[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.