[This is the first article in a 4-part series on fundraising]
In the last four years, I’ve had the opportunity and privilege to speak and consult with many acquaintances and friends expressing interest in starting their own investment funds. Most of them have very decent credentials: having worked in large corporates, Fortune 500 companies, reputable advisory and consulting firms, as well as investment banks. Some had spent decades in their current roles, have acquired the operational know-how in their industries and were at a point in their professional lives where they feel a desire to take their expertise to the next level.
The common denominator here is: Whether it comes down to starting a business or a fund, most people are driven by the notion that they could be creating more value than what they are doing in their current roles and achieving better monetary returns with the knowledge and resources accumulated over the years.
This no-frills article isn’t a standardized blueprint, framework or a holy grail for successfully raising any private equity or venture capital fund. The perspectives shared here are personal opinions and catered generally for anyone thinking of setting up a fund, are new to this area and do not really want to sound stupid when making conversations with investors, Limited Partners (“LPs”) or other aspiring fund managers.
Budgeting is an important part of this process and in part 3 of this series, I include a very indicative estimate of what are the expenses required. Every manager has a different budget and uses a different approach towards raising capital. I do not think there is a one-size-fits-all solution.
Starting a fund is an extremely entrepreneurial journey. The process and fundraising roadmap for everyone is different. It depends largely on credentials, investment strategy, geographical location and organizational setup. I hope the perspectives and anecdotes trigger your thoughts on the resources required and that you find them useful, logical and applicable in the real world.
Team composition is probably the most important consideration in starting any venture.
The General Partner (commonly known as the “GP”) is the “product” of the business. A fund manager sells itself in the same way a retail shop sells its merchandise. The quality of the product is the quality of the team, both collectively and individually. To manufacture a great product in the fund management world is to assemble an all-star team, thereby maximizing the GP’s chances in successfully raising a fund.
The most ideal configuration is the team comprising professionals from an existing private equity (“PE”) or venture capital (“VC”) shop. They have the relevant experience, track record and industry knowledge of how fund managers operate. To a certain extent, they also inherit some of the branding and relationships from their previous shops, although the key success factor in fundraising still rests solely on their personal achievements.
But not everyone has that privilege to work in a PE role.
So I’m not from a PE/VC shop…
The combination of experienced professionals from investment banks (“IB”) and management consulting firms (depending on their level of experience and functional roles) are quite popular. Consider The Carlyle Group, which was founded by two bankers and a lawyer, and TPG, which was founded by a management consultant and a seasoned lawyer.
The success of this concoction is driven by a few factors including the parties’ collective experience of working alongside the same transactions (in different capacities), but also largely because they share a common lingo — they understand the nuances and intricacies of sourcing deals, carrying out due diligence, structuring transactions and approaching business valuation.
Perhaps the achilles heel in such an arrangement is the lack of skin in the game.
Unfortunately (without prejudice), most bankers and consultants work predominantly on the sell-side of things i.e. their commercial interests tend to be limited up to the point when the deal is closed and fees paid. And in the process of doing so, they may not consider too much, the implications of their recommendations after the investment.
Of course, the financial and operational impacts on the acquired entity are being assessed and taken into consideration during the negotiation phase and at closing. But without skin in the game, any valuation and due diligence done, bluntly put, is just a desktop exercise. Sell-side advisors and consultants today rarely bear any tangible responsibility for the future performance of the target company.
Beyond the banking and consulting world, industry practitioners also make one of the most ideal PE operators - especially those in key management roles or C-suite positions. These people are responsible for driving top-line growth and profitability in the business, ‘fight fire’ on a day-to-day basis, and responsible for keeping up the quarterly reports to shareholders and investors.
More than just technical knowledge, good operators also have the management skills in operating the day to day activities of a PE portfolio. This skillset is nurtured from working many decades across different divisions with the companies they are in. They manage the sales teams, are familiar with pricing strategies, costing and the bill of materials, are up-to-date on what competitors are doing, and at times, have the ability to forge invaluable relationships with external stakeholders across the industry value chain.
What they lack in innovative financial structuring, they make up for in operating experience — something not all consultants and bankers are able to replicate.
That said, a group of seasoned industry operators coming together to form a fund may not necessarily have the complete know-how in terms of fundraising, legal/financial due diligence, deal structuring, and sometimes even access to additional resources beyond their sector of expertise.
