[This is the final article in a 4-part series of articles on fundraising]
Formal investor roadshows work well with large and mature funds and companies. This is largely because the people showing up at these meetings tend to be already aware of the fund managers and investor education is minimal.
If you have worked in an investment bank, you are probably familiar with ‘non-deal roadshows’ — which is basically a short briefing with prospective investors to introduce the company. No formal communication of offers are made at these meetings though there might still be interest and queries on the company’s future direction, strategy and whether they are exploring the idea of raising capital. The same way pretty much works with funds.
Unless you are an established fund manager, the first step of any fundraising is almost always investor education i.e. to get the word out and let everyone know that you are in the market. A few basic approaches are:
1. Curating a fund presentation deck There are no set guidelines, no ideal pitchbooks. Ultimately when you bring your deck into a meeting, investors will see what they like to see. I personally recommend no more than 15 pages: 30% strategy, 30% team, 40% case studies and track record. If you have additional slides, chuck them into the appendices.
Many GPs tend to overload the slide deck with generous servings of macroeconomic and industry data to try and “educate” investors, painting a rosy outlook of the geography or sector. I think many LPs will not say this but don’t you think that as large institutional money managers, they’d have good access to all that macro research?
Case studies on the other hand can be relatively more effective as they are personal, relatable and demonstrate more credibility for the presenter.
The best deck I’ve personally seen so far was at a face-to-face meeting in which the deck comprised of only two pages showing four case studies, each case study highlighting three metrics (i) entry equity (ii) exit equity and (iii) exit multiples. A 1–2 pager teaser also works just as well for less formal or extremely brief meetings, or if you are sending to preliminary prospects.
2. Leverage social media, expound thought leadership Social media platforms such as Facebook and Twitter used to be associated largely with casual and informal information shared by our personal contacts. Today, this is very different. Social media has become a ‘broadcasting’ tool to showcase not only personal experiences but also professional updates — a career move, promotion, transition into a new role or even starting a new venture.
Thought leadership articles such as a written publication on a particular topic or subject can be useful in kickstarting the fundraising process. Write about stuff related to your experience, background and relate them to your investing strategy or industry. While it might all appear to be academic, this can be effective in piquing the interest of your professional circle.
3. Conferences and speaking engagements Investment focused conferences (especially those that have a strong focus on private equity and venture capital) have been fairly effective in elevating publicity for new funds coming to the market. Speaking and sharing your views on a panel discussion is another way to demonstrate thought leadership to the investor community. Because some of these events are covered by media, there is good chance that your new fund gets mentioned as part of the news reporting.
In addition to that, many LPs typically also attend these events to get acquainted with new funds or share their perspectives on the macroeconomic outlooks as well as where they are allocating capital over the next 2–3 years. Some conferences also offer 1-on-1 meetings with other delegates at the venue, so look out for these features when choosing which ones to attend.
While mass events may not be in the format of your traditional roadshows, they serve as an excellent non-transactional platform to meet and engage potential investors and set the stage for a more formal and orchestrated meeting down the road.
4. Enlist a reputable figurehead Getting a publicly renowned senior professional on your fund’s advisory board is a good way to reinforce credibility and galvanize initial interest amongst potential investors. It also aids publicity depending on how influential your figurehead is.
However, many new fund managers equate the presence of a senior figurehead to a successful fundraising i.e. “If I have the former minister on my advisory board, LPs will invest in my fund”. Unlike the initial public offerings in which retail investors flock to buy shares of the company upon the entry of a large cornerstone investor, private funds people are not discerning and will still place emphasis on the executive team’s operating capability rather than the reputation of a few non-executive industry influencers.
Much like any fundraising exercise, it is important to ask “what does this person bring to the table?” and “how does he/she create value or fit into the overall investment strategy of the fund?”. Too many people overplay the publicity card, forgetting that real substance is in execution.
5. Create a digital profile Don’t undermine the importance of a digital identity.
The ease of access to the Internet these days make an online profile really easy to set up. It doesn’t cost a lot of do up a simple corporate fund website even though you have nothing to show for at the beginning.
