Lessons learned from first time fundraises
Raising an inaugural private equity fund has traditionally been a time consuming, arduous process since many investors prefer to focus on more established managers. However, the current macro-economic and private equity market conditions for launching a first time fund (FTF) are favorable. Also, investors are increasingly recognizing the superior returns that first time funds can offer1. As a result, investors are more open to investing in a FTF; a recent survey found that more than half would invest or consider investing in such an offering2.
Monument Group has helped many first-time managers to raise a fund successfully. For example, we worked with Silversmith Capital Partners, which hit the fund cap of $460 million after approximately three months of marketing in 2015. The following are some lessons learned from such fundraising processes.
Consider the value proposition and timing of the new fund carefully. Have you identified a compelling market opportunity? Can you demonstrate evidence of good investment judgement? FTFs have a higher perceived level of risk, so your value proposition needs to be clear. There mere fact that one has previously worked at a well-recognized investment firm is not sufficient. Also, consider the best time to leave your existing investment firm; leaving in the midst of a fundraise or soon afterwards can create animosity. Maintaining an amicable relationship with your previous employer is key for obtaining strong references and track record attribution (see below). It may also lead to the firm or its individuals investing in your new fund; a powerful signal for other investors.
Seek to minimize perceived organizational risk. A key concern for LPs will be how the team dynamics will work. Assuage their concerns by distributing carried interest broadly amongst the investment team. Also, although not always necessary, completing several investments before launching a fund can be a great way to demonstrate that the team can work together to source investments and create value. Finally, be thoughtful about the non-deal related aspect of the business; for example, identifying a strong (and presentable to investors) CFO shows concretely that a new firm is properly investing in itself.
Focus on a path to track record attribution. The gold standard remains full, written attribution for all relevant investments from a prior employer. However, many firms are not willing to provide this information, in which case a letter confirming which investments a person played a senior role in is also useful. If the employer is not willing to provide anything in writing, a positive verbal reference will be additive. Failing that, you will need to re-construct your track record using publicly available data and reference calls. Typically, the best time to negotiate for track record attribution is before you leave; you may find that afterwards the level of co-operation declines. Finally, try to preserve the right to update your track record periodically, especially if there is a large amount of unrealized value shown in the track record.
Be wary of what you give up to a cornerstone LP. It is tempting to strike a deal with a large investor to achieve a fast first closing. However, care must be taken not to scare off later investors; other LPs will be allergic to any outside influence on the team’s investment process or governance. Providing economic benefits to a cornerstone investor, such as reduced carried interest or lower management fees, is fairly common and – provided the alignment of interest is not unduly diminished – typically not a deal breaker for other LPs.
Mitigate concerns about ‘leaving the mother ship’. If the team’s background is with a large firm, LPs will naturally wonder if being part of that organization afforded benefits with regard to sourcing, due diligence and back office that will be difficult to replicate in your new firm. As such, it is important to focus your marketing messages on the positive aspects (for example, a more nimble decision-making process). Demonstrate how deal flow is related to personal networks rather than the company name on a business card. Line up executives you have worked with who are willing to describe the personal value added rather than the brand value of a prior firm – don’t hesitate to remind them of specific contributions!
Focus on LPs that genuinely have the right risk appetite. Many investors are keen to jump on the FTF bandwagon in theory but far fewer actually execute such deals. Identify the types of investors more likely to back a FTF – for example family offices, endowments and certain fund of funds – and investigate their track record of actually investing in such managers. Also, LPs that have invested with your previous firm can be an excellent starting point.
The best-case scenario for a FTF is to hit the fund’s cap within a few months of launch, with a well-diversified mix of high-quality investors. Keeping the above points in mind will provide the best chance of achieving this goal.
Footnotes;
- ‘Making the Case for First Time Funds’ (Preqin, November 2016) shows that for a sample set spanning 2000 to 2012 vintage years, in all but one year, first time funds outperformed more established ones.
- Same report: 51 percent of more than 400 institutional investors surveyed in June 2016 will invest, or consider investing, in a first-time private capital fund this year. That is a 12-percentage point increase from 2013.
