It was the spring of 2015 when Hollie Moore Haynes, former managing director at Silver Lake, had an investor meeting she wouldn’t forget. Armed with a 10-page slide deck and a lot of enthusiasm about her new firm, she laid out Luminate Capital Partners’ strategy in a 30-minute presentation.

“That’s really exciting, but you basically don’t have anything – there isn’t even anything for us to consider. It’s just you and some PowerPoint slides,” the investor told Haynes.

The investor was nice about it, but it was a ‘no’, she tells Private Equity International. That was one of the first of about 550 LP meetings Haynes had between January 2015 to May 2017, flying back and forth across the US from her San Francisco base, to raise capital for her debut fund. She was seeking $200 million.

Every year since 2003, an average of 70 first-time fund managers have successfully raised capital, according to data from PitchBook. They will no doubt relate to Haynes’ experience.

First-time funds accounted for 11.8 percent of all fundraises in 2019 by number. While the number of debut fundraises broadly tracks the ups and downs of the overall fundraising market – a benign market clearly attracts hopeful first-timers – there are also reasons to start up during tougher times.

The economic fallout of the covid-19 crisis will undoubtedly have an adverse effect on some established firms’ portfolios. As the prospect of profit sharing gets pushed further into the future – and in some instances unlikely to materialise at all – the reason for ambitious executives to hang around is diminished. Once the “new paradigm” brought about by the health crisis is adopted, expect to see an increase in first-time managers raising capital, says Jean-François Le Ruyet, a partner at fund of funds QuilVest Capital Partners. Roughly a third of QuilVest’s fund commitments are to new managers.

Why leave the comfort of an established firm to head into the unknown? A common “push” factor among the firms we spoke to for this feature was a divergence of the individual’s investment ambitions and their current firm’s strategic direction.

For Dublin-based Melior Equity Partners, the former Carlyle Ireland team, it was obvious the Irish market was going to be too small for a domestic fund by a large, listed manager. The idea to spin off was raised by Carlyle to Peter Garvey and Jonathan Cosgrave, managing directors of the firm in Ireland, prior to the end of the investment period of Fund I in 2019. The pair didn’t think about it for too long, according to Garvey. “We had the opportunity to build our own business, and we have an existing revenue stream through managing out Fund I, the support of our existing investor base, and what we think is the best team in the Irish market,” Garvey says.

One senior executive at a different firm, who asked not to be named because his departure was not on amicable terms, left to seize opportunities in the mid-market of his home country China, rather than the regional strategy being pursued by his existing firm. “I saw this huge opportunity in greater China, and I felt my previous firm wasn’t positioned well to capture that.”

Founder of Sky Island Capital, Jack Waterstreet, had been chief investment officer of Texas-based Insight Equity, but decided he wanted to go back down market and fill a gap no longer of interest to Insight.

“I just noticed that where the firm was going to wasn’t where my interests lie. I just missed doing the smaller deals,” Waterstreet tells PEI.

For Haynes, it was a question of investment strategy. She wanted to pursue growth buyouts focused on enterprise software companies. “That just didn’t seem like the core strategy at Silver Lake. But it was important to me as I thought there was a hole in the market.”

Haynes was a 15-year veteran at the tech investment powerhouse, having joined the firm when it launched in 1999 and been on the investment teams for Silver Lake I and II. She co-founded Silver Lake Sumeru, the firm’s mid-market strategy in 2007, which raised $1.1 billion in 2008 and made 14 investments.

In December 2013, Haynes walked into her boss’s office to say she was leaving to start her own firm. She declines to name the Silver Lake partners who were in the meeting, but notes the reception was friendly. She stuck around for another year, while transitioning out of the firm and planning the infrastructure to set up Luminate.

Haynes made a proposal to her former employers about how her departure would work, what economics she would keep, when she would go off the payroll, and observe her non-compete and non-solicitation agreements.

Leaving well

A well-orchestrated departure should be the first priority of any spin-out manager, according to Sarah Sandstrom, head of North America fund placement at Campbell Lutyens. This means doing right by one’s contractual obligations in the employment agreement to spin out in an amicable way.