Finding the right balance.
For many private equity funds, having an “operating partner” onboard allows the GP to mitigate the execution ‘gap’ in the team’s collective capabilities. The ideal set-up for a fund that invests in more mature and later-stage businesses could include a good mix of experts in M&A/strategy and industry veterans. Even better if all parties had collaborated previously in some capacity, and in particular, if and how they have leveraged complementary capabilities between each other.
The team should have at least two founders. Most investment funds do not have a single member. However, this model seems to work with some funds that focus on technology and angel investing. They are probably limited in their ability to scale compared to other mainstream PE/VC funds as the underlying concentration risks around one key person is just too huge.
Read the next section on designing a fund strategy.
The Starbucks at Capital Towers brings back memories of how I was helping a company look for investors some years back.
I was sitting with a client to debrief him on the feedback from a week long investor roadshow. It was the year that Joseph Schooling won Singapore’s first ever gold medal. The nation celebrated. It wasn't only a victory in the local sports scene but also a symbolic inspiration to everyone that: Dreams and ideas, no matter how small they were, could come true.
But none of the investors said ‘yes’ to those dreams in that funding round.
We had successfully assembled a string of eleven meetings within a span of 4 days, with each meeting lasting around an hour or so. It was a decent conversation on every occasion. Both sides introduced themselves, talked a bit about each other and then about the company. It was professional and well-staged, but no one would put any money in.
At Starbucks, the client stared at me point blank and said,
“Why did Joseph Schooling win?”
Erm...cos he trained hard? "No!! It was because he believed in himself!".
And he went on to talk about how a young boy born and bred in the little city unknown to most parts of the world became a global champion, likening it to his company, a champion in the making, but no one had been willing to believe in what they were doing.
“It is a no brainer! People should be lining up for this! Why aren’t investors buying our business??”
As he raised his voice and slammed the table, I stood there, wide-eyed and dumbfounded with the fact that this guy was putting the blame on me for the “lousiness” of his company. A couple of weeks later, the company put together a product demo on my suggestion and as part of a follow-up from the roadshow.
We sent memos out to the folks that had graciously sat in our meetings to inform them about the 2-hour session held in the company’s office. It was not only an opportunity to see it first hand how it worked in real life, but more importantly, a second chance for the company to prove itself. Of the 10 emails that were sent out, only two replied and eventually one showed up - largely because his office was located around the vicinity.
The session went ahead as planned anyway but the demo was unimpressive. It was almost equivalent to selling a 2000 version of Windows Professional today --- archaic, full of bugs and over-priced. Fortunately we had at least one investor on scene to watch the demo. After that, I’d stopped doing any roadshows.
That day, I learned a few things:
You can't put lipstick on a pig. The product is the heart of any business. A company should not go out there to raise institutional capital without being able to produce a working prototype.
Self-bias is a real thing. Business owners tend to be oblivious to the shortcomings of their own business. To make matters worse, most of them aren’t also open to candid feedback.
Most CEOs are employees i.e. they aren’t equipped / positioned to raise capital. This applies especially to start-ups. The founder of a start-up that delegates his CEO to fundraise for the company can be a huge red flag.
This is how most employees see their income - a gradual accumulation of their savings over time.
The employee lives from paycheck to paycheck with the constant fear of retrenchment as he progresses up the corporate ladder. He is concerned only with his salary, the amount of increment at the end of the year, the size of his bonus and the number of leave days.
On the other hand, this is how an entrepreneur sees the business:
He is not only acutely aware of the cost structure, but also motivated to be as creative and innovative as possible so as to maximise his profits. He is driven that way because with the right ingredients at the right time, there is a chance that he might be able to achieve outsized returns on his investment.
Four years into trudging and bruising, I retraced my steps and got myself thinking about what makes an entrepreneur, a business owner, a founder, and what drives them to do the stuff they do.
Most people go into a new venture for the money. Some do it for the publicity. Media does a successful job of dramatizing those who start a business or raise their own fund. In fact, to me, it should always be about the money. I'm not being a mercenary, it's just more commercial. Unless you are operating a charity or social enterprise, starting a new business should always be about maximizing profits. Companies are sometimes willing to provide incentives and discounts to key customers or early takers at the expense of profits. This is fully understandable. That discount is an intangible marketing and relationship building cost, and the company expects that goodwill to pay off sometime in the future.
