Spinout activity remains strong even as first-time fundraising drops

The depths of the great financial crisis do not seem like the optimal time to launch a new firm.

Yet, that’s exactly when Justin Ishbia and his partners chose to launch Shore Capital Partners. The firm started out in 2009 by investing deal by deal, pooling money in minifunds for each investment.

Shore Capital completed five investments this way, building a prefund track record it was able to use to raise its first institutional fund in 2014.

Ishbia and Partners Ryan Kelley, Mike Cooper and John Hennegan formed Shore Capital with a view toward investing in the small side of the middle market. Partner Don Pierce joined in 2013. 

There was a gap in this part of the market, Ishbia said, created by successful GPs who raised larger funds and moved up market and GPs who failed and faded away.

Shore’s original investors, some of whom were senior partners at big PE firms, backed the first fund, giving outside LPs confidence in the group. The firm collected $112.5 million for its debut, with about $200 million of demand, Ishbia said.

Shore collected $190 million for its second fund last year, maintaining fund-size discipline to stay in the same small side of the market it targeted from the beginning.

Even as Shore Capital was working on its five prefund deals, it was meeting with limited partners, Ishbia said. “A lot of people we met in 2010, 2011, saw our progression … and for the next fund, they were with us,” Ishbia said.

A few key points helped Shore establish and grow: The firm had a compelling strategy in a niche it believed it could exploit; it included partners who worked on five prefund deals and were “in the foxhole together”; and it had a demonstrable track record.

Raising a first-time fund “always takes longer than you think,” Ishbia said.

Shore Capital took a tried-and-true path that many sources say is the best way for a new manager to raise a first-time fund: Build a track record by investing deal by deal before raising an external fund. It’s only the rare firm that can start raising a fund at inception.

“Prove out what your investment thesis is and leverage that into raising an actual fund,” said Scott Reed, co-head of private equity USA at Aberdeen Standard Investments.

Such spinout activity is still going strong in this frenetic fundraising environment, even though actual fundraising numbers for first-timers have gradually declined.

Last year, 372 first-time funds raised $48.1 billion, down from $49.6 billion across 423 funds in 2016, alternative-assets-data provider Preqin reports. That’s drops of 12 percent in funds and 3 percent in dollars.

So far this year, 142 first-time funds have collected $19.1 billion, Preqin said. Peak fundraising for first-time funds came in 2014, when 352 funds raised $51.1 billion, Preqin said.

“It’s still a very good time for capable private capital investors to go out on their own, raise new money and start a fund,” Reed said.

“There’s a lot of money out there to get put to work and a very large cohort of experienced people who’ve been trained over the last 15 years in the industry who are now at an age and stage where they’re capable and competent to go out and do their own thing.”

One of the first-time-fund success stories this year was Nonantum Capital Partners, formed by ex-Charlesbank executive Jon Biotti. He launched Nonantum in January and closed the debut fund on $385 million (including commitments from the firm’s partners and affiliates) in April.

Nonantum is unusual in that it got support from parent Charlesbank, including office space, access to people and advice on best practices, and access to the Boston firm’s LP base, Buyouts reported.

Spinouts receiving support from parent organizations is not all that common, sources said. But another spinout this year, Gallant Capital Partners, formed by two ex-Gores Group executives, got support from Alec Gores, who was set to commit to Gallant’s debut as an LP and also took an economic stake in the GP management company.

“It’s an incredibly productive scenario when they can do that,” said Tracy Harris, partner at StepStone Group, talking about spinouts with support from the former organization.

“That sends a message immediately for prospective LPs that not only did this individual leave the firm on the right terms, but they have the belief and support of the predecessor firm.”

On the other hand, poor succession planning is also driving spinout activity to some extent, Harris said.

And another aspect of the spinout market this year is that many new shops are sector specialists, sources said.

“We’re seeing a lot of formation in the consumer area, the healthcare area, tech and tech-enabled services, but also just in general business services,” Reed said. “Very few spinouts are generalist managers.”