- Deal attribution is a major challenge for new firms
- Attribution letters can help, but come in many forms
- MiddleGround sticks to its identity
How do you go from a job installing bumpers at a Toyota factory in Kentucky to managing hundreds of millions of dollars for a private equity fund?
It’s a compelling story, and one that John Stewart is happy to share when he talks to limited partners. It flows nicely into his pitch for emerging manager MiddleGround Capital: As experienced operators at manufacturing companies, Stewart and his two partners can honestly tell would-be portfolio companies: “We understand the problems that face employees working in industrial businesses.”
The story has resonated with investors. MiddleGround, which spun out of Monomoy Capital, has raised about $410 million toward a target of $425 million for its debut fund. It is one of a handful of first-time funds finding success in an environment that is becoming harder for new entrants.
Some 395 first-time funds raised a combined $42.5 billion worldwide last year, down from 553 first-timers that raised $74.6 billion in 2017, according to Preqin. In that environment, having a story that sets you apart is critical.
“The vast majority of dollars are going to larger established managers,” said Mina Pacheco Nazemi, who listens to pitches from new managers as a managing director at Barings. “There’s so many managers out there … the competition is steep,” she said. “We’re finding first-time funds taking longer to raise funds, and it’s because LPs are taking their time making decisions on which emerging manager they’re going to back.”
Just getting an LP’s attention is hard. So it helps when you have an interesting story to tell, like Stewart. His professional career started on the shop floor of a Toyota plant. He began as an hourly worker on the second shift, installing bumpers on the Toyota Camry. From there, he completed an undergraduate degree through a program offered by Toyota and rose through the ranks of the organization. Along the way, he learned a lot from the Japanese mentors the company brought in to work with the American workforce.
“I embraced everything they taught me,” he said. “They took me under their wing from an early age and indoctrinated me in their methodology in processes and systems.”
By the end of his career at Toyota, Stewart was running the car maker’s largest division in Europe.
Another MiddleGround partner, Scot Duncan, worked with Stewart for 13 years at Toyota and later worked with him at Monomoy.
MiddleGround’s third partner, Lauren Mulholland, spent six years at Monomoy after stints at Banc of America Securities and Macquarie Capital.
The operational background helps MiddleGround stand out from other middle-market firms, especially when it comes to working with manufacturing companies, Stewart said.
In a difficult fundraising environment, some emerging managers are finding success by going back to their roots. Jon Biotti, a long-time executive at Charlesbank Capital Partners, decided to break out on his own last year. What could have been a difficult fundraising path was smoothed out when he got the backing of Charlesbank, where he had worked for almost 20 years.
Biotti’s firm, Nonantum Capital Partners, closed its debut fund last year on $385 million raised from Biotti’s former partners and a select group of LPs in a few months. Nonantum is a unique case in that most spinouts don’t receive backing from the firm they spun out of.
“We got tons of support from Charlesbank partners. They all invested in my fund, they provided references and I had access to the Charlesbank LP base, so it resulted in a pretty prompt fundraising process,” Biotti said.
About 55 percent of Nonantum’s Fund I capital came from Charlesbank partners and LPs, with the remainder from new investors, he said.
Even with his old firm’s support, Biotti found fundraising daunting. “The feeling is like you’re sending out invitations for a party and you can never be 100 percent certain anyone is going to show up,” he said. “Whenever anyone does show up, you’re pretty honored and gratified by that.”
Most new managers cannot depend on support from their old firms, so they need to find other ways to get attention from potential investors. One way to do that is to find an anchor backer to help get the word out. That strategy helped MiddleGround, which got a $75 million anchor commitment from Archean Capital Partners, a joint venture of Veritable and Moelis Asset Management. Archean’s support was especially helpful because the partners were barred for a period of time from approaching investors with the previous firm, Monomoy, due to covenant restrictions, Stewart said.
