Setting up a new PE or Venture fund – creating value

So, let’s fast forward to the first investment from your new fund: how are you going to improve the value of your new portfolio company? Value creation has come under increasing scrutiny since the financial crisis, 10 years ago. Even if leverage is an important component in your investment strategy, using leverage as the primary tool to generate returns is no longer sufficient. Today, successful managers are able to point to strategies and operational improvements that they have successfully used in the past to drive revenues, increase efficiency and reduce costs. In short, they have enhanced the businesses they invested in.

Developing a performance track record for a new fund is an important part of the process although you may face attribution issues if you are seeking to include deals you worked on (or even led) at a previous firm. Furthermore, it is not enough to detail only the financial aspects of your track record, before launching a fund you should make sure that you can talk to investors about your previous success and how the strategies you employ that will make that success repeatable.

Of course, value creation in privately held businesses is typically only crystallised upon a financial exit (partial or whole) and you must have a solid grasp on the likely exit routes for your investment. Although listing is an option for some firms, in current times a typical outcome for a portfolio company is some kind of sale, either to another financial sponsor (a “secondary buyout” in the case of control deals) or to a “strategic” trade buyer. Knowledge of the other private equity firms operating in your preferred sectors (particularly those operating “upstream”, doing larger deals) is vital, as is developing access to acquisitive businesses with a heritage of acquiring firms in your portfolio companies’ industries. Whilst good sell-side advisers can dramatically improve the likelihood of a good financial exit when the time comes, you should know who the obvious buyers are before you begin investing.

In this piece and the previous article, we look at the questions a new fund manager needs to be able to answer with confidence, before launching a project. To the extent that these determine the likely success of the fund, these same questions are important to potential investors into your fund. However, although you may have good answers to these questions, this alone is unlikely to suffice if you do not have strong relationships with some potential key investors. We will look at marketing to investors in more detail in a subsequent piece in this series but, for now, it is important that you have a good idea of who are the likely backers for your new fund.

One important caveat: the tight regulations governing what can and can’t be said to an investor without constituting “marketing”, mean that it is important to take legal advice before sharing any specific information. Don’t make the mistake of going to market without the correct permissions and landing yourself in hot water with the FCA.

So, in conclusion, before spending a meaningful amount of time and money on your project you must be certain that:

  • You have locked down the investment strategy for your fund
  • You know how to select the “winners” from the “maybes” and you can convince them to work with you
  • You know how to create value in your portfolio and crystallise this upon exit
  • You have an idea of who will invest in the fund, once you start marketing it.

And if you have the answers to all of that, it’s time to get started with the real work…