“You have to think about what your bait is, and your bait is dealflow. That’s the way for LPs to get to know you. Your highest and best use of your time is to get a deal done and bring it to them”
Senior advisor
US-based fund of funds

“It is almost always in the best interest of both the parent manager and the spin-out to negotiate a separation agreement with clear ground rules. In most cases, both parties can seek protection around what they care about most,” Sandstrom says.

For the parent, this may be restrictions around further employee poaching, non-solicitation of existing investors, continued board of directors roles or having the spin-out delay their launch or pursue a less competitive strategy, she adds. For the spin-out, economic considerations and track record attribution are at the forefront.

Garvey notes that from Carlyle’s perspective it was always “investors first” throughout the spin-out process. Melior co-founder Cosgrave adds the split from Carlyle was “very collaborative, constructive and amicable”. Carlyle itself and the investment giant’s founders are understood to have committed to Melior’s debut fund, which was launched at the beginning of 2020 with a €175 million target and a €200 million hard-cap.

For some spin-outs, it’s about severing ties with the parent firm. This was the case for the China-focused manager whose founder wanted a “clean break” and did not provide continued engagement upon departure from the previous firm.

Haynes declines to go into the details of her arrangement with Silver Lake, but notes it was “all very clear” and that “doing the right thing worked out nicely”. “We are not competing. That’s not true for a lot of spin-outs.”

Track record attribution

As Campbell Lutyens’ Sandstrom notes: track record attribution, along with economic considerations, is at the top of the departing manager’s list of priorities. There is no standard for how that track record is attributed and communicated. It can range from a detailed spreadsheet, updated with live quarterly valuations with the former shop’s blessing, to a two-sentence letter with a list of portfolio companies.

Sometimes it is clear cut. Carlyle Ireland’s entire investment team transferred to Melior and employ the same strategy that was executed for the previous six years. Carlyle was “very supportive” and allowed the team to disclose the track record in an approved format and provided whatever references were needed for potential investors, according to Garvey. The co-founders had also obtained positive references from their former colleagues at the likes of Warburg Pincus and Goldman Sachs.

In a worst-case scenario, a departee will have to recreate it from scratch. Such was the case for the team at Equip Capital, a spin-out of Norwegian firm Herkules Capital, which had to re-construct their track record from public sources and gather testimonies from the management executives of each of their portfolio companies.

Only two out of the 10 spin-out managers PEI spoke with for this story had issues with attribution.

Back in 2015, Haynes’ plan was simple: leave Silver Lake and find deals. Once those deals are secured, raise money. She would go deal-by-deal until she could raise a fund.

This is by no means the only way to kick-start a new firm, but can be very effective, says a senior advisor to a US-based fund of funds. “You have to think about what your bait is, and your bait is dealflow. That’s the way for LPs to get to know you. Your highest and best use of your time is to get a deal done and bring it to them.”

Hi! My name is…

Coming up with a name: a task that is both simple and fiendishly difficult at the same time. Hollie Moore Haynes, founder of Luminate Capital Partners, had been working with some operating advisors called Radiant Systems in Atlanta. She liked the name and looked up all the synonyms for radiant and found “illuminate”.

Melior Equity Partners co-founders Peter Garvey and Jonathan Cosgrave found brainstorming unfruitful and in the end Garvey googled “better” in Latin, “melior”. “The genesis of it may be a bit corny but we believe that we can build a great investment firm. To do that, we had to do things better, make better investment decisions, make the companies we invest in better. And ultimately, we need to deliver better returns for investors,” says Garvey.

There are still some geographical features that have not been claimed by private capital firms. When one of the founding team members of Dallas-based Sky Island Capital came up with the name, managing partner Jack Waterstreet thought its qualities – an isolated mountain range surrounded by different lowland environments – fit well with the concept of the firm “finding great deals among a desert of other deals”. “Most importantly, it was short and available, and we got the domain name for about a dollar,” he says.

The name for Herkules Capital spin-out Equip Capital was suggested by one of the partners’ mothers, says founder Sverre Flåskjer. The word “equip” comes from the Viking word “skipa”, meaning to ready a ship for a journey. The word resonated with the team – they were essentially equipping a company for a journey, Flåskjer says.

