Considerations for Raising Your Own Private Equity Fund

Executive Summary

Raising a private equity fund is a natural progression for ambitious investment managers.

  • Funds provide a more secure capital base, allowing for longer-term planning and scaling of an investment operation.
  • Having discretionary, committed capital gives more flexibility to make quick decisions within opportunistic investing environments.
  • A fund structure allows for a manager to access debt instruments that can enhance its range of investment opportunities.
  • Managing investments under a fund umbrella provides more diversification benefits over single deal-by-deal investing.

The strategy and operations of a fund should be thoroughly planned in advance.

  • Unlike single investments, a fund must prepare for the ramifications that a set of investments can have on a portfolio as a whole, in terms of costs, cash flow, and profits.
  • Thorough preparation of a fund’s strategy and commercial model will allow for you to undertake a number of scenario analyses to look at all possible performance outcomes.
  • A detailed budget and schedule for investments will minimize the effects of having too much or too little cash on hand. The ability to follow-on with investments and the overall percentage return of the fund will depend on this.
  • Planning the strategy and philosophy of the fund will also ensure that you can scale your human operations effectively. This will lower the time to onboard new staff and align them quickly with the goals of the fund.

Be well aware in advance of the securities laws that you will have to adhere to.

  • Before marketing to investors, it is critical to understand the type of investor and money that can and cannot invest in the fund. Different investors have different levels of sophistication, desires, and legal protections.
  • Third-party agents can be used to help to raise funds. As with any kind of outsourcing arrangement, have all interests aligned and clear communication channels to ensure that your core message is being presented as you would intend.
  • Legal work for raising a fund can cost between $50,000 and $300,000. This is a necessary cost, but it can be minimized by ensuring that attorneys are utilized efficiently. Have drafts clearly prepared and agreed upon, to lower any repetition of time spent with counsel.
  • You do not necessarily have to invest your own money into your fund, but be prepared to make compromises in other areas of the fund’s economics, if you choose not to invest.

There comes a time in many investment managers ’ careers when the following legitimate step is starting a private investment fund on their own. Either the coach has been working for others as an employee and now wants to go solo, has been investing their own money and wants to raise outside capital, or has been investing with others ’ capital on a one-off basis and wants to scale. Whatever the reason, in many cases, the right answer is to set up a fund. A fund can stabilize an investment commercial enterprise and help the coach not only grow assets under management but besides create a valuable investment platform .
Whether co-mingled or from a individual investor, a fund has many clear-cut advantages over one-off capital raise :

  1. Having a fund can provide a larger and more secure capital base for prospective investments, creating the ability to grow staff, resources, and profitability.
  2. In today’s competitive investment environment, a discretionary fund may also allow a manager more flexibility to operate and make decisions quickly, facilitating quick investment closings.
  3. A fund can allow a manager access to lines of credit or fund-level debt unavailable for one-off investments.
  4. Funds with multiple investments provide diversification benefits, both to the manager and investors.

many fund managers have built businesses and created significant wealth through fund vehicles, and it might be the proper future tone for your business arsenic well. The increase of the numeral of private equity funds over the by ten corroborates that raising a fund is an increasingly popular path to take .
private equity fundraising and number of firms has increased

All of that said, raising a fund requires a different mentality than managing money as an employee, as a personal investor, or through an informal syndicate. For a coach considering an investment fund, here is your flat coat on what to expect, what to think about, what questions to ask, and how to get it correct the beginning clock time .

Understanding the Strategy and Operations of a Private Equity Fund

Beyond making successful investments, one of the greatest challenges for a first-time fund coach is understanding the mechanics of a investment company ’ mho operations and net income model. Creating a complete and thoughtful determine of pro-forma financials early on is the best direction to ensure that you will be successful, not just at raising and operating your fund but besides at making a profit .

Profits, Fees, and Costs

One dispute to consider when raising a fund is that the profit model is frequently significantly different from single or even multiple syndicated investments. divide investments are often straightforward—the director can figure out what the likely results are a well as the fees and profits that they can expect. They can besides promptly assess how much time and price is associated with managing the investment and, therefore, project a ballpark net profit number accurately. besides, if a unmarried investment in a pool of many fails to work out as planned, it will not generally alter the profitableness of other investments .
Looking at the legal structure of a investment company, there are many relate entities and directional flows of money that must be intelligibly understand before starting out. The image below shows an exercise of a distinctive private equity fund structure .
legal structure of a private equity fund
In planning for a store, a coach has to assess not only a specific investment which is immediately available for detail evaluation, but besides future investments that are neither concrete nor available at the prison term the store is raised. This makes it much more unmanageable to make profitableness calculations and comprehend the likely fiscal results of a investment company ’ sulfur operation. furthermore, the timeframe on which investments will be made can besides be unmanageable to project. Given that investment profits and fees paid to sponsors in many funds are based on when investments are made and how they perform, it can be much more ambitious to estimate a fund ’ mho revenues up front .
Costs are besides a challenge to project relative to a single investment. not lone is it unmanageable to know up battlefront the sum of capital that will be managed at any given time, it ’ randomness besides difficult to estimate how many people will be needed to manage the investments and how much those people may cost .
Beyond the challenges associated with projecting a fund ’ second profitableness, the fund structure in and of itself can complicate matters. As most funds are cross-collateralized across their investments, a single investment failure can have outsized implications on the bottom cable of a fund patronize, even if the fund investors are ultimately satisfy with the fund ’ s results .
unfortunately, there is no slowly suffice in setting a fund ’ randomness gross and cost parameters to make it work. Each fund is different based on its size, the investments it makes, the type of investors who participate, and the expectations of its managers. In accession, the capital markets often get an crucial vote, and there is always the danger of ending up being “ the most profitable fund that was never raised. ”
The best approach path to dealing with these issues is to design the investment company ’ s commercial model carefully, accounting both for probable outcomes and understanding the sensitivities to changes, unexpected events, and shifts in the commercialize .

