Against the odds

When markets are volatile and the economic outlook is, to say the least, dubious, investors are naturally inclined to seek out safe havens – hence why gold is at record levels, and the Swiss franc has soared against the euro (see p. 36). So you’d think this would be a pretty tough time to try and raise a first-time fund – which, by definition, represent a gamble of sorts. However strong the credentials of the new firm’s principals, they’re still running their own shop for the first time. There’s no guarantee that they’ll be able to replicate their previous success.

 It’s clear that this is a very different market to the period before the financial crisis, when a number of new firms successfully raised big debut funds. “It’s much tougher to raise first-time funds today than in 2007,” says Robert Fitzsimmons, co-founder of High Road Capital Partners, which spun out from Riverside in 2007. “LPs are more skittish now. You’re going to be very thoroughly vetted.”

 Whole team spin-outs are usually the easiest thing for LPs to swallow, because it reduces the element of the unknown. “Being a first-time fund today is in almost all cases a negative,” says Blair Thomas, chief executive of EIG, which closed its debut fund this year after spinning out from US asset manager TCW. “EIG was an exception because we kept all our existing funds, we kept all our existing employees, and we kept our track record. If you lose any of these three pieces, you’re really behind the eight-ball”.

 The good news, however, is that sophisticated investors are not shying away from debut funds altogether. In fact, most not only want but also need to pick up a number of first-timers in every fundraising cycle. “We firmly believe in the manager lifecycle,” says Helen Steers, head of European primary investments at Pantheon. “Some of these older buyout firms have been around for 25 to 30 years. Some have been very successful in renewing themselves, and bringing through the next generation; others, for whatever reason, have not. And it’s not just about money; it may also be about being involved in the running of the firm and determining its investment strategy. Perhaps the firm has moved away from its original ‘sweet spot’, and some of the principals want to go back there.”

First, make sure you have a clearly defined strategy that’s consistent with what you’ve done historically. Second, make sure that you’ve got a stellar, documentable track record to back it up

Robert Fitzsimmons

Steers says that Pantheon wouldn’t back first-time investors at the moment – but for managers with a clearly attributable track record, and a clear rationale, it’s a different story. “These can be quite attractive opportunities,” she says. “Some of these smaller funds can have really outsized returns. That’s particularly true for those spinning out of bigger groups, who are applying the expertise they’ve learned at the mega-fund in smaller-cap situations – not just the financial toolkit, but how to get the best out of company managers, how to write a good 100-day plan, and so on.”

So what’s the key to impressing? “There are two important elements for first time funds,” says Fitzsimmons. “First, make sure you have a clearly defined strategy that’s consistent with what you’ve done historically. Second, make sure that you’ve got a stellar, documentable track record to back it up.” New principals doing a spin-out can usually take their track record with them as long as they were the lead partner on the deal(s) in question, and the parent firm is amenable, he says. “Spinning out without that is very tough.” 

There’s also a team element, of course. “We look at the quality of the people first and foremost,” says Steers. “Is it just a group of talented individuals, or will the whole be greater than the sum of the parts? That requires a lot of diligence, a lot of ‘getting to know you’ meetings.” She argues that this actually makes it difficult for smaller investors to back debut funds. “Although you might think the smaller investors would go into the smaller funds, in practice they don’t always have the resources, the experience or the insight to do the level of due diligence required.”

Fitzimmons argues that the team needs to have worked together for a period of time. “It’s much better [that way],” he says. “It’s very tough for people to come together from different places to form a first time fund.” 

Not everyone would agree, however. When Ian Snow left Ripplewood to found Snow Phipps Group in 2007, he didn’t take any of his old team members. But he still managed to raise his debut fund – which performed sufficiently well for him to raise a second fund this year. “We recruited several operating partners I’d worked with in the past, but no one that came directly from Ripplewood,” says Snow. “We built the new team by focusing on the same industrial operating partner strategy that I had successfully employed at Ripplewood.”

In one key respect, first time funds might actually be better off than their predecessors. “In 2007 investors were putting a lot of capital behind the mega-buyout funds, so the middle market strategies didn’t have as much currency at that time,” says Snow. “I would say there was greater interest in middle market funds this time around, as well as in the operating partners strategy.” Most sources agree that mid-market strategies are a lot more fashionable today than they were four years ago. This should benefit first-time funds, who will generally be operating in this end of the market.

 In fact, debut funds arguably can’t afford to think too big at the moment. “The days of the multi-billion first-time fund are largely gone,” says Fitzsimmons. “It’s tough even for the older more established guys to raise multi-billion dollar funds.” 

EIG’s Thomas agrees: “One of the things new entrants have learned is, if you go out and try to do a really big first-time fund, in all likelihood you’re not going to succeed,” he says. “It would be crazy to set a $2 billion target for a first-time fund. If you end up with $600 million, the perception in the market is that you failed, when in fact $600 million for a first-time fund is a very good outcome. It’s much better to go out with a smaller target and then exceed it, so you’re oversubscribed.”

First-time funds will still get raised in the current climate, as long as the sums involved are not too large and the proposition is a good one. And even if new managers will have to work hard for every dollar, we shouldn’t expect them to stop trying. Whether the lure is a different strategy, a new market opportunity, greater autonomy, or just the chance to have their name on the door and build a business from scratch, managers will always be drawn to the idea of striking out on their own. “You get to define things your own way, create your own strategy and tweak things that your institution may historically have done differently,” as Fitzsimmons puts it. And at the back of their mind, all these new firms will be thinking the same thing: the likes of Kohlberg Kravis Roberts, Permira, The Blackstone Group and Oaktree Capital Management were all first-time funds once upon a time…