First Time Private Equity Funds: Tips for Success - Morse (2022)

Raising capital for a first time private equity fund is difficult. First time fund managers often are surprised by how long it takes to secure enough capital commitments to hold a fund’s initial closing, particularly when seeking commitments from institutional investors.

The good news is that first time funds have recently been in favor with investors. First time fund managers have seen growth every year since 2013, both in terms of the number of funds raised and in the percentage of the industry’s overall fund raises, according to Pitchbook.

Investors are attracted to the strong performance of first time funds

Strong performance is one reason why investors seek out first time funds. First time funds outperformed follow-on funds by a significant degree in recent years. Pitchbook reports that for 2012-2014 vintages, first time private equity funds produced a median internal rate of return of 17.1%, compared to 10.8% for follow-on funds.

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Three factors help to drive the strong performance of first time funds: their smaller size, the managers’ incentives, and the absence of distractions from legacy portfolio investments.

First time funds tend to be relatively small compared with funds raised by established managers. Smaller funds can focus on smaller, less-efficient segments of the market where the lack of competition offers potentially higher returns. They can pursue narrowly-focused strategies where the manager has a competitive advantage in industry, geography, or asset class. A smaller fund size also forces the manager to ration the fund’s capital, which creates an incentive for the manager to be more disciplined when executing the fund’s strategy.

First time fund managers have many incentives to produce strong returns for their limited partners, while limiting the risk of losses. If a manager’s first fund is successful, the manager can look forward to receiving generous payments of carried interest, raising a larger follow-on fund that will provide a second management fee stream for the firm, and potentially achieving financial and professional independence. If the manager’s first fund suffers losses, however, the manager’s professional reputation may be harmed, the manager may suffer significant financial losses, and the manager will have disappointed the fund’s limited partners, many of whom may be family, friends, or business colleagues. With so much at stake, the pressure to succeed can create a sense of urgency that keeps the management team focused, diligent, and prudent when executing the fund’s strategy.

A first time fund manager, by definition, only manages a single investment fund. The manager therefore can devote all of his or her time and attention to that fund, without being distracted by the need to manage legacy investments made by his or her prior funds.

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Institutional investors perform extensive due diligence on new managers

When evaluating first time fund managers, institutional investors tend to focus on the firm’s strategy, deal sourcing capabilities, track record, team continuity, and back office operations. Managers seeking capital from institutional investors should be prepared to go through an extensive due diligence process that covers each of these topics, among others.

Strategy. The fund must have a compelling strategy, and the manager must be able to clearly articulate that strategy to prospective investors in the fund’s offering documents. The fund’s strategy ideally will be in an area where the manager has a competitive advantage, whether through his or her expertise, network, or otherwise. The strategy should be tailored to the manager’s strengths. A manager that has a strong track record investing in early-stage cloud application companies based on the West Coast of the United States will likely have more success raising capital for a fund that focuses on that narrow strategy and geography, rather than for a fund that has a more generic focus of investing in early-stage technology companies based anywhere in the world.

Sourcing. The manager must be able to demonstrate that it will be able to find enough suitable investment opportunities for the fund to invest all of its capital. If the manager has difficulty finding suitable investment opportunities, he or she might seek to invest the fund’s capital in less suitable opportunities (i.e., those that are riskier or offer less potential upside) or decide to invest less than all of the fund’s committed capital, which results in a higher expense-to-investment ratio for investors. Diligent investors will test a manger’s sourcing claims by, for example, evaluating whether the manager’s historical access to investment opportunities was based on the manager’s own personal relationships or on a non-portable source, such as a former employer.

Track record. Institutional investors want to see a track record, which clearly presents a challenge for new managers. Institutional investors often say that they will invest with first time managers, but never with first time investors. Presenting a track record is easier when a new manager has a history of making investments at a prior firm. It is more difficult when the manager is someone whose attractiveness to potential investors is based more on the manager’s industry knowledge and connections than on investment experience, such as a former chief executive officer.

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Managers who do not have established investment track records may have difficulty attracting capital from institutional investors. These types of managers sometimes pursue a strategy of being a “fundless” sponsor – someone who offers investment opportunities to prospective investors on a deal-by-deal basis. This strategy helps the manager develop a track record over time while also building relationships with a core group of investors who may become anchor investors when the manager raises a traditional multi-investment private equity fund in the future.