Cash Is a Drag

Another oft-cited challenge of managing funds is the ever-present write out of cash management. When making a single investment, the question of cash is normally uncomplicated. Funds are accessed when needed for the investment, never ahead. The wonder of holding cash reserves is typically limited to the coach, and the use of extra portfolio-level finance typically doesn ’ thymine exist .
For funds, it is more complicated. Funds, by contract, need to manage cash cautiously. First, there is the danger of having excessively much cash. Because most investment company profits are structured around the prison term value of money, having cash on hired hand, even for reserves, reduces a sponsor ’ s profits. This is because the fund investors typically get paid for every fund dollar called and in the fund ’ second possession, whether or not that dollar is invested. Given that many funds make their profit by outperforming a baseline refund pace, this abridge performance can end up coming directly out of the fund coach ’ randomness pocket .
On the other side of the coin, funds need to concern themselves with having adequate reserves on hand to make follow-on investments, shore up or protect investments that are having challenges, and to cover unexpected costs that may come up during the fund term but after the investment period .
The chart below shows a timeline exercise of a private equity store ’ s cash flows and the delicate libra that exists between capital drawdowns, distributions, and returns .
cash flow profile of a private equity fund
As with tax income and profitableness questions, having a well-developed cash management plan can help a fund director avoid electric potential challenges and sic themselves up for success .

General Management

Another challenge for a raw fund director is setting the right investment criteria and planning for the fund. Outside of a fund context, an investor can pursue whatever they think will produce a good reappearance, even if it is out of line with their historical investment strategy or their current investing plan .
On the other hand, even though most funds have “ discretionary ” capital, most investment company agreements contractually define the limits of that free will. While fund sponsors will much try to ensure that the definition is across-the-board adequate to allow them room to operate, sponsors that push for very broad delicacy much fail to attract investors. The reason is that investors prefer funds that are focused on a certain investment strategy or asset class and have a intelligibly specify area of expertness and focus .
At the lapp prison term, besides narrow a definition can be painful adenine well. The fund may end up foregoing good opportunities or becoming unable to place capital at all if the grocery store shifts and its mandate nobelium longer makes sense. Entangled with all of this is the type of investor the fund caters to and the degree of expertness and track criminal record the sponsor brings to the table. A group of class and friends who have invested with the sponsor successfully many times in the past may trust it wholly and give it wide latitude to choose investments, while an institutional investor may demand a very specific mandate or flush require approval rights for every investment the sponsor makes. Therefore, establishing a strategy that is both accomplishable from an investment point of view and salable to investors is a key expression of a successful store sponsorship.


operational issues are besides more challenging in the fund context, where the job of identify, evaluating, and managing investments is no longer one that can be handled by the coach entirely, and having a professional staff becomes important .
Staff allows for greater scale, but besides becomes a management challenge as the professionals involved have to be properly hired, managed, and motivated. Often, there is besides the challenge of effectively communicating the investment company ’ mho scheme, vision, and approach to making investments to new staff. What may have been a dead letter for a single investor or an established little team can become much more complicate and difficult when cognition needs to be built into a process and doctrine that can be applied by a larger team—especially a larger team that may have had no contribution in developing the doctrine to begin with .
The suffice to both of the challenges in this section is to have a distinctly defined investment scheme before taking a fund to market or hiring staff. The scheme should, at a minimum, explain :

  1. The type of investment the fund plans to make
  2. What criteria those investments have to meet
  3. Under what circumstances investments are to be reviewed and reconsidered
  4. In what cases exceptions or variances from the core strategy are allowed, and what processes are in place to allow a fund to take on an out-of-strategy investment safely and with careful consideration

Be Aware of Securities Laws

If you plan to raise a investment company in the United States, you may already know that private equity fund-raise is heavily regulated and that there are numerous legal and regulative requirements that an investor must adhere to in order to be in submission with securities laws. The SEC takes this complaisance very badly and a qualify lawyer needs to be involved in the fund-raise process early to make you aware of the rules and regulations associated with fund-raise, investing, and managing the store. here are the key questions to ask when your lawyer proposes a structure .