There is also a lot of fun in building a business. But beyond the fun and the congratulatory notes from supportive friends, I sometimes wonder if people really know what they are getting into?
Most people are oblivious.
I caught up with a friend recently and shared with him what I'd been up to the last few weeks and months. Despite all the gloom around travel restrictions and crimping of dealflow, etc, I was sanguine and I got him enthusiastic about what we've been doing, the multiple platforms we have, the result of our hard work over the years, translating to tangible and "pursue-able" opportunities. He'd loved to be part of the "action".
I really don't think people really appreciate or know, first-hand, the pain and struggles experienced by being a business owner.
The pain of having to put up cash for operating overheads, do payrolls, pay for expenses, source for new revenue, execute, and yet, all at the same time, not having to draw a salary for yourself.
So many choose to see only the rosy side.
And because they see only what they want to see, they tend to be ignorant of what it really takes to operate a business and crystallize those nice sounding opportunities.
I am not trying to be a wet blanket. Neither am I belittling our achievements over the past 4 years, nor am I trying to discourage people from pursuing a dream of starting up.
But the struggles undertaken by someone on the path of entrepreneurship simply cannot be adequately described through conversations, the sharing of anecdotes in webinars, or inspiring commencement speeches and classroom workshops.
Some want to be heroes.
Some years back, I had closed a huge cross border M&A deal. Because of its size and complexity, it drew the attention of senior management, and as a result, I got an accelerated promotion (I think).
More than just the vote of confidence at the workplace, the project gave me the breadth to exercise a great deal of autonomy throughout the negotiation process. Although being relatively 'junior' at that point in time, I was effectively thrown into the deep end of the pool to learn on the job.
I ran negotiations with various stakeholders in the project, piloted the financial model between two contesting bidders and coordinated the work streams between the stakeholders and lawyers. It wasn't a perfect process: I mucked up some of the translation at some of the meetings between the parties, ran into impasses at negotiations where I felt helpless, and broke some parts of the financial model.
Bankers who work on similar multi-million M&A and IPO deals often wear these similar deal creds like a badge of honour when they speak to their peers or at interviews. A lot unfortunately become arrogant and get carried away by the disillusionment that they are highly sought after professionals just simply because they were on the deal team. I loosely coin this as the 'hero mentality'.
It is this misplaced sense of glory and pride that makes bankers arrogant. The hero mentality also leads many disgruntled employees from large organizations into starting their own business, who would then realize after falling flat on their faces and that once you jettison the big bank brand off your shoulders, it is not that easy after all.
When you are running a deal in a large institution, your clients see you as an equivalent of the company you represent and are therefore willing to do business with you. You are an endorsement of your company i.e. you are nothing without the enterprise. Don't give yourself more credit beyond that.
When you are operating your own firm, clients work with you choose you because of who you are personally. You are the brand of your own business. You have a significantly smaller reach and network and no one in the market knows you unless you have a personal relationship with them. The strength and extent of these networks are often smaller and weaker than what you think they are.
Assembling an M&A deal takes more than just execution.
Beyond financial models and info memos, there are "hidden" work streams involving years of investing into relationships. Most clients will not deal with directly with you or pay you at a commensurate level working for a large financial institution. For them, the credibility and the branding of engaging with an internationally recognised firm is what they paid for.
So if you think that you did a lot of work in executing that M&A deal and deserve more credit than the organization employing you, think again - you probably would not be able to pull it off without leveraging on the global network and brand that is on your name card.
Adding it all up, it sometimes looks like the net result between being an employee and starting a new business, making profits and then eventually selling it for a buttload of cash - could ultimately be the same.
Perhaps one key difference there is that: While you can certainly live as an employee with a somewhat visible income stream, there is no guarantee you can exit your business profitably as an entrepreneur. That being said, the life skills you acquire from being a business owner remains starkly different from an employee.
How does one define success in entrepreneurship? Can someone be considered a successful entrepreneur even when you are flat broke? Is the goal always to achieve a billion dollar valuation on your business? Is size the definitive metric for measuring entrepreneurial success?