EMD Due Diligence: What Private Investment Funds Should Expect

This article is current as of the time of publication, is for informational purposes and does not constitute professional advice. Independent legal advice should be sought prior to relying on any information herein.

For a private investment fund, engaging an exempt market dealer involves more than signing a dealer agreement and beginning to process subscriptions. Before an EMD makes a fund available to its clients, the dealer needs to understand the security it is distributing. In practice, that generally means reviewing the fund, its manager, its investment strategy and portfolio, the terms and risks of the investment, its financial and valuation information, material conflicts, its offering and marketing materials, and the manner in which the fund raises capital.

The scope of that review will vary considerably from one fund to another. An established mortgage investment corporation with a substantial portfolio, audited financial statements and an experienced management team presents a different diligence exercise from a newly formed real estate development fund. A private credit fund making senior secured loans raises different questions from a REIT holding stabilized income-producing properties. There is therefore no universal package of documents or questions applicable to every EMD onboarding.

For an established private investment fund considering an EMD relationship, however, there are several areas that should generally be expected. Understanding those areas in advance can help management prepare an organized diligence package, identify issues before they delay onboarding and establish a clear division of responsibilities between the fund and the dealer.

Why Does an EMD Review the Fund?

An EMD is a registered securities dealer and has its own regulatory obligations when it makes an investment available to clients. One of the central requirements is the dealer’s know-your-product, or KYP, obligation under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. At the firm level, an EMD must take reasonable steps to assess the relevant aspects of securities made available to clients, including their structure, features, risks and costs. The firm must approve securities before making them available to clients and take reasonable steps to monitor approved securities for significant changes.

The appropriate KYP process depends on the dealer’s business model and the securities it offers. For a private investment fund, the dealer will generally require enough information to understand the economic substance of the investment and the material risks associated with it. That can require understanding what the fund owns, how it expects to generate returns, how its assets are valued, how much leverage it uses, what fees investors bear, whether investors can redeem, what conflicts of interest exist and who is responsible for managing the fund and its assets.

That product-level review also informs what happens when the EMD deals with individual investors. A dealer cannot meaningfully assess whether an investment is appropriate for a particular client without first understanding the investment itself. The diligence process is therefore part of the foundation on which the EMD’s subsequent investor onboarding and suitability processes are built.

Prospectus Exemption and Product Approval Are Different Questions

A fund’s ability to rely on a prospectus exemption should be distinguished from the EMD’s approval of the fund as a product. A private fund may be legally permitted to distribute securities without a prospectus under the accredited investor exemption or another exemption in National Instrument 45-106 Prospectus Exemptions. That does not itself require an EMD to approve the fund for distribution.

The prospectus exemption addresses whether the distribution may occur without a prospectus. The dealer’s KYP and related registrant obligations address the dealer’s responsibilities when making the security available through its firm. Similarly, an investor’s qualification as an accredited investor does not by itself establish that a particular investment is suitable for that investor. EMD onboarding therefore involves understanding both the fund and the regulatory framework under which its securities will ultimately be distributed.

The Fund Manager and Key Principals

For many private investment funds, investors are substantially dependent on the people responsible for sourcing investments, deploying capital, managing assets and making decisions concerning valuation, leverage and liquidity. The people behind the fund are therefore an important component of EMD diligence.

The dealer may review the ownership and organizational structure of the manager, the identities and experience of directors, officers and key investment personnel, the manager’s operating history and the functions performed by affiliated entities. Depending on the circumstances, the review may also consider regulatory or disciplinary history, material litigation, prior funds or businesses operated by the principals and the allocation of responsibilities among the manager, general partner and other entities involved in the fund.

The relevant experience will depend on the product. For a MIC, experience originating, underwriting and administering mortgages may be particularly relevant. For a private REIT, the focus may include property acquisition, financing, development and asset management. For a private credit fund, the EMD may be more interested in underwriting, credit analysis, collateral management and experience dealing with defaults or workouts. A newer manager is not precluded from EMD distribution, but a limited operating history may require greater attention to the experience of the individuals actually making investment decisions and the controls surrounding them.

The Fund’s Legal Structure and Governing Documents

The EMD also needs to understand the legal structure through which investors participate in the fund and the rights attached to the securities being offered. Depending on the structure, this may involve reviewing the limited partnership agreement, declaration of trust, articles or other constating documents, general partner arrangements, management or investment management agreements, subscription agreement and material agreements with related entities.

The purpose of the review extends beyond confirming that the documents exist. The dealer needs to understand matters such as the fund’s authority to issue securities, the classes or series available to investors, distribution entitlements, redemption rights, transfer restrictions, the powers of the manager or general partner and any material voting or approval rights retained by investors. Where several entities are involved, the EMD may also need to understand how those entities interact and where contractual responsibilities actually reside.