1. Who will I be able to raise money from?

Regulations offer assorted options for a sponsor raising money, chiefly depending on and related to the type of investors, the type of market, and the amounts being raised. typically, regulations create more hurdles and requirements for funds that intend to raise money from less sophisticated investors or where there is no prior relationship with the sponsor. The extreme of this is a publicly listed company that sells stock on an exchange to any member of the public—here, the requirements in terms of registration and public disclosure are the most rigorous .
Before marketing a store, it is important for a patronize to understand who will be able to invest, in what amounts, and what the sponsor will have to do to market to these investors properly and validate that they are appropriate investors .

2. How can I raise the money?

In addition to understanding which investors can participate in a fund, a presenter should understand how those investors may be approached to invest. Depending on the structure of the fund, a sponsor may be allowed to marketplace the fund publicly or may be limited in outreach to only investors that the patronize already knows or that meet a certain set of standards. This question can be farther complicated if the patronize hires a professional to raise funds, as they must ensure that it holds proper licenses to raise private fairness on behalf of a third party .
The patronize will besides need to think cautiously about what the message to investors will be and how it will be delivered. It ’ randomness significant to balance the need to marketplace and promote the fund with scrupulous honesty about what investors can expect. Many an investor lawsuit has started when expectations were not set appropriately, and an fanatic sales feat improving front can be dearly-won in the long range .

3. What kind of money can be invested?

Another business is the type of money that a fund or store sponsor can accept. There are a assortment of restrictions in this sphere, but the two most common are investments from retirement accounts and investments from alien accounts. Each of these areas creates downstream issues regarding the ways in which a patronize can invest, wield, and report results to investors. consequently, having a broad agreement of the type of investor funds that can be separate of the fund should be a key element of the market strategy. Speak with your lawyer to learn how these choices may complicate or direct your efforts, both before and after the money has been raised .

Each fund is different, and each lawyer is different, but you can expect to spend between $ 50,000 and $ 300,000 in legal costs to complete your fund, and frequently more .
One way to manage legal costs is to have a comprehensive fund-raise scheme before hiring an lawyer. The fundraising strategy should include :

  1. How much money the fund will target
  2. Likely investors
  3. The marketing channel for reaching investors
  4. The fund’s investment strategy
  5. Costs and other terms

By limiting the exploratory phase of investment company constitution, a patron can focus their lawyer ’ s clock time and feat on key submission questions, avoiding expensive discussions and rewrites .
Another strategy to control legal costs is to have your fund ’ mho selling materials and a draft of its investment scheme and monetary value structure ready for review as you begin the legal process. This will help an lawyer not only understand more quickly what the fund is trying to accomplish but will besides limit the time they need to spend reviewing and/or preparing fund documents .

Other Considerations

How long will it take?

Raising a fund can take well longer than raising money for a single investment. Depending on interest from investors and the timeline to complete conformity requirements, a patron should expect to spend at least six months on a fund, and the process can often take more than a year from concept to close. A large or complex private equity fund can take even longer .

What will investors look for?

investor expectations vary by sophistication, goals, and relationship to the patron. Large, institutional investors, for case, are highly concerned with an investor ’ s track record and experience. Going to those investors as a raw fund can be difficult. Smaller, private investors may be less concern with track record but more implicated with a tied of personal trust with the sponsor or access to an investment classify. A patron should conduct an honest judgment of the store ’ s strengths and weaknesses from a marketing position and set targets consequently .
There are many different types of specify partners, ranging from big foundations and institutions to high net worth individuals. As the chart below shows, there is no excessively dominant beginning of capital, and it is potential to be successful focusing on a variety of sources of das kapital. The samara is to be selective and to target your plan, selling message, and social organization to your choose audience .
composition of limited partner investors in a fund

Do I need to put my own cash in?

Investors are much more willing to invest in a fund if they know that the fund presenter has capital invested along with them. That said, there is a range of expected fund coach investment levels depending on the fund ’ sulfur structure, costs, management, and existing relationship with its investors. however, if a patronize is planning to make only a limited investment in the fund, that presenter should be prepared to make concessions in early areas.

You Need a Profitable Model… with a Plan

Starting an investment store of your own can be a profitable, useful tone in building an investment business. however, an investment director has many issues to consider up battlefront before beginning the market and fund-raise process. Doing this sour before the fund-raise begins will save significant time and price, giving the fund the best chance of ultimately becoming successful .
similarly, having professional aid from feel consultants and attorneys can facilitate the fund-raise serve, making certain a presenter develops a fund plan that is attractive to investors, remains in conformity with the SEC, and performs a successful fund-raise in the minimum measure of time .
disclosure : The views expressed in the article are strictly those of the writer. The author has not received and will not receive direct or indirect compensation in central for expressing specific recommendations or views in this report. Research should not be used or relied upon as investment advice .

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Category : Finance

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