Setting up your own private equity fund is a daunting business. Even for those who have been in the industry for many years, it’s rare to have been involved in all aspects of it. And there are many unknowns. Often the process can turn out to be far longer, more complex and more expensive than you ever anticipated.
But with a bit of advance knowledge and preparation, it doesn’t need to be this way. Here are some pointers to bear in mind:
The Team
Raising a new fund can take up to two to three years, and this means you need to ask yourself some difficult questions. For starters, do you have sufficient financial resources to see yourself through this period? Many funds have failed simply because they have run out of money. Syndicating your management company interests to third parties can be an expensive but necessary evil to allow you to reach your first close.
But of course it’s about more than just money. For instance, you’ll need to ensure your family is aware of what’s happening, and that they will be ready to support you through what could be a difficult period. Relationships within your team are just as important. You will all need to be able to live and work together for the next 15 years at a minimum. And you’ll be spending a lot of time in one another’s company, not just at “work” but in airports, hotels, etc. That’s important because interpersonal problems among team members have been the undoing of many failed funds.
Regardless of your compatibility with colleagues, the team must also show investors it can get results. This usually means having a track record of leading deals. It can be very difficult to attract investment without this.
On top of all this, you’ll need to decide how specific roles and functions are assigned within the team. You must decide who will be the principal (if indeed you’re going to have one at all), who is most suited for marketing and investor relations, who will oversee the legal side of things, who will be CFO, and so on.
And this all needs to be given thought and attention in advance, because investors will ask.
The Strategy
Bearing in mind that “generalist” funds are no longer attractive to many investors, you’ll need to decide what your investment strategy is—knowing what’s currently in demand and whether your team has a track record in it.
When determining the terms for investors, it is wise to avoid anything outside of the “2 & 20” fee norm. These days, there are so many different approaches in limited partnerships that investors will look for any reason to disengage, and unusual terms can provide the perfect excuse.
Investors are increasingly looking for co-investment options, so you need to be clear on that strategy in advance—deciding whether those options will be offered, and if so to whom and whether a fee will be charged.
Limited partners will also expect the management team to have significant skin in the game, so you’ll need to consider how much you can afford and how it’ll be financed. Typically, partners do not prefer this to offset their management fee.
Fund Structure
There are numerous variables to consider when it comes to fund structure. First, you’ll need to decide whether your fund will be a partnership or a corporate, listed or unlisted. Then serious thought needs to be given to where it will be domiciled. Both answers should depend on what your investors are comfortable with, but keep it simple. Onshore funds tend to be cheaper to set up and maintain than those offshore, but certain investors want certain structures, and ultimately you’re creating a product for them.
Then there’s the question of how big the fund will be. That depends on the type of investments being made, but remember that investors have minimum subscription sizes. Make sure you don’t automatically disqualify yourself from the investors you’re looking to attract.
The Fund-Raising Process
Keep in mind, the fund-raising process will inevitably be long and tortuous. It’s not unusual to take 400 meetings just to secure 40 investors for the first fund. Never underestimate the challenge here. If you do, you can lose motivation.
It’s worthwhile to consider appointing a placement agent. They have years of experience, know who is likely to invest in your fund and who the right people are to speak to. If a placement agent is willing to invest time and resources in your team, you can be confident he or she will deliver for you. If not, that should tell you something. An agent can also help you with the preparation and rehearsal of presentations.
Having a cornerstone investor is also key, someone who will back your team materially based on past performance. This will greatly assist the fund-raising process. These parties, though, will want a piece of the general partnership or preferred fee arrangements.
Try to limit the number of closings you have to around three or four. Some go as far as having eight or nine, and this can be prohibitively expensive. You’ll also need to consider whether to use an electronic data room.
But Most Important Of All …
The best advice that can be given to anyone thinking of starting their first fund is this: Talk to as many people as you can. There’s a lot of help out there: Placement agents, fund administrators, auditors and even other managers will all give help and share experience for free. Lawyers will generally give the initial meeting for free before the “clock is on,” but others will often continue with “free” dialogue.
And, as always, be prepared. Have ideas about the structure and domicile of your fund before you start. Walking into a lawyer’s office with a blank sheet of paper can be a very expensive exercise. The process will take longer than you expect: Be ready for this, and ensure you have the time, money and stamina required to make it to the finish line!
David Bailey is the group head of marketing and communications at Augentius.
