The marketplace for institutional capital in private markets is more competitive than ever before. Preqin data shows there are over 3,100 currently on the road (as at June 2017), and that institutions are increasingly consolidating their GP relationships, with 2017 showing the highest concentration of committed capital on record. This presents a daunting picture for first-time managers as they embark on journeys that average 18 months or longer when raising a fund.
The good news is that investor attitudes towards new managers are improving: the outperformance of first-time fund managers in recent years versus more established managers has shifted the market – 51% of LPs interviewed by Preqin in December 2016 indicated that they will now consider investing in first-time funds (up from 39% in 2013).
The issue then is one of risk, as while first-time funds do offer outsized returns, the distribution of the best and worst performers is far greater than for established managers –the risks of team cohesion and the operational challenges of the private equity business model are therefore very real.
So what can managers do to show investors they can offer superior returns for these risks, help manage the most common concerns, and ultimately – successfully raise a fund?
- Strategy. It goes without saying, but in order to compensate for the additional risk you need to be offering a compelling strategy and one that your team has a proven track record in. An issue here is disclosure: more than 50% of investors indicated that their most common critique with PPMs is inadequate disclosure and consistency on fund strategy – so make sure all information shared in the investor data room is on message.
- Track record. Always a chicken-and-egg problem. Funds with the most success in fundraising either come from a spin out, mature from a fundless sponsor model, or have invested on balance sheet for an insurance company or bank. Another approach worth considering is marketing a first deal as part of the fund – and having that warehoused before you get to first close. Regardless, the track record needs to be clearly attributable to the existing team and full transparency on allocations and assumptions needs to be shared with investors – here there are a few technology solutions available to facilitate this so you can manage multiple DDs at once and don’t get bogged down in ongoing data requests.
- Fees and carry. If you are going to go outside of the 2&20 on your first fund, there had better be a great reason why investors would be willing to speak with you. Again, on disclosure, most investors take issue with a lack of disclosure around fees.
- Operational excellence. One of the easiest areas to remedy and one that so many funds fall down on. First-time funds have a greater burden of proof to demonstrate they have the “business of running their business” handled. LPs are saying to managers of first-time funds that they need to have the same infrastructure in place – regulatory, personnel, systems and reporting capabilities – as more mature funds, and that these can scale to funds two and beyond. Here technology and outsourcing are key ways we see managers offering the institutional-level quality that investors are after without diverting too much focus from their core investment activities. A growing segment of this is in middle-office software, which offers investors greater assurance around the investment performance data they are receiving from managers and the possibility of greater granularity and frequency in reporting, without costing managers anything in regards to administrative cost.
- Know the market. For most LPs, the decision on whether they can commit to a first-time fund has already been made at a board level before you get in the door – almost half the market have indicated they would not even consider investing in a first-time manager – it is a lot easier fighting for a piece of an existing allocation than turning a no into a yes. Data is the key here – know in advance whether an LP will take first-time managers, who they have committed to in the past and whether they are over or under allocated to your strategy.
First-time fund managers have obvious benefits in terms of returns and diversification for investors in terms of scale and exposure to niche strategies, and are essential to the health of industry in nurturing the next generation of marquee firms. Investors have come around to this and more are considering upping their exposure, but the market is competitive and the need for compelling differentiators has never been higher.
Outside the obvious requirements on track record and fees, there are two essential tools that improve a manager’s chances of successfully raising a fund: (1) Market Data – having a large number of investor roadshows is unavoidable – but ensuring the ones you are in have the highest possible probability of success before you do is a no-brainer – know your customer and your competition; and (2) Operational Excellence – running a private equity shop for the first time is a risk that investors treat as their top concern outside of strategy and performance – investors and regulators want more assurance and information than ever before. Use technology and outsourcing to equip you with the institutional quality you need so you can focus on delivering the core strategy.