Team continuity. One risk of investing with a new manager is that the management team might not get along with each other. This risk is mitigated when the management team has successfully worked together for a number of years at a prior firm, but is heightened when the management team is comprised of people without substantial prior relationships. Regardless of the level of continuity among a manager’s team, the manager should be prepared to explain to prospective investors why they should not worry about the team’s cohesiveness.

Fund operations/back office. Institutional investors will evaluate a new manager’s infrastructure to determine whether the manager will be able to handle the basic operational requirements of a private equity firm. These requirements range from managing the fund’s cash flows to navigating an increasingly complicated regulatory environment.

An investor evaluating a firm’s operations might ask questions such as the following:

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  • Is the firm’s accounting being handled in-house by someone new to the private equity industry, or by an experienced private equity fund administrator through an outsourcing arrangement?
  • Is the firm using a private equity transactional lawyer, or someone who is experienced with private equity fund formations and operations?
  • Does the firm have policies and procedures in place to manage potential conflicts of interest between the manager and the fund?
  • Does the firm have policies and procedures in place to ensure that expenses are appropriately allocated between the fund and the manager?

The back office due diligence process is intended to ensure that investors’ money will be used for its intended purposes (and will not be stolen in a Ponzi-scheme), that investors will only pay for the items for which they are responsible (and not for the manager’s personal expenses), and that investors will receive accurate information about the status of their investments over time.

Managers that are prepared for the diligence process have a fundraising advantage

The fundraising environment is strong, but the fundraising process is hard. New managers can give themselves an advantage in the fundraising process by anticipating the questions that investors will ask, and by preparing thoughtful answers to those questions. Some of the important topics that investors will examine are identified above. More are available in standard industry due diligence questionnaires.1 All of these questions, regardless of their specificity, fall within two broad categories — What is the upside potential? What is the downside risk? Focusing on the first category might attract the attention of investors, but ignoring the second category might allow them to slip away.

For more information, please contact a member of our Private Investment Funds and Advisers Practice.

Footnotes.

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1. The Institutional Limited Partners Association publishes a standard due diligence questionnaire that was designed to ease the administrative burden placed on private equity limited partners and general partners by standardizing the most frequent diligence questions posed by investors. ILPA’s questionnaire is more appropriate for established managers with significant track records than for first time fund managers. The questionnaire, however, provides valuable insight into the types of questions that institutional investors will ask. A copy of ILPA’s questionnaire is available on the ILPA website or by clicking here.

FAQs

How hard is it to raise a PE fund? ›

Raising a fund can take substantially longer than raising money for a single investment. Depending on interest from investors and the timeline to complete compliance requirements, a sponsor should expect to spend at least six months on a fund, and the process can often take more than a year from concept to close.

What is the average return for a private equity fund? ›

The 11.0% annualized return for private equity for the entire 21-year period is impressive compared to the 6.9% annualized return for the Public Stock Benchmark and the resulting 4.1% annualized return difference exceeds the 3% annual premium or excess return generally associated with return objectives for private ...

What is the minimum investment for private equity? ›

The minimum investment in private equity funds is relatively high—typically $25 million, although some are as low as $250,000. Investors should plan to hold their private equity investment for at least 10 years.

What percentage of portfolio should be in private equity? ›

Abstract. Private equity provides diversification benefits in portfolios with at least 60 percent equity. Illiquidity, risk, and inefficient markets cause some investors to consider private equity unsuitable for their portfolios.

Does PE or VC make more money? ›

In general, you'll earn significantly more across all three in private equity – though it also depends on the fund size. For example, in the U.S., first-year Associates in private equity might earn between $200K and $300K total. But VC firms might pay 30-50% less at that level (based on various compensation surveys).

How much do small PE firms pay? ›

Private Equity Associate Salary + Bonus

For the vast majority of private equity associates, the base salary is around $135k-$155k. Then, based on fund performance, bonuses tend to range from 100% to 150% of the base salary.

What percentage of private equity investments fail? ›

Looking at bottom-quartile funds, he found that 75 percent had failure rates of 35 percent or higher. The average is around 27 percent for buyout firms.

What is a good IRR for a private equity fund? ›

What is a Good IRR For an Investment? Most venture capital firms aim for an IRR of 20% or higher. However, it's important to consider the length of a project when evaluating an IRR. Longer-term projects could result in more returns, even if the IRR is lower.

What is the average maturity of a PE fund? ›

According to Blackstone's Private Wealth Solutions group, the life cycle of PE funds is typically 7 to 10 years, and is generally broken down into three stages: the fundraising period, the investment period, and the harvest period.

