Leaving the comfort of an organisation and stepping out to set up your own fund management business, and your own fund, is a daunting prospect. Few have been involved in all aspects of the business in their previous roles, and few have set up their own business before. There are many unknowns. Often the process is far more complex than ever anticipated and more often than not, it takes longer and is more expensive than ever contemplated.
Here are four key things to consider when you are setting up a new fund.
The track record of your team – as a team – will be a critical success factor. Investors will want to see a team that has, and can, work together to produce results. A clear and attributable track record of having led specific deals is critical. Never take credit for deals that you have simply been a part of, prospective LPs will quickly see through this. Thought and attention must also be given to who will do what roles – investors will ask questions about some of the roles.
Your investment strategy should be clear and of interest to investors. For example, “generalist” funds are no longer attractive to many investors. Fund terms also need to be determined. Any terms outside the standard – 2 & 20 approach to management fee and carried interest, with an 8% hurdle – should be avoided. So many managers approach LPs that they often look for an excuse not to engage. Looking for terms outside of the norm can be an easy way for them to disengage. Investors will expect to see details of co-investment rights. The team should be clear, in advance, as to the approach to be taken. LPs will also expect a management team to make a significant personal contribution. LPs generally prefer this to not be a management fee offset if possible.
The fund structure
Consideration must be given to investor requirements when determining the best structure for your fund. Whatever the structure it should be one that your investors are comfortable with.
With respect to the size of the fund – it will depend on the type of investments being made. Development capital needs USD100m, whereas an infrastructure fund needs perhaps USD1bn. Remember investors have minimum subscription sizes and maximum percentages of a fund they can invest into so if the fund is too small they may not be able to subscribe. Ultimately, you are creating a financial product to meet the needs of your investors.
The fund raising process
This will be a long and challenging process. We know of clients that have had over 400 meetings to secure their first fund of circa 40 investors. Don’t underestimate the time, cost and effort involved.
Consider whether to appoint a placement agent. They have years of experience of raising funds, they know how to do it, who is likely to invest in your fund and the right people to speak to. They will also help you with the preparation of presentations and rehearse the team.
A cornerstone investor is key but often these parties will want a piece of the GP and/or a preferred fee arrangements. Remember you need a Fund 1 before you can have a Fund 2, so it may be necessary to allow this. Last but not least, closings are expensive and time consuming so try to limit the number of closings that you have to say three or four.
There are numerous factors, you will need to consider during this process. To assist you we have put together a guide for first time managers, including questions to consider and a helpful checklist.