Coming back to the market for Fund II (or Fund III or…)

So you successfully raised your fund and have now invested it in a portfolio of (hopefully performing) investments. Now, four years down the line, you are thinking of returning to market to raise a successor fund.

Let’s take a look at the most important considerations.

Timing

At first look, it would seem the timing of a successor fund is fairly obvious – it’s when you are out of capital! In reality, it is not as straightforward as that and managers in fact have a wide degree of discretion as to when they go fundraising for a successor vehicle.

The LPA of your prior fund will dictate when you can and cannot go fundraising. However, the relevant provisions are often fairly loosely drafted, such that ‘fundraising’ can often commence before a prior fund has reached the relevant committed capital threshold, but a manager may not ‘establish’ or ‘operate’ another fund until the relevant threshold is reached. And remember, it is normal to include capital for follow-on investments and future fees and expenses within the calculation as to whether the relevant threshold has been met.

Importantly, you do not want to commence fundraising for a successor fund only when you have exhausted the capital in the prior vehicle. This risks you being out of the market whilst you are fundraising, which is not a good place to be. Remember, fundraising can be a 12-18 month , or more, process.

Ideally, you will have had one exit, or at least a liquidity event, within the existing portfolio, such that your prior fund has a positive DPI (the ratio of distributed capital to paid-in capital). And it should ideally also be in positive TVPI (total value to paid-in capital) territory. A DPI of zero, or a TVPI below zero, will make fundraising difficult, to say the least.  Remember, if you haven’t returned any capital back to investors, you are effectively asking them to double down on you without having had any return on their initial commitment and without proof that you can deliver. This can be a hard ask in some cases.

Preparation, preparation, preparation

This starts with the fundraising documentation. Fundraising and due diligence materials and your dataroom should be prepared in advance of a fundraising, in order to facilitate prospective investor due diligence and maximise both velocity and chances of a timely first close.

However, preparation extends not just to fundraising and diligence materials, but also to preparing yourselves and the wider team for investor meetings and due diligence meetings. Your second Fund may be larger than your initial fund and consequently involve more investors in the process. You also now have a larger team. Whilst with the first Fund, fundraising may have been carried out by a small number of people (perhaps just the firm’s founders), now the majority of the team will be involved. At some point, prospective investors are going to want to undertake an onsite diligence meeting. As part of this, they will almost certainly want to meet with the wider team. Are they ready for this? Consider one or more training sessions to prepare the team for onsite due diligence.

Work the portfolio

Consider the likely development of your portfolio and any major events that are likely to happen in the coming months. Nothing helps give a shot in the arm to a fundraise like a substantial exit. To the extent possible, timing the raise of a successor fund so that it happens at the same time as exit or other liquidity events, or other positive portfolio developments, will help enormously.

Consider utilising a placement agent

Most first time funds are seen as a risky proposition by placement agents. However, many will consider a second Fund, especially if the fundraise is larger and there is confidence that existing investors will be supportive.

Having a placement agent on board is a very strong signal for a manager and will give prospective new investors confidence you are an institutional quality manager with a compelling product. This is often an especially important consideration for second funds, which are often a) larger than their predecessor vehicle; and b) involve an expansion and institutionalisation of the investor base.

A final word

Throughout this series of Insight articles, we have tried to provide useful advice, but it should be remembered that each fund is different and a nuanced approach is always preferable. If you would like more specific input into your strategy, please get in touch and we are available to assist and work with you.