Consistency across the documents is particularly important. If the offering memorandum describes quarterly redemptions subject to specified restrictions, the governing documents and subscription agreement should support that arrangement. If the investor presentation describes a particular fee structure or distribution policy, the legal documents should tell the same story. Inconsistencies among governing documents, offering materials and subscription documents can create uncertainty about the security itself and frequently generate additional diligence questions.

The Investment Strategy and Underlying Portfolio

The EMD must understand the economic substance of the investment. Describing a fund simply as investing in real estate, mortgages or private credit is generally insufficient for that purpose. The dealer may need to understand the fund’s investment mandate, asset selection process, portfolio composition, geographic and asset concentration, leverage, liquidity, use of subsidiaries or special purpose vehicles and material counterparties.

The relevant questions depend heavily on the asset class. For a MIC, the review may extend to mortgage ranking, loan-to-value parameters, geographic and borrower concentration, construction or development exposure, arrears, defaults and the composition of the mortgage portfolio. For a private REIT, the dealer may consider property types, occupancy, property-level financing, leverage, development exposure and valuation methodology. For a private credit fund, relevant considerations may include borrower concentration, seniority, collateral, covenants, loan maturities, default experience and the liquidity of the underlying loans.

The central question is how the investment works economically. The dealer should be able to understand where investor returns are expected to come from, what assumptions those returns depend upon and what circumstances could cause distributions to decline, liquidity to become constrained or investors to lose capital. The more complicated the investment structure or underlying assets, the more detailed that analysis may become.

Offering Terms, Fees and Liquidity

Understanding the portfolio is only part of the exercise. The EMD also needs to understand the security being sold to investors and the economics associated with owning it. Relevant terms can include the subscription price, minimum investment, distribution policy, management and performance fees, commissions and other distribution costs, redemption rights, notice periods, lock-ups, gates, suspension rights, early redemption charges and the relative economic priority of different classes or securities.

Liquidity deserves particular attention for many private funds. A fund may permit monthly or quarterly redemption requests while holding mortgages, real estate, private loans or other assets that cannot readily be sold. The EMD will generally need to understand how the fund manages that mismatch, how redemptions are funded and what happens if redemption requests exceed available liquidity. A redemption right that is subject to gates, available cash, manager discretion or suspension provisions should be understood in that context rather than treated as equivalent to daily liquidity.

Regular distributions can raise similar questions. Where a fund advertises a target distribution or has historically made consistent distributions, the dealer may seek to understand the source of those payments and the circumstances in which they can be reduced or suspended. The EMD should ultimately be able to understand both sides of the investor economics: how an investor is expected to earn a return and how the investor can lose money or encounter restrictions on access to capital.

Financial Information, Valuation and Performance

The financial diligence required will depend on the fund’s structure and operating history. An established fund may be asked to provide audited annual financial statements, interim financial information, NAV calculations, portfolio reports, distribution history and other information necessary to understand its financial position and historical operations.

For funds holding illiquid assets, valuation can be particularly important. The dealer may need to understand who values the assets, how frequently valuations occur, what methodologies are used, whether independent appraisals or third-party valuation providers are involved and how those valuations affect the fund’s NAV and the price at which securities are issued or redeemed. In some structures, the EMD may also need to understand how valuation decisions are governed where the manager or a related party has discretion over material inputs.

Historical performance requires similar discipline, particularly when performance information is used in presentations, fact sheets or other investor-facing materials. A fund should be able to explain how performance figures were calculated and support them from its underlying records. This becomes particularly important where marketing materials refer to historical returns, yields, target returns or distributions, or where a presentation could cause an investor to draw conclusions that are not fully supported by the fund’s financial results.

Conflicts of Interest and Related-Party Arrangements

Private investment funds frequently operate within groups of affiliated companies. The fund manager, general partner, property manager, mortgage administrator, developer or other service providers may share ownership, personnel or economic interests. Those relationships can create conflicts that require careful consideration during EMD diligence.

Examples include assets acquired from or sold to affiliates, loans involving related parties, property management performed by an affiliated company, development or administration fees paid to related entities, investment opportunities allocated among multiple related funds, shared personnel and expenses, cross-fund transactions, referral arrangements and compensation tied to capital raised. The existence of a related-party arrangement does not necessarily prevent an EMD from approving a fund. The dealer will, however, generally need to understand the nature and materiality of the conflict, the economic benefit received by the related party, how the conflict is addressed and whether the arrangement is appropriately disclosed to investors.