Sometimes, a website isn’t so much as to showcase (or show off) track record but for establishing some form of legitimacy. Start a corporate LinkedIn page, get on Twitter, and fill them up with content. Good things take time to accumulate and not before long, you’ll find that your fund’s digital profile and credibility will be enhanced by the fact that it has ‘been in existence’ for some time.
Closing thoughts It is true that many institutional LPs do not bank with new funds coming to the market. But don’t get too caught up with the fact that you are a ‘first-time fund’. Many large PE/VC shops started as a first fund.
Perhaps one of the things that many fund managers do is to focus too much on getting the money in and forgetting about building the core business — which is to identify and seek out good companies, invest in them, and then actually selling them or exiting those investment at a decent return. The process itself looks blatantly obvious but it is always not at easy as it sounds.
"Most big recent successes (Microsoft, Apple, Facebook, Google) were started by people with skin and soul in the game and grew organically-if they had recourse to funding, it was to expand or allow the managers to cash out; funding was not the prime source of creation. You don't create a firm by creating a firm; nor do you do science by doing science." - (from the book, Skin in the Game)
And therefore by extension: You do not start a fund by simply just raising a fund.
If you actually need OPM (other people’s money) just to start a fund, then maybe you shouldn’t be raising a fund at all. Good ‘first-time’ fund managers know an opportunity when they see one and moblize their own (financial) resources to invest even if there are no LPs present.
Real track record ultimately speaks louder than marketing pitches and beautiful presentation decks. If you can demonstrate lucrative returns on projects, this is effectively tangible proof that the your team and investment strategy works, and institutional money will naturally come.
Starting a fund can be a costly process — no different from launching a start-up. It will not be easy, so do sufficient homework before taking that leap. Learn from the experiences of others and always remember that the best way to sell is to show that the product works.
Structuring and Licensing
[This is the third article in a 4-part series on fundraising] Read the previous chapter on fund strategy.
If you aren’t an investment professional, a lawyer or a banker, fund set up and the mechanics of how LP-GP structures work can be somewhat challenging to understand.
The majority of the business community are familiar with corporate entities limited by shares. But market practice and conventional wisdom seem to dictate that most funds be structured as partnerships. It happens to be the most common and most widely acceptable structure in the PE/VC world.
If this seems complicated, just remember:
At the crux of every commercial entity—be it a corporation or a partnership — is decision making.
Playing by the rules of the game. A typical PE fund structured as a partnership looks something like this:
In the above structure, the main responsibility of operating the fund on a day-to-day basis lies with the General Partner. The Limited Partner (being “limited” by definition) contributes capital but does not have any decision-making rights (much akin to the notion of preference shares in a corporation).
The ‘rules of the game’ — so to speak — are being defined in the Limited Partnership Agreement (“LPA”). Comparatively speaking, instead of the usual board of directors in a corporation, decision making resides in the Investment Committee, which is a group of people nominated by the GP and LPs (the same way shareholders nominate the board of directors). Naturally, those who contribute a larger share of the economics get a larger say in terms of who sits on the board or in this case, the investment committee.
There are many comprehensive resources detailing the mechanics of both partnerships and corporations, but below is an extremely simplified table outlining the few key commercial ‘equivalents’ which illustrates how partnerships in funds operate as contrasted to a typical corporate entity:
The process of ‘receiving’ investors (LPs) into the fund is all about defining the ‘rules of the game’ i.e. Formalizing them in the LPA. A fund formation lawyer can help do this, but as the fund manager, you will need to provide them the game plan, as well as the ‘boundaries’ of the playing field.
Amongst a ton of many things to consider here, some of the key commercial items to take note include:
(i) Amount of management fees and carried interest (profits from exiting an investment)
(ii) When the carried interest will be paid
(iii) Redemption — if, how and when limited partners can withdraw their capital
GPs may carve out special arrangements or preferential economics for different LPs in a side letter. Nothing is stopping you from including these clauses in the main LPA but eventually, it’s really all about how generic you want this to be.