Archean pays special attention to first-time partners’ ability to build a business, said Rob Lazaroff, a co-portfolio manager with Archean. “The learning curve is building a private equity firm, back office infrastructure, compliance infrastructure, LP fundraising and/or client relationships, building an origination platform,” Lazaroff said. “All the things that are more likely that they didn’t have to do in the prior firm, so we spend time getting to know people from that standpoint — their leadership style, ability to attract talent and mentorship.”
Early on, MiddleGround’s partners plotted out the strategy and the economics of the firm going forward 10 years through three funds, Stewart said. They even contemplated how a future partner promotion would change those economics, Stewart said.
MiddleGround’s partners also decided not to take any deal attribution from Monomoy, leaving the firm with essentially a blank slate. Deal attribution is a major challenge for first-timers, who generally are not allowed to cite deals they worked on at their prior funds. Many firms consider track record the property of the firm and not the individual deal-makers.
This is an issue for first-time fund managers because LPs want to see a track record. Around 84 percent of 98 institutional investors who responded to a Probitas Partners survey in 2017 cited “verifiable track record” as the most important factor in backing a first-time fund.
Sometimes the attribution story is very clean and has been agreed upon by the prior firm and the group that’s leaving; but often they don’t have any legal right to their track record,” said Todd Milligan, Partner at Private Advisors. “It requires more investigation through references and detailed diligence to understand who was involved in each phase of a deal, from sourcing to exit.”
However, deal attribution requires more than just figuring out who worked on executing the deal, but also who was involved in the decision making process through the life of the investment, Milligan said.
“The challenge, but also the opportunity, is determining where the investment judgment resided in the prior organization,” he said. “You want to make sure you’re backing individuals who were actually responsible for making the call on investment decisions.”
One way new GPs can highlight their past deal experience is through attribution letters. These can range from a detailed breakdown of who worked on which deals, and how those deals performed, to simple affirmation of when a specific executive worked at the firm.
That was the case for Alex Navab, the former No. 3 at KKR who left and formed his own firm, Navab Capital Partners. Navab will likely target around $3 billion when he launches his debut fund, which is expected this year.
Navab has a letter from KKR that allows him to cite around 50 deals across three funds done during his time as head of the firm’s Americas private equity, Buyouts previously reported.
There is no standard attribution letter, as each firm deals with the issue differently, said Kelly DePonte, managing director at placement agent Probitas Partners.
One way to do it is through “contribution letters” that simply confirm the executive worked at the firm for a certain period of time and that his or her title was during that stint, DePonte said. Other firms may provide a list of deals the person worked on in some capacity, but not detailing the role the person had in each deal.
“This sometimes happens when the person serves on the investment committee but was not deeply involved in due diligence or oversight of each deal,” DePonte said.
In the strongest case, the prior firm provides an attribution matrix that details what roles each individual had on each deal. This is usually accompanied by deal-by-deal performance as of a specific date, DePonte said.
“It is not really a question of ‘this is my deal so it can’t be yours,’ but more, ‘these are the roles I played on these deals,’” DePonte said. “This approach is not only more accurate, but is less confrontational. In addition, if presented in this manner, the LP can actually decide what they think the individual’s track record is based on the roles they played.”
These are just a few of the challenges facing first-time managers when they set out on their own. More than anything, successful managers say, is that starting a new firm requires sacrifice. That likely means leaving a comfortable, established position, forgoing a salary and putting all your free hours into building your new business.
It requires a “leap of faith,” Mike Bego, founder of small secondaries focused shop Kline Hill Partners, told Buyouts in 2017. “I walked away from a healthy income and healthy profit sharing to do this. And the home bills didn’t go away.”
Stewart knows the feeling. He is an avid (if only semi-successful) fisherman and always dreamed of owning a fishing boat. His career eventually got to the point where he could make that dream a reality. But when he launched MiddleGround, he realized he had to give up on the earlier dream. He sold his boat to help fund the new enterprise.
“I made a personal guarantee for getting everything off the ground. I put it all into the firm,” he said. “If you get a fisherman to sell his boat, he’s pretty dedicated to what he’s going to do.”