- More people leaving large firms to spin out
- Track record, visibility among LPs 2 keys to success
- Startup costs for fund formation “not insignificant”
1. Are PE executives more willing to spin out?
When capital is plentiful, the willingness of people to create their own funds or spin out is greater than it is in down markets. In 2011, 2012 and 2013, there weren’t a lot of people trying to spin out, capital-raising was hard and name-brand people hunkered down. Anecdotally, we’re seeing more people leaving or proposing to leave large firms and raise their own funds.
Those are the ones that get funded. There remains that universe of junior-level professionals in organizations that bounce out and try to raise capital, they’re less successful, they don’t have the patina around them as some of the more senior professionals might, and as a result, their overall ability to raise capital is more challenging.
2. What are some keys to fundraising success for spinouts and first-time managers?
You don’t need to be a big-name executive but you do need [a] few things: certainly an attributable track record … is an advantage. Have something you can point to, ‘this is what I’ve done.’ You should also have some sort of visibility within the LP community. If you are really a junior partner sitting in a firm, without an awful lot of interaction with LPs and no track record, it’s going to be hard to get people to bank on you.
People invest in businesses, [not] in ideas. That’s the way we look at spinout funds and first-time funds: We see a lot of good ideas, but show how that looks like as a business, with a structure in place and a track record, with LPs who recognize you as having achieved things.
3. What are some challenges those considering spinning out should remember?
It’s important to remember it will take a significant amount of time to raise capital. The industry average is anywhere from 12 to 18 months and the failure rate of first-time funds or spinouts is bracketed around 45 to 55 percent. Also, investors invest in businesses, not ideas, so build out an infrastructure. Gone are the days when you could have three people with business cards with three different home offices coming together to build a fund.
Understand the time and the economic sacrifice you have to make. Sometimes the economic sacrifice is more of a detriment versus the time sacrifice. The startup cost as it relates to fund formation is not insignificant.
4. What are some things spinout GPs need to know about bringing on an anchor investor?
You have to be cautious that whatever economics you give up to the anchor for putting you in business. you don’t create an impediment for future institutional investors to join the party. You want to ensure that your economic relationship [and] the management of your firm are properly aligned to the benefit of all LPs.
What you’re trying to ensure is the economic benefit that accrues to your anchors remains appropriate over time for the size of their commitment, both on an absolute basis and [relative] to the overall fund size. As you [grow,] the anchor’s economic participation will decrease appropriate to their overall commitment to your fund.
5. What’s your outlook on the emerging-manager market?
The emerging-manager space and/or sub-Fund-III manager space is important and core to our business. We were intrigued a short while back by the amount of managers spinning out and capital flows to the space. We believe now that some of that toppiness has moved on and that we’re more in a regular way or steady-state environment for spinouts and how they get funded.
Photo of Kevin Naughton courtesy of Credit Suisse