For fund managers, the practical point is that conflicts should be identified and explained directly. Leaving the dealer to reconstruct related-party relationships from organizational charts, financial statements and scattered disclosure tends to make diligence slower and can create additional questions about whether other relationships have also been omitted.

Service Providers and Operational Infrastructure

The EMD may also examine the fund’s operational infrastructure and the parties responsible for important functions. Depending on the product, these can include the auditor, fund administrator, custodian, legal counsel, investment manager, property manager, mortgage administrator, valuation provider and transfer agent or recordkeeper.

The dealer may want to understand which functions are performed internally and which are delegated to independent third parties, as well as how subscriptions are processed, how investor records are maintained, how NAV is calculated, how distributions are administered and how material information is communicated. For a fund with a significant operating history, the EMD may also need to understand whether the current infrastructure is capable of supporting the contemplated volume of ongoing distributions.

Established independent service providers can be relevant to understanding a fund’s control environment, but their involvement does not replace the dealer’s own product review. The EMD remains responsible for satisfying its own obligations and should therefore understand how the various components of the fund’s operational structure fit together.

Offering Documents and Marketing Materials

An EMD’s review will generally extend beyond the formal offering memorandum or private placement memorandum. The dealer may also review the subscription agreement, investor presentation, term sheets, fact sheets, website content, email campaigns, historical performance materials and other communications used with prospective investors.

These materials should describe the investment consistently. If the offering memorandum describes substantial restrictions on redemptions while the website presents the investment as readily liquid, that discrepancy requires attention. The same issue can arise with fees, leverage, investment strategy, distribution policies and descriptions of risk. Marketing statements concerning target returns and historical performance should also be supportable and presented with sufficient context to avoid giving investors an incomplete understanding of the investment.

This means a fund’s marketing materials should be treated as part of the EMD onboarding process rather than as a separate commercial exercise. In practice, the dealer’s review may result in changes to investor presentations, website language or other materials before they are approved for use in connection with the dealer’s distribution activities.

How Is the Fund Currently Raising Capital?

For an established fund, one of the most important areas of diligence may concern the existing capital-raising operation rather than the portfolio itself. The EMD needs to understand how prospective investors are identified, contacted and ultimately brought into the fund.

That generally requires mapping the process from the first investor contact through subscription and closing. The dealer may want to know who generates leads, who contacts prospective investors, who presents the investment, who answers questions about returns and risks, who discusses an investor’s financial circumstances, whether employees receive compensation tied to capital raised, whether finders or referral sources are used, whether referral fees are paid, whether third-party capital raisers are involved and which individuals are registered under securities legislation.

These questions matter because engaging an EMD does not automatically permit an issuer’s existing personnel to continue every activity they previously performed. The fund and dealer need a clear allocation of responsibilities between the issuer’s unregistered personnel and individuals conducting registrable dealing activities through the EMD. Where a fund uses issuer-sponsored dealing representatives, those individuals operate as registered representatives of the EMD and are subject to the dealer’s compliance and supervisory framework.

Existing finder, referral and compensation arrangements may also require review. An EMD onboarding exercise can therefore identify aspects of a fund’s historical or current distribution model that need to be changed before the dealer begins facilitating new investments. A fund manager should be prepared to explain how capital raising works in practice, including who says what to prospective investors and how each participant in the process is compensated.

Prospectus Exemptions and the Fund’s Target Investors

The EMD will also need to understand the exemptions under which the fund expects to distribute its securities and the jurisdictions in which those distributions will occur. Many private funds rely primarily on the accredited investor exemption under NI 45-106, although other exemptions may be available depending on the offering, investor and jurisdiction.

The applicable exemption affects investor eligibility, the representations required in subscription documentation, applicable risk acknowledgement requirements and exempt distribution reporting. The EMD will therefore need to determine whether the proposed investor onboarding process and subscription documents support the exemptions on which the fund expects to rely.

An important distinction arises here. Accredited investor status does not itself establish suitability. An investor can satisfy the financial criteria for an accredited investor category while having liquidity requirements, investment objectives, risk capacity, time horizon or existing portfolio concentration that raise suitability concerns in relation to a particular private fund. The availability of a prospectus exemption and the dealer’s investor-level obligations therefore address different questions.

Product Approval and Investor Approval Are Separate Steps

For fund managers, it can be helpful to view the distribution process as a sequence:

Fund due diligence → Product approval → Investor KYC → Prospectus exemption qualification → Suitability determination → Subscription and closing

The EMD first needs to understand and approve the product. Once the fund is available through the dealer, the EMD can then consider prospective investments by individual clients. At that stage, the dealer’s KYC information concerning the investor and its KYP understanding of the fund come together in the suitability analysis.