Fund structures and LPAs — being legally drafted — are pretty much predicated on market precedents, which is ultimately driven by demand, i.e. the investor pool. If a structure has been tried and tested in the market, an LP is more likely to use it. This partly explains also why the popular 2–20 fee arrangement has not really changed significantly in the last three decades.
Ultimately, it boils down to managing risk and uncertainty. Most investors (LPs) will try to be more conservative and stand by something which is easier to justify — for a good reason because huge amounts of institutional capital are at stake here.
Is there a need to be regulated / licensed? Broadly speaking, any regulator, fund formation lawyer or sponsor will always advise you to be licensed, for a good reason: to provide more credibility, as well as to protect the interests of the most important stakeholders (the LPs) in your fund, which again in turn, drives credibility.
If you are receiving money from ‘mom and pop’ investors, the answer to being regulated is always yes. In most mature fund jurisdictions, the general rule is: As long as you take monies from any institution (including accredited investors), you need to be regulated / licensed.
What if I just raise capital from people I know? In the eyes of the external parties, getting a fund properly licensed puts the fund manager in good publicity, and is also synonymous with endorsement by the local regulatory authorities. Investors are generally get more comfort that if a fund is licensed, the basic regulatory checks have been done.
In theory, you could even operate a “fund” without being licensed or regulated if you have an extensive proprietary network of individuals who are ready to commit capital with you. The key risk or consideration here is whether or not these investors can seek adequate recourse in the event you screw up.
In reality, most funds are set up for the purposes of taking in institutional money for long periods of time. Therefore, regulation and licensing not only allows for proper governance but paves the way for raising more third party capital in the future.
One of the biggest financial hurdles with getting licensed is of course the upfront expenses (potentially up to $1 million paid-up capital required). Most first-time fund managers may not be willing to part with such a huge amount of capital especially if there is no certainty in raising the fund.
[This is the third article in a 4-part series on fundraising] Read the final chapter on the fundraising process here.
Designing a fund strategy
[This is the second article in a four-part series on fundraising] Read the previous section on GP team.
While the background and experience of the GP naturally drives the fund strategy, there are also numerous external factors to consider, such as: geopolitical landscape, the overall demographics of the economy and market forces. These considerations are also guided by the inherent attributes of the GP (their experience and capabilities in those areas), and should ultimately shape the overall direction and strategy of the fund.
When looking at extrinsic factors, the geopolitical environment forms the overarching consideration, followed by other macroeconomic factors such as:
Key industries that drive and underpin the broader economy
Population size and demographics
Consumption patterns and habits
The depth of liquidity in the market and access to capital such as commercial bank lending, public and private capital markets
For example: a company based in an emerging economy such as Myanmar or Laos, without abundant sources of domestic bank funding, is more likely to rely on equity funding (or foreign debt) rather than traditional bank debt for its business expansion.
The macroeconomic factors are also closely linked with the spread of industries targeted by the fund, which in turn, determine the possible pipeline of target companies.
For example, the theses for designing the investment approach for a Southeast-Asia focused manufacturing fund could include:
(i) Shifting of regional production bases to Malaysia, Vietnam or Indonesia due to US-China trade tensions
(ii) Strong emphasis (and dependance) on the manufacturing sector as a core part of Southeast Asia’s GDP
(iii) Trends of companies relocating to Southeast Asia due to comparatively lower production costs and easy access to human capital
(iv) Precedents of foreign companies investing into and/or trading in the market
Size matters In addition to industry sectors, the geographical location of the portfolio plays an important part in the ticket size i.e. the amount of capital to be deployed in each company.
Assuming your fund is prepared to write checks for companies with more than $100 million in EBITDA, there may or may not be a sizeable pool of companies in the region that could fit the bill of a $600 million EV (enterprise value) assuming we apply a 6x valuation multiple.
