As private equity has matured as an asset class, market tenure has become a powerful force. It is tempting to think that convincing limited partners to take a chance on a first-time fund is near impossible.
“It’s exceedingly difficult,” Greg Myers, a European and Asian fundraising pro at Lazard, said of the environment for starting a new fund. The reasons why include a lower risk appetite by LPs in an uncertain economy and falling public equity values, which in turn depress new private equity allocations.
But interviews with placement agents and first-time groups also reveals a surprisingly large number of LPs who do not view a limited track record as a problem in itself. But they will want to spend more time considering a team’s composition, coherence, and prior expertise before stroking a check.
One tip for first-time groups: Bear in mind that target LPs will rarely be thinking only about just that one fund. If an LP is going to invest the resources to conduct a thorough due diligence, it is going to want to be involved in more than just Fund One. So a first-time fundraiser must worry more about convincing LPs of the long-term viability of the strategy, and the long-term coherence of the team. Also remember that first-time funds still have plenty of advocates, especially if the coherence and track record of the team is not in question. LPs even have patience for emerging managers—untested groups that must start building a track record over the course of the fundraising.
“You just need to resign yourself to the fact that if you want to hit a number, you’re going to have to be in the market longer,” said Mounir Guen, the former Merrill Lynch placement agent who now runs his own firm, London-based MVision. What is a first-time fund actually likely to experience on the road? The answer depend on many factors outside the GP itself. Without a doubt, investors have raised the bar on due diligence, moving beyond simply checking a box when the documentation is accounted for. “We’re just seeing people asking for a lot more information,” said Susan Good, a principal at placement agency E.L.K. Capital Advisors. “I think that’s a trend we’ll see continue.”
First-time GPs also feel enormous pressure from backers to get on with the business of investing, to avoid the distractions of the road show. Often that means they are accepting lower sizes for their funds — or at least giving up hope that their targets will be exceeded — in the hopes of raising whatever capital they can raise and deploying it quickly. That strategy lets them build a modest but thorough track record. Some new groups have also adopted a start-and-stop strategy that lets the accumulate fresh capital and a track record at the same time.
“If you’re a first-time fund in the United States, expect to be out there two-years plus,” Guen said. “What you need to be doing is managing the pace of your cycle, so that you raise a bit of money, make an investment or two, raise a bit of money, make an investment or two, so that as you develop your portfolio you can get to about 30-percent-plus invested.”
And what is the most common mistake that first-time groups make? Often, it can be not realizing the importance of finding one or more pioneer or anchor investors who can help attract others. It’s easy to underestimate the cache of a leading pension, endowment, or individual as a foundation to attract recognition.
“The key thing is making sure that you have a core group of referenceable investors who are really excited to give your endorsement,” said Bear Albright, who head fundraising and investor relations at Bain Capital, one of the industry’s leading accumulators of fresh capital. “People pay attention to that. You do need an anchor tenant, and…that is critical in building momentum.”
To attract those key investors, first-time fundraisers often find it helps to offer back-ended carry, taking profits comparatively late in the life of the fund to ensure LPs get the first fruits of your labor. In addition, GPs that sink a significant portion of their net worths into their debut funds sends a powerful message of confidence in their own investment prowess.
This is another in an occasional series looking at the pitfalls of raising a private equity fund today. Suggestions for more topics can be sent to yours truly at firstname.lastname@example.org.