What is private equity for beginners? ›

Private equity, in a nutshell, is the investment of equity capital in private companies. In a typical private equity deal, an investor buys a stake in a private company with the hope of ultimately realising an increase in the value of that stake.

Can small investors invest in private equity? ›

Private equity involves investing in businesses or funds not listed on public stock exchanges. Private equity investments offer high returns, but are illiquid and have high minimums. Traditional private equity is only open to the wealthy, but newer forms are available to smaller investors.

What is a good return for a private investor? ›

A good return on investment is generally considered to be about 7% per year. This is the barometer that investors often use based off the historical average return of the S&P 500 after adjusting for inflation.

How much cash should you hold in a portfolio? ›

Three to six months of cash is what you always want to have on hand,” says Fred Rose, head of Credit & Liquidity Solutions at RBC Wealth Management-U.S. “Sometimes you could go up to twelve months if you feel like you have more risk in your life.”

What is a good portfolio amount? ›

Some experts say that somewhere between 20 and 30 stocks is the sweet spot for manageability and diversification for most portfolios of individual stocks. But if you look beyond that, other research has pegged the magic number at 60 stocks.

What is a typical investor percentage? ›

When it comes to angel investors, the general rule is to offer approximately 20-25% of your business earnings. If you're selling the business in its infancy, this is the amount that investors will expect in returns.

How much carry does a PE VP get? ›

$350-$500K

How much does a VP at a VC firm make? ›

While ZipRecruiter is seeing annual salaries as high as $241,500 and as low as $32,500, the majority of Venture Capital Vice President salaries currently range between $80,000 (25th percentile) to $164,000 (75th percentile) with top earners (90th percentile) making $207,500 annually across the United States.

Is private equity lucrative? ›

Private equity is a very lucrative career. As an asset class, private equity has enjoyed tremendous success over the past decade. Investors around the globe continue to pile their money into private equity firms.

How much does a VP in private equity make? ›

Salary Ranges for Vice President, Private Equities

The salaries of Vice President, Private Equities in the US range from $200,000 to $400,000 , with a median salary of $349,000 . The middle 67% of Vice President, Private Equities makes $349,000, with the top 67% making $400,000.

How many hours do you work in private equity? ›

Private Equity Associate Lifestyle and Hours

At many smaller funds and middle-market funds, you can expect to work 60-70 hours per week, mostly on weekdays, with occasional weekend work when deals heat up.

How long do PE firms last? ›

Private equity investments are traditionally long-term investments with typical holding periods ranging between three and five years.

What is the main disadvantage of private equity investment? ›

Debt. By design, private equity shops use significant amounts of debt to perform deals in financial markets. This can be damaging not only to the company being acquired but also to investors and the financial markets more broadly.

Does private equity outperform S&P? ›

From 1990 to 2010, private equity firms outperformed the S&P by 6.3%, net of fees. However, according to the American Investment Council, in the decade preceding September 2020, private equity funds generated a 14.2% median annualized return compared to annualized return of 13.7% for the S&P 500.

Which financial asset Scariest the most risk? ›

Why Equities Are the Riskiest Asset Class. Equities are generally considered the riskiest class of assets. Dividends aside, they offer no guarantees, and investors' money is subject to the successes and failures of private businesses in a fiercely competitive marketplace.

Is 7% a good IRR? ›

For levered deals, commercial real estate investors today are generally targeting IRR values somewhere between about 7% and 20% for those same five to ten year hold periods, with lower risk-deals with a longer projected hold period also on the lower end of the spectrum, and higher-risk deals with a shorter projected ...

Is a 12% IRR good? ›

Typically for a multifamily project, a good IRR for a project could fall anywhere from 12% to 18%. The higher the IRR the higher rate of return you got on your cash based on time, the idea is to now quickly re-invest that capital to continue to earn a solid return.

Is a 20% IRR good? ›

Typically speaking, a higher IRR means a higher return on investment. In the world of commercial real estate, for example, an IRR of 20% would be considered good, but it's important to remember that it's always related to the cost of capital.

What is MoM in private equity? ›

Money Multiples

A private equity fund's multiple of money invested (MoM) is represented by its total value to paid- in ratio (TVPI). 3 The TVPI consists of a fund's residual value to paid-in ratio (RVPI) and its distributed to paid-in ratio (DPI).

