In previous editions of our Insights series we’ve looked at some of the key considerations regarding the first deal from your fund, and one of the key considerations is: When should I hold a first close for my fund?
The question is of course significant and not only for the practical reasons laid out in our last article. It is also as much art as science. The dynamics of your particular fundraising (the specific investors you have in play and their timetables, whether you have an anchor LP on board, your investment pipeline, etc.) will ultimately dictate the best timing and as such the best time to hold a first close will vary from fund to fund.
Having said that, there are a number of considerations any manager, whether raising a first time fund or a successor vehicle, should bear in mind.
Firstly, it is worth stating that there are no hard and fast rules. In the past, there was something of a rule of thumb that a first close needed to be at a level that represented at least half the target size of the fund raise. This rule no-longer holds true in all instances.
The first close needs to be meaningful enough that it proves the viability of the fundraising. In this regard, bigger is obviously better. A first close at 60% of target or more shows clear momentum with a fundraising and will act as a powerful galvanising factor to additional prospective investors. The unspoken takeaway being: we had better get on with this or we are going to miss out.
However, other considerations and factors may drive your thinking and the decision around when to hold a first close.
The key factor here is the prospective investors you have in play, their level of engagement with your process, and timetables. For many managers, especially emerging managers raising a first or second fund, having a sizable anchor or cornerstone investor on board is crucial to the success of a raise, if in fact not a sine qua non. In such a case, you are well advised to only hold the first close when your anchor or cornerstone LP is ready.
A quick first close can give the impression of velocity, as it is a clear signal that this raise is getting done and getting done at speed. This in turn can help in developing a perception of scarcity around the raise, as prospective LPs worry about missing an opportunity and so get on board with the process in line with the Managers’ vision.
At the opposite end of the spectrum, if you have already spent many months fundraising (which is inevitably a distraction from the real business of making and managing investments), this may argue for a first close at a level of capital that is smaller than one might ideally like. There is a real danger in being ‘out of the market’ for too long. The advisory community, upon whom most private equity firms rely for deal flow, to a greater or lesser extent, will quickly get a sense if you are not in the market. The danger then is that they stop showing you opportunities, as they know you cannot fund them, or (probably worse), you get a reputation for being unable to deliver. This can be fatal.
Unless your fundraising is overlapping with finishing up the investment period of a prior fund and/or you are deliberately targeting a dry closing for your new fund, the need for new capital to continue to make investments will be an important consideration, as discussed in previous Insights.
The question of when to hold a first close is often linked with the topic of when (and how) to make the first investment and, as we discussed, there can be a tension between fundraising and the need to invest. Near-term attractive pipeline opportunities may favour a quicker, albeit smaller, first close, in order that you get capital in place to make investments. This can have the benefit of giving you a more fully-formed story to sell to later closers, as you have proven the ability to execute the strategy and prospective LPs can see the type of investments being made. This can be especially helpful for those emerging managers that lack a lengthy track record of prior investments.
It is important not to rush to start a first close process unless you are confident in the capital you expect to be able to commit at that stage. You risk losing credibility if you announce, for example, that you are going to hold a first close in March and it doesn’t happen until September. Better to close on a smaller amount with absolute confidence than attempt something more audacious that risks failure. Whatever you decide, in terms of timing, be clear and unambiguous in your guidance to prospective LPs.
And finally, remember that the timing of when you communicate the first close to the wider market is your decision. Your announcement of a ‘first close’ does not in fact have to be your final first close as there is the ability to do a series of rolling closes or a 1a / 1b type of close, callinga the ‘first close’ when a certain level of capital is achieved.