For some investors, deals are not a must-have. “If we are happy with the diligence on the attributable track record in the prior firm, we don’t need to see a pre-fund deal before we commit,” says QuilVest’s Le Ruyet.

Why not raise capital and do deals simultaneously? Sverre Flåskjer, part of the team that exited Herkules Capital and founded Equip, says securing deals early in the process brought the firm’s capital raising efforts closer to the finish line. Equip has completed six deals thus far and is expected to hold a final close on its debut fund above its €150 million target by year-end.

Prolific dealmakers, however, don’t always make successful spin-outs, says Javad Movsoumov, head of Asia-Pacific for UBS Private Funds Group.

Movsoumov notes that one of the common issues with spin-out managers is they lack experience in fundraising and don’t have enough direct LP relationships. “They might think, ‘I have a good track record; I will be able to raise easily.’ And they go out and face the harsh reality with LPs.”

Deal number one

Returning to Luminate, Haynes found a company to buy in early 2015: Texas-based enterprise software company Professional Datasolutions. Getting the equity together to fund the deal was not easy, she says. Ultimately, she got her former employers – two of Silver Lake’s founders and two managing partners – to back the acquisition. She offered an attractive proposition: she wouldn’t take any fees or cash compensation until they exited the company.

Says Haynes: “I told them I will not make a dollar on this deal until we sell this company.”

Haynes, living without a salary at that time, had already spent almost $500,000 out of her own pocket on the diligence on that deal. “I had to get it done. There’s no concept of ‘this isn’t going to happen’,” she says. “I told myself I’ve got to make this real for people.”

That deal was sold 13 months later for 8.8x invested capital.

“In my opinion, if you can’t find a deal and go get some LPs to fund it, then you shouldn’t start a firm anyway. That’s the whole job,” says Haynes.

Making people aware the firm existed to source deals had been one part of getting the firm off the ground. Tactical hiring was another.

Haynes recruited an old contact and a former director at Thoma Bravo as Luminate’s chief operating officer. The COO introduced a former colleague, who joined in October 2015 as a principal.

“You have to be pretty tactical when you hire. You don’t have time to interview 100 [people]. You interview three and you hire one of them,” she says.

With a growing team, Haynes needed an office. She looked at three places in San Francisco and in June of 2015 made a $100,000 per year lease commitment out of her own pocket. “I just needed to show some incremental progress and there were obvious tactical decisions that needed to be made, like hiring and setting up an office.”

“It is almost always in the best interest of both the parent manager and the spin-out to negotiate a separation agreement with clear ground rules”
Sarah Sandstrom
Campbell Lutyens

“You’ve got to keep it simple. We had an office, desk, chairs, email, cell phones. Good to go. I put up a website. I said we were a PE firm. I didn’t say we had money, but we didn’t have any money. We were just trying to find deals. We looked at companies anyone called us on.”

Melior’s Garvey adds first-time managers shouldn’t underestimate how intense the work is around the spin-out and fundraising. “From hiring a placement agent, finding an office, keeping the team on board, getting regulated if you need to, coming up with a name, building a website – all that takes an inordinate amount of time.”

It’s not just time. The cost of starting a new firm is often one of the hardest things for a spin-out group to grasp, says Sam Kay, a partner at Travers Smith and legal advisor to Melior. “You will often have a situation where the team that’s spinning out have only limited support from the prior firm and will need to set up their own legal, finance and regulatory functions as part of the transition.”

Sky Island founder Waterstreet says no one in the firm took any salary until they closed their first deal, Material Sciences Corporation, in March 2019, six months after the firm was set up. Around that time the firm had secured more than $50 million from LPs, according to a filing from the Securities and Exchange Commission.

Waterstreet notes the firm had to make smart spending decisions and save money where it counts, including taking midnight flights and staying in cheaper hotels.

“We no longer had the corporate Amex, we had to make sacrifices, but we knew it would be worth it in the end,” he says.

In Luminate’s case, the firm was living off Haynes’ bank account until it held a first close in early 2016.

