.
  • Capital account A capital account is the running balance of a single partner's economic interest in a fund: contributions in, allocations of income, gains and losses, less distributions out.
  • Partners' capital Partners' capital is the equity of a limited partnership fund, the sum of every limited and general partner's capital account, equal to total assets less liabilities.
  • Accrued carried interest Accrued carried interest is the amount of carry the general partner would be entitled to if the fund sold every investment at its current fair value and ran the proceeds through the distribution waterfall, recorded as an allocation from limited partners' capital accounts to the general partner's capital account rather than as a payment, and reversed if values fall.
  • Schedule K-1 Schedule K-1 (Form 1065) is the annual IRS form on which a partnership, including a fund organised as a limited partnership, reports to each partner their share of the partnership's income, gains, losses, deductions and credits for the tax year, so that the partner can report those items on their own return.
  • Fund administrator A fund administrator is the firm, or the software operated in-house, that maintains a private fund's books: partner capital accounts, capital call and distribution processing, fee and waterfall calculations, NAV, investor statements and audit support.
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