What happens at the end of a private equity fund? ›

At the end of the life of a fund, remaining investments are liquidated. Proceeds are distributed. Limited extensions to fund term possible – usually 2 years at the discretion of the GP and then longer if a majority of investors wish it.

Why is PE not a hedge fund? ›

Private Equity Funds

They frequently use leveraged buyouts to acquire financially distressed companies. Unlike hedge funds focused on short-term profits, private equity funds are focused on the long-term potential of the portfolio of companies they hold an interest in or acquire.

Is private equity difficult? ›

Landing a career in private equity is very difficult because there are few jobs on the market in this profession and so it can be very competitive. Coming into private equity with no experience is impossible, so finding an internship or having previous experience in a related field is highly recommended.

What skills does private equity need? ›

There are a number of key skills that the most successful players in the private equity business have in common.
...
Key Skills for Succeeding in Private Equity Jobs
  • Financial modeling.
  • LBO modeling.
  • M&A modeling.
  • General financial analysis.
29 Mar 2021

What is the minimum corpus required for a PE fund? ›

Funds are not pooled, and investors have separate Demat accounts. A minimum corpus of Rs. 20 crore is required.

What is the risk of investing in private equity? ›

Liquidity risk exists since private equity investors are expected to invest their funds with the firm for several years on average. Market risk is prevalent since many of the companies invested in are unproven, which can lead to losses if they fail to live up to the hype.

How much money do you need to invest with Blackstone? ›

Blackstone Offerings

Blackstone Real Estate Investment Trust BREIT, a non-tradable REIT, has a minimum investment of $2,500. And it produced an annualized return of 14.5% for the five years through April 30. The S&P 500 generated a 13.34% annualized return for the five years through June 7, a slightly different period.

How do you make money in private equity? ›

Private equity firms buy companies and overhaul them to earn a profit when the business is sold again. Capital for the acquisitions comes from outside investors in the private equity funds the firms establish and manage, usually supplemented by debt.

What should I invest in to get 5% return? ›

There's no totally safe way to earn 5% consistently.
  1. Checking. A transactional account that allows for numerous withdrawals and unlimited deposits. ...
  2. Savings. A bank account that keeps your money safe and secure, while paying you interest.
  3. MMA. ...
  4. CD. ...
  5. 401K. ...
  6. Brokerage. ...
  7. REIT. ...
  8. Robo Advisor.
12 Sept 2022

How do you find 12% return on investment? ›

Assuming an annual return of 12%, you need to invest around Rs 43,000 every month to create a corpus of Rs 1 crore in 10 years. If you want to make Rs 1 crore in 15 years, you need to invest Rs 19,819 every month. Assuming you have 20 years, you need to invest around Rs 10,000 every month.

Is a ROI of 50% good? ›

ROI of 50% can be considered good, but there are other factors to consider to understand if your investment was a good one. You should also compare your ROI from previous years to get a better understanding.

How much is too much cash? ›

The general rule is 30% of your income, but many financial gurus will argue that 30% is much too high.

How much is too much cash in portfolio? ›

A common-sense strategy may be to allocate no less than 5% of your portfolio to cash, and many prudent professionals may prefer to keep between 10% and 20% on hand at a minimum. Evidence indicates that the maximum risk/return trade-off occurs somewhere around this level of cash allocation.

What is average net worth by age? ›

Between 35 to 44, the average net worth is $436,200, while between 45 to 54 that number increases to $833,200. Average net worth cracks the $1 million mark between 55 to 64, reaching $1,175,900. Average net worth again rises for those ages 65 to 74, to $1,217,700, before falling to $977,600 for someone over age 75.

How many shares should I buy as a beginner? ›

Most experts tell beginners that if you're going to invest in individual stocks, you should ultimately try to have at least 10 to 15 different stocks in your portfolio to properly diversify your holdings.

Where should a beginner invest? ›

Share Market Investment for Beginners
  • Demat Account. A Demat account serves as an electronic house for your shares. ...
  • Trading Account. A Demat account and trading account go hand in hand. ...
  • Linked Bank Account. ...
  • Investing In The Primary Share Market. ...
  • Investing In The Secondary Share Market.

How much should you have saved for retirement at 40? ›

By age 40, you should have three times your annual salary already saved. By age 50, you should have six times your salary in an account. By age 60, you should have eight times your salary working for you.

What is the 2% rule? ›

What Is the 2% Rule? The 2% rule is an investing strategy where an investor risks no more than 2% of their available capital on any single trade. To implement the 2% rule, the investor first must calculate what 2% of their available trading capital is: this is referred to as the capital at risk (CaR).