Access to leverage (debt) is important too as this ultimately also determines the EV and equity ticket size. Banks have differing risk appetites for different industries. Consider a real estate focused fund with hard underlying assets -Being able to get bank funding at 70% loan-to-value will enable you to just put in $300 million of equity capital to acquire a $1 billion portfolio.
Minority or Control? The considerations for control of minority deals are largely driven by the ability of the GP team to create value within the portfolio, and to a certain extent, the operating dynamics of the underlying businesses. For venture deals and early stage companies, fund managers tend to allow the existing founders to retain a larger portion of shareholding so that they (the founders) remain sufficiently motivated to make the business a success.
I generally adhere to these three principles:
Is there a viable roadmap to exit? While it is important to build a good pipeline of deals, it is even more important to ascertain whether or not there is a viable roadmap to a liquidity event. A liquidity event could be:
(i) An Initial Public Offering (IPO);
(ii) Selling the business to a competitor (consolidation play) or;
(iii) Someone who wants to enter the market
(iv) Selling the business to another fund
(v) Selling the business back to the original owners (a put option)
Some indicators of whether a liquidity event in the market is possible include:
Is your fund size realistic? So, you got your estimated fund size, your ticket size and your pathway to exit, but what does this mean in terms of the number of companies under the your fund’s portfolio? Let’s use a simple calculation to derive this:
Consider this: Most funds charge a management fee of 1.0% to 2.0% i.e. if you are raising a $1 billion fund, that translates to approximately $20 million in management fees every year - well enough to pay the rent, accounting and fund administration expenses, as well as a sizeable headcount.
However, if you are raising a $20 million round (assuming this is your first fund) or your check sizes are a lot smaller, the corresponding management fees would amount to between $400k to $1 million. If this is your first fund, you could be looking at even lower management fees of 1.0%. The bigger question here is: will this be sufficient to operate the portfolio? Will there be enough professionals to work on transactions and due diligence? Not to forget, travel expenses, due diligence costs, etc.
Let’s look at some illustrative estimates:
The figures above do not yet include organizational fees such as licensing the fund (could be fixed/billable hourly expenses), fund formation fees such as LPA advisory, drafting and closing (billable hourly) as well as fund administration expenses (these are generally fixed but subject to complexity).
The US market has some good disclosures on fund organizational expenses from publicly listed private equity firms. They can be used as a general guide, but differs for different fund types, structures and jurisdictions.
To summarize: Assuming your annual operating expenses are about $1 million and you apply a 2.0% fee structure, this implies that your minimum fund size should be at least $50 million.
You can of course choose to raise less than that but may need to revisit your fund strategy and/or tweak some of the operating expenses.
A special note on GP commitment For first-time funds, GPs have to practically fund themselves. If you think for a moment that you can make a living out of just collecting management fees over the fund life, then you are very wrong.
In order to show ‘skin in the game’, managers are usually required to commit 4 to 5 percent of the total fund size as part of the fundraise based on a report by Preqin. Assuming a $100 million fund, this translates up to $5 million. For many first-time fund managers, this is not a small sum and most of it will probably be financed from internal resources, which can put a significant strain on cash flow.
Since LPs are paying GPs to manage their monies, they ultimately want them to work towards maximizing the returns on exit rather than relying on management fees for revenue. If the first fund performs well, GPs enjoy their share of the carry, but it is usually with the subsequent funds that the GP team can really rely on the management fees for a more steady income stream.
Taking all of the above into account, you should ask yourself these questions:
(i) Does the fund size and strategy still sound reasonable?
(ii) Is there a well balanced and realistic professional-to-portfolio company ratio?
(iii) Does the envisaged team size have sufficient bandwidth to execute deals?
If the answers to one or more of the above is not a affirmative ‘yes’, you might want to consider revisiting the fund size, organization set up or refining the investment strategy. Repeat this process as many times as required so that the equity story checks out in the bigger scheme of the macro-economic climate and industry landscape.
Designing a fund strategy is all about research & iteration…This process is incredibly iterative and requires you to continuously challenge your investment thesis. More importantly, it plays an important role in ensuring that your overall fund strategy is coherent.