Thankfully for ambitious execs, many legal advisors will be flexible on fee schedules. Peter Hammerich, a partner at Norway-based law firm BAHR and legal advisor to Equip Capital, shares that managers unable to raise their fund will often have a rebate on legal fees. “We will then only bill if the fund has reached a first close. This isn’t a formal agreement, but trust-based and on a case-by-case basis with clients.”

“You’ve got to keep it simple. We had an office, desk, chairs, email, cell phones. Good to go. I put up a website. I said we were a PE firm. I didn’t say we had money, but we didn’t have any money”
Hollie Moore Haynes
Luminate Capital Partners

Kay’s firm, Travers Smith, normally invoices a GP when the fund has had its first close. “If the whole fund falls over, the firm may well issue an abort charge,” he says.

“That’s a hard thing to do as an advisor because you are having to invoice individuals. As an advisor, we will take a risk-based approach, but also accept that we are investing in the long-term relationship.”

Capital raising

Back to Luminate: In the space of 18 months, Haynes did her first Luminate deal, started raising capital and gave birth to her fourth child.

Raising a debut fund, as alluded to earlier, is a numbers game. Says Haynes: “An investor asked me once, ‘How do people get comfortable with you as a first-time fund?’ They generally do not get comfortable. They think it’s a terrible idea. But that’s a great part of our business: you don’t need that many people to say yes.”

In late 2016, she brought in Moelis & Company to help finish the fundraise and ended up gathering $266 million for Fund I, $66 million more than its original target, a little over two years since it was founded. Investors in the fund include Exelon Corporation, Teagle Foundation and New York State Common Retirement Fund, according to PEI data.

“As an advisor, we will take a risk-based approach, but also accept that we are investing in the long-term relationship”
Sam Kay
Travers Smith

Few women-led private equity firms have created the kind of stir Luminate has. Haynes has won several awards over the years, including being named dealmaker of the year in 2018 and one of the most influential women in US mid-market M&A in 2019 by Mergers & Acquisitions. Luminate was also recognised by the Private Equity Women Investor Network as one of the best women-owned firms in 2019.

Luminate raised $425 million for its sophomore fund in 2018 and is understood to be raising capital for its third offering with a $700 million target. Haynes declines to comment on fundraising for its latest vehicle.

“You asked what would have happened if I didn’t get that first deal done? We just wouldn’t be here,” Haynes tell PEI.

The class of 2021

Starting up in 2021 will be a different story. Travel is still limited and LPs have turned to established relationships in a pandemic-slowed market. The total private equity capital raised in the first nine months of 2020 was roughly on a par with the same period in 2019. But the number of funds raised dropped sharply, suggesting capital is flowing to larger, established managers.

And despite increased adoption of virtual diligence processes, LPs still find it difficult to commit to managers without a face-to-face meeting. A survey from placement agent Campbell Lutyens found that over half of LPs (54 percent) are willing to hold on-site due diligence virtually, yet less than a quarter said they can fully underwrite a commitment to a new manager without an in-person meeting.

When Haynes was raising Fund I, she would book a flight to a major hub and start messaging LPs: “I’m in town for a couple of days; can we grab coffee?” Right now, that is not an option.

Capital raising for first-time managers is going to be a challenge over the next 12-18 months, but not impossible. GPs who have got to know LPs ahead of time – in their prior existence and not necessarily with a pitchbook – will be in a good spot to raise capital, industry participants say.

“First-time funds coming to market now have an even higher bar to clear, yet there will continue to be successful new managers in today’s environment where they can evidence differentiated attributes and the ability to have generated outperformance historically,” says Warren Hibbert, managing partner at placement firm Asante Capital Group, who has worked on over 20 first-time funds, including Melior and Equip.

Although fewer successful new groups will emerge, LPs have adapted to completing diligence virtually, so it won’t be an impossible task, he adds.

Others will have to capitalise on technology and just put in the time.

As a director at a New York pension puts it: “Think of this as a long game. It’s a relationship business and you have to approach getting the attention of large LPs as any personal relationship you’d want to build over time.”