Product approval therefore does not mean that every prospective investor will be able to purchase the fund. Similarly, qualification under a prospectus exemption does not guarantee that the EMD will approve a particular investment. For fund managers accustomed to thinking primarily in terms of whether an investor is accredited, this distinction is important when designing the investor onboarding process and setting expectations for the issuer’s sales or investor-relations team.

What Commonly Delays EMD Onboarding?

EMD diligence does not necessarily produce a simple approval or rejection. In many cases, the review identifies matters that can be clarified, documented or corrected before the fund is approved.

Common examples include stale or incomplete offering documents, inconsistencies among the offering memorandum, subscription agreement and governing documents, unclear ownership structures, incomplete financial information, unsupported performance claims, unclear valuation methodologies, related-party transactions that are inadequately explained, inconsistent descriptions of fees or liquidity, undocumented finder or referral arrangements, uncertainty regarding the activities of unregistered personnel and incomplete operational procedures.

The significance of those issues depends on the circumstances. A drafting inconsistency may be relatively straightforward to correct. A material question concerning valuation, financial information, conflicts or historical distribution practices can require substantially more analysis. The purpose of the diligence exercise is therefore broader than collecting documents. It is to determine whether the EMD understands the product sufficiently and whether any matters need to be addressed before the fund is made available to clients.

How Long Does EMD Due Diligence Take?

There is no standard timeline for onboarding a private investment fund because timing depends substantially on the complexity and preparedness of the particular fund. An established fund with current financial statements, coherent legal documents, experienced management and a clearly documented distribution process will generally present a more straightforward diligence exercise than a fund with a complex organizational structure, unusual assets, numerous related-party arrangements or unresolved questions about existing capital-raising practices.

The quality of the initial diligence package also matters. Where management can provide organized documents and promptly answer follow-up questions, the dealer can focus on analyzing the product rather than repeatedly identifying missing information or reconciling conflicting documents. Fund managers considering an EMD relationship should therefore treat preparation for diligence as part of the engagement process rather than waiting for the dealer to identify every document and issue individually.

How Should a Fund Prepare for EMD Due Diligence?

A fund can do substantial preparatory work before formal diligence begins. At a minimum, management should consider assembling its organizational records, governing documents, offering memorandum or PPM, subscription agreement, material management and related-party agreements, audited and interim financial statements, portfolio information, NAV and valuation materials, service-provider information, current investor presentations and other marketing materials.

The fund should also document how it currently raises capital. That includes the roles of investor-relations personnel, employees, registered individuals, referral sources, finders and third-party capital raisers, together with the compensation arrangements applicable to those participants. The EMD should be able to understand who performs each stage of the distribution process and where responsibility passes from the issuer to registered dealer personnel.

Before providing the diligence package, management should review the materials collectively rather than document by document. Do the governing documents and offering memorandum describe the same redemption rights? Are fees described consistently? Does the investment strategy presented to prospective investors correspond with the legal disclosure? Can historical performance claims be reconciled to the fund’s records? Are related-party arrangements clearly identified? Can management explain the source of distributions and the fund’s valuation process? Addressing these questions before diligence begins can eliminate avoidable follow-up and expose issues that may be easier to correct before the dealer formally reviews the offering.

Due Diligence Continues After Initial Approval

EMD product review does not end when the fund is initially approved. NI 31-103 requires registered firms to take reasonable steps to monitor approved securities for significant changes, which means an ongoing private fund relationship requires a process for communicating developments that could affect the dealer’s understanding of the investment.

For an evergreen private fund, potentially relevant developments may include material changes to the investment strategy, fees, redemption terms, leverage, management, valuation methodology, conflicts or financial condition. Amendments to offering documents, new classes of securities, material litigation or significant developments within the portfolio may also warrant consideration. The relevance of any particular change will depend on its nature and materiality.

This ongoing component is particularly important for funds that raise capital continuously. An EMD may continue onboarding investors months or years after its initial product approval, so the information on which that approval was based cannot simply remain frozen as of the original onboarding date. The fund and dealer need an effective process for keeping the dealer informed of significant developments.

For fund managers, this means that EMD onboarding should be approached as the beginning of an ongoing dealer relationship rather than a one-time approval process. Establishing clear responsibilities for product information, material changes, investor onboarding and ongoing distribution at the outset can help the fund and EMD maintain an effective relationship as the offering continues.

Contact Us

Startly Inc. provides outsourced exempt market dealer services to investment funds and other issuers raising capital under prospectus exemptions. If you are launching a new fund, expanding an existing exempt offering, or evaluating your distribution model under National Instrument 31-103, contact us to discuss how our EMD platform can support your capital raising activities.