At any given time, there are multiple first-time private equity funds touring the LP circuit trying to raise the needed capital to implement their respective investment strategies. Whether these funds actually succeed or not depends on many factors, including how well the GP and related advisory team prepares and executes on a meticulous plan. With that in mind, I’ll provide some thoughts for GPs working towards a first-time fund, along with insights from influential LPs I know as well.
To begin with, the GPs of a maiden fund need to objectively access their entire skill set (including junior team members) and determine whether they are able to create / exploit a compelling niche that is welcomed by LPs in this increasingly crowded fundraising environment. Assuming that is the case, partnering with a dedicated marketing / due-diligence / and capital raising team in the funds respective vertical(s) can minimize costly errors / time-wasters, and mean the difference between a successful launch and final close. Moreover, managers seeking to raise funds need to be realistic and accountable on their short and intermediate-term goals, be able to generate good deal flow (proprietary is best), clearly demonstrate a single or team-based prior track record (if available), have dedicated subject matter experts / advisory members to draw upon when needed, and have multiple avenues for exits down the road.
From an LP perspective, it can still be very challenging at times to pinpoint a first-time group that is going to actually succeed. Moreover, even after all the due-diligence, whether in-house or outsourced, it can still be hard at times to access which GPs are going to make it to, or near their funding targets, as pockets of LP capital available for emerging managers is more limited than established funds.
While there have been, and will still be, a certain amount of successful first-time funds without a previous history among the management, some LPs feel more comfortable allocating to emerging managers as a result of spin-outs. When the GPs are part of a team that worked together previously it makes things easier to assess, versus a team that’s coming together for the first time with multiple backgrounds. When GPs fall into the second category, their ability to convey how their various backgrounds and skill-sets compliment each other is paramount.
While spin-outs from larger and successful GPs can generally provide less of a barrier towards gaining an LPs trust and comfort with the emerging manager team, as noted above, there’s still new managers that only had the use of a parent company’s balance sheet, a portion of endowment funds, or even long-term family office capital. In fact, there’s many examples of teams leaving a seemingly endless source of capital, and spinning out towards new horizons: i.e., Charlesbank Partners spinning out of Harvard’s endowment; Madison Dearborn spinning out of First Chicago Bank; and Shore Capital Partners who’s founding general partners actually came from four different firms, including Wind Point Partners, Water Street Healthcare Partners, Valor Equity Partners, and an SFO (Henry Crown & Company).
Regarding due-diligence, documentation, and access to data, first-time GPs should ready themselves with a plethora of information to respond to the inevitable scrutiny from LPs. More than ever, increasing expectations from limited partners with respect to their due diligence process need to be efficiently satisfied by the potential GPs whom they may partner with. Ranging from near intrusive background checks to plenty of questions about cyber security, insider-trading policies, compliance, and various personal financial questions. Another aspect for new firms coming out of established institutions to realize, is there’s most likely a limitation on what they can actually divulge about a previous track record, including what information can actually be disclosed in the new funds PPM as well.
GPs starting a new fund should also focus on securing a strategic / anchor investor who can ultimately pledge a sizeable amount of capital. Whether it’s an endowment, SFO, insurance / pension plan, SWF, or key UHNW Individual, by securing a prominent LP in what I call “SMART” capital, the nascent GP will inadvertently attract other high-quality investors to allocate as well, or at least go through their respective due diligence process. Moreover, while having the backing of a sizeable and influential LP is wonderful, GPs should also be mindful of additional economic responsibilities that come with such capital infusion. Notably, the strategic LP will usually negotiate a waving or severe reduction in the management fee, and even carried interest, especially if co-investment occurs.
Overall, there will always be first time funds coming to the market, along with LPs that are willing to invest in them for potentially outsized returns. In order to position themselves in the best light, new GPs need to have the regulatory, infrastructure, complimentary team members, and a compelling story in place before entering the unforgiving market for capital. As LPs continue to increase their due diligence requirements for maiden funds (and established funds), GPs will have to execute flawlessly. If they can’t do it organically, GPs should strongly consider partnering with a dedicated third-party focused on their funds niche to increase their chances of going the distance.