What is considered a wealthy investor? ›

Types of High-Net-Worth Individuals

An investor with less than $1 million but more than $100,000 is considered to be a sub-HNWI. The upper end of HNWI is around $5 million, at which point the client is then referred to as a very-HNWI. More than $30 million in wealth classifies a person as an ultra-HNWI.

What is the 1% rule for investors? ›

The 1% rule of real estate investing measures the price of the investment property against the gross income it will generate. For a potential investment to pass the 1% rule, its monthly rent must be equal to or no less than 1% of the purchase price.

How long does it take to raise a PE fund? ›

Typically takes about 3-6 months. Initial investor commitments are made and the fund launches. Initial “calls” are often not full the full amount committed. Also called “first closing.”

How hard is it to move up in private equity? ›

Landing a career in private equity is very difficult because there are few jobs on the market in this profession and so it can be very competitive. Coming into private equity with no experience is impossible, so finding an internship or having previous experience in a related field is highly recommended.

How do PE firms raise money? ›

Private equity firms raise funds by getting capital commitments from external financial institutions (LPs). They also put up some of the their own capital to contribute into the fund (commonly 1-5% but it can be higher).

How hard is it to raise money for a hedge fund? ›

It's extremely difficult to raise enough capital to scale and become institutional quality. Management and performance fees are falling. You are not just investing, but also running a business – and you may not even get that much time to invest. Most non-quant strategies have been out of favor.

How long is the life of a private equity fund? ›

According to Blackstone's Private Wealth Solutions group, the life cycle of PE funds is typically 7 to 10 years, and is generally broken down into three stages: the fundraising period, the investment period, and the harvest period. Fundraising Period: The first few years is spent raising capital to create the fund.

How can I raise funds fast? ›

If you borrow money from friends or family, it's best to draw up a contract about the terms of the loan.
  1. 1) Liquidate Your Assets.
  2. 2) Take on Odd Jobs.
  3. 3) Track Down Your Loose Change.
  4. 4) Organize a Garage Sale.
  5. 5) Get Money From Your Retirement Accounts.
  6. 6) Part With Your Plasma.
  7. 7) Borrow Money From Friends or Family.

How long do PE firms last? ›

Private equity investments are traditionally long-term investments with typical holding periods ranging between three and five years.

How much does a VP in private equity make? ›

Salary Ranges for Vice President, Private Equities

The salaries of Vice President, Private Equities in the US range from $200,000 to $400,000 , with a median salary of $349,000 . The middle 67% of Vice President, Private Equities makes $349,000, with the top 67% making $400,000.

Is PE better than consulting? ›

PRIVATE EQUITY WINS. Compensation. The package is often designed to attract investment bankers, who are better paid than strategy consultants. As a consequence, you should expect a significant increase of your total compensation package, up to 100% in some cases.

Are hours better in private equity? ›

In private equity, you'll work hard, but the hours are not nearly as bad. Generally, the lifestyle is comparable to banking when there is an active deal, but otherwise much more relaxed. You usually get into the office around 9am and may leave between 7pm-9pm depending on what you're working on.

What is a PE strategy? ›

Private-equity strategies can include wholesale purchase of a privately held company or set of assets, mezzanine financing for startup projects, growth capital investments in existing businesses or leveraged buyout of a publicly held asset converting it to private control.

How much do partners at PE firms make? ›

Managing partners pulled in $1.59 million, on average, at small private equity firms, while partners and managing directors averaged $985,000 in salary and bonuses. For firms with $2 billion to $3.99 billion in assets, top bosses made $2.25 million, and partners and managing directors averaged about $1 million.

Can you make millions at a hedge fund? ›

It will earn $20 million in fees. If the firm makes 20% and has no high water mark before the 20% kicks in, the hedge fund will earn $200 million X 20% = $40 million. If the hedge fund has a 8% high water market, then the hedge fund can only earn 20% on $120 million, or $24 million in shared profits.

Can you make millions working at a hedge fund? ›

If you're at the right fund and you perform well, you can earn into the mid-six-figures, up to $1 million+, even as a junior-level employee such as a Hedge Fund Analyst. And the top individual Portfolio Managers can earn hundreds of millions or billions each year.

How rich do you have to be to have a hedge fund? ›

1 2 Hedge fund general partners and managers often create high minimum investment requirements. It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate.

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