Setting up a new PE or Venture fund – first things first

Launching a private equity fund will typically involve raising a large amount of capital from individuals and institutions, but there are many steps that need to be taken before it is time to reach out formally to potential investors with your proposition. This series of short articles aims to introduce first-time and would-be fund managers to the steps that need to be taken to launch a private equity fund. First, we will look at the tests you must subject your proposition to, even before reaching out to professional advisers.

The investment in your time and resources (including your cash!) required to successfully launch a private equity fund means that it is vital to evaluate your chances of success with a cool head, prior to embarking on the project.

In essence, there are five questions to ask yourself and we will deal with the first two in this article:

  1. Do I know the types of companies I will be investing in?
  2. Can I identify the most attractive ones and convince them to take me on as an investor?

In the next piece, we will look at answering the following questions:

  1. Can I improve the value of these companies while I hold an investment in them?
  2. Can I achieve a financial exit from these companies?
  3. Assuming positive answers to all of the above, will I be able to find external investors to back my fund?

Without a high degree of confidence in these areas, it is extremely unlikely that the project will be a success. And if you are planning a leveraged buyout strategy, we can add one further question: do I have relationships with lenders (banks or others) that will satisfy the leverage requirements for my deals?

Having a clear and differentiated investment strategy is vital, particularly for the first-time and fledgling fund managers.  Traditionally, an investment strategy would consist of four main elements: geography (where the investment targets are located), sector (the industries they are in), size (the enterprise value) and control (minority investments for growth; majority investments in the case of buyouts).  In addition as the industry has developed, some private equity funds have begun to describe their investment strategies from a thematic perspective – for example ‘an aging population becoming more tech savvy’ – for a new fund trying to make its mark, it can be a key point of differentiation of your strategy.  Overall the more specific the strategy, the better, for example a new fund proposing to invest for a controlling stake in firms across Europe in all sectors and with an enterprise value of £10m to £1bn is going to struggle to stand-out, whereas for instance a fund looking to help family-owned business in highly-regulated business services, to productise its services and professionalise sales and marketing in order to move into new sectors and geographical markets is going to be more eye-catching for specific investors.

Once your investment strategy is defined, it is important to remember that you will likely be competing for the attention of the investment target companies. Other private equity firms, but also banks, direct lending and other alternative financing options are all in competition with you. Do you have the connections and skillset to find and secure the investments you want? Do you have a network that you can use to get in front of the CEOs of the most exciting companies in your target market? If not, how are you going to get their attention? What about you and your firm is going to be compelling for business owners and management teams?

It’s not enough to have a compelling investment strategy. If it is not possible to execute the strategy, because your approach to value creation is not sufficiently attractive to the businesses you seek to invest in, or because you cannot identify which businesses in this target pool are the most attractive for your strategy, you are still not ready to launch a fund. Understanding how you will originate dealflow and how you will identify those deals you want to do is crucial.

In the next instalment, PART 2: CREATING VALUE, IDENTIFYING INVESTORS we will look at some other important questions that any new fund manager needs to be able to answer: How will you create value within the portfolio for your investors, and how will you raise the capital required to make investments, in the first place?