Denice R. Preston
Fundraising as an aspiring Private equity (PE) fund manager is challenging. I’ve condensed the steps into this checklist, which will aid you in putting together an appealing investment argument for potential investors.
PE Fundraising Checklist
Private equity investors, referred to as limited partnerships (LPs), generally have hundreds of funds but typically only make investments into a small portion of them. To make it through, it is essential to think about the five points together to make an argument to the question, “Why should we invest in you?”
Develop your investment strategy and identify the source for competitive advantages.
Set aside the budget for the funds and other costs required to implement the plan.
Create a legal framework that allows for flexibility in the future.
Create lists of investors and divide them into groups based on the long-term capital allocation goals.
Plan for the marketing phase by setting clear goals for return and benchmarking metrics.
What Is Your Investment Strategy and Competitive Advantage?
Your strategy should be formulated in plain language and communicate the value of your product about a more significant LP allocation. LPs depend not just on the notion of “asset-based” but also on an “outcome-based” view to determine their allocation. To get them interested, you must explain the main factors that drive wealth growth the LP has access to by committing the funds. Every PE strategy is a compromise between these wealth-generating factors:
Do You Have a Proven Approach to Achieving Superior Returns? Can Your Strategy Be Easily Replicated?
If you are a first-time fund manager, focus on your distinct value proposition and present a different approach. Prepare to talk about your competition and the strategies you will use to find and secure deals. It is essential to have a distinct advantage in bidding procedures. Paying the highest price is not the most effective strategy. Ensure you clearly explain these distinctions to avoid being considered a JAMMBOG (just one more middle-market buying group).
If you’re starting, the most important thing you can do is focus. Focus is the key to harnessing institutional expertise and unique information that can win auctions and add value. As you expand, recognize the features of your profitable deals and establish patterns of recognition of ideal goals. This will help you grow to other sectors or geographical areas while looking for ways to use more capital in the future.
How Will the Strategy Perform During Downturns?
It is essential to consider the cyclical risk during due diligence and to establish a picture of the portfolio’s risk profile. Some options include top-down restrictions on exposure to specific sectors and shifting leverage ratios. For instance, Invest Europe, which defines the rules for VCs and PEs, suggests that LPs take into consideration their exposures to these risk categories:
Risk of funding: The risk of failure to pay for a capital call that could lead to loss of partner stakes.
Liquidity risk: The risk of illiquidity that comes with selling part of the fund on the secondary market.
Risk of the market: The fluctuation of the market’s price affects the value of the NAV.
Risk of capital: The money may be used inefficiently by the fund and forever lost.
Also, look at the tools you can utilize in your overall approach to managing your portfolio to reduce risk. They can be divided into post-deal and pre-deal-like, for instance, when you conduct due diligence on the former and continuous risk monitoring for the latter.
Does the Team Being Assembled Provide a Platform for Success?
Your team must have an established track record, as many investors hesitate to invest in first-time investors. The most effective way to prove this is through attribution letters from previous employers. However, employers are often unwilling to supply these letters. If that’s the scenario, there are many alternatives I’ll discuss in a future post. Ideally, your team must be able to prove throughout the entire cycle to demonstrate that you’re equipped to manage all aspects of investment processes. Even as a brand-new manager, you’ll be able to analyze your track of actions taken in the various stages of the investment process:
Origination of deal flow: Finding companies, gathering co-investors, and then negotiating the terms.
Performance of investments: The financial returns of the deals or funds you’ve been able to manage.
Employment: Have you unearthed and nurtured the best talent in your teams?
Timing: Have your deal’s timings for entry and exit coincided with macroeconomic cycles?
The LPs will always find more excellent opportunities than they can afford to fund. One advice from BVCA, which is especially useful, is not to present yourself as an alternative to LPs with their existing investments. Be professional and transparent in your pitch. Don’t make claims that are exaggerated or put the judgment of investors into question.
Fund Size and Fees
The size of your fund will have to fit into your strategy. It is essential to think about the market map of possible Portfolio companies, the amount of investment required, and the number of investors. It is best to establish an appropriate fund size that is oversubscribed and increase the goal rather than falling short of your round’s adjective and taking longer to close. But, LPs will insist on having a hard cap close to your target so you can finish fundraising quickly and start investing. Also, LPs want to take control of the decay in alpha caused by higher AUMs due to the inefficient allocation of funds to “next best” ideas.
How Competitive Are Your Fees and Terms?
If you are a new fund manager, the most efficient method is to provide LP-friendly terms. This means that the management fees should be reasonable (approximately 2 percent) and decreased after the investment period. The fund should utilize a European carry mechanism to calculate carried interest on a fund-wide basis. Additionally, a substantial part of your assets should go to the account. After establishing a more robust record, your fund may gradually move to more flexible terms that are GP-friendly; however, being LP-friendly initially will increase the likelihood of success during your initial fundraising.
