How does the process play out practically?
For background, currently sort of an independent sponsor hyper focused on one space. We have a handful of control + non-control positions.
Our goal is to raise ~$100mm - $125mm as our first fund because that is a number that I now feel great about deploying well. I don't want to be stupid and risk subpar results on our first fund.
Flexibility is very important to us, as a big source of alpha has been the ability invest in whatever we want in the particular space we focus on - and however we'd like.
The liquidity profile on our deals is actually very similar, but the vehicles/structure are not. IE some investments appear to be venture, others like control positions in distressed companies obtained via straightforward methods like buying equity or control via debt.
I understand that the above might mean difficulty marketing to pension funds and other institutions. Luckily, given our fund 1 target is pretty small, I don't feel it matters too much because it seems feasible to raise 100% of the fund from family offices.
Now, regarding warehousing and GP commit...
There's one company in our portfolio that I do not want to sell because dynamics are great, and should be at ~$3M in EBITDA soon, probably $5m in the next year. It's the company I want to roll into the fund/use as a GP commit. Partner and I own the whole cap table, so not overly complicated. How does valuation for a GP commit in the form of a company look? Do we just throw out a rough valuation range with logic behind it and hope our LPs are ok with it?
Side note. We would sell off our other active positions prior to raising the fund.
It looks like your average GP commit is only ~3% - 5% according to Preqin data + my conversations with a few emerging PE GPs. This means our commit would be substantially more than a typical GP puts in, which from my understanding means we should be able to secure better terms?
Around raising funds. Have strong verbal commitments from family offices I've coinvested with before or who have allocated into some of our deals + our commit works out to be quite chunky even at only $3m in EBITDA. Does anyone with experience raising funds for EMs know at what point it becomes very easy to fill the rest of the fund? 20%? 40%? 75?
Thanks!
I guess first question, why do you want to go this route of using the company as your GP commitment? I've frankly never heard of this, and it might make your fundraise more challenging than it needs to be.
Perhaps get a 3rd party valuation from a firm that focuses on that, then bring it to your largest prospective LP to sign off on it. I'd be quite wary of a valuation set by a GP that determines their commit % to the fund. If I brought that to my IC, there'd be a ton of questions.
Another point, why not move all of your existing investments into a new fund, have a Secondary group serve as your lead LP to determine the price, and add the unfunded to it to get to your dry power goal?
"This means our commit would be substantially more than a typical GP puts in, which from my understanding means we should be able to secure better terms?" I wouldn't think so, to be honest.
The reason I want to keep this particular portfolio company is because it's one of the best companies I've ever been involved with or looked at before. It's pretty much guaranteed to deliver very high IRR/MOIC for whoever holds it. The way I see it, it's how I guarantee fund 1 outperforms.
Does anyone take 3p valuations seriously? Kind of like the secondary idea, but I'm already into the process of selling off some of our other positions. One of our other platforms might make a great standalone company too kind of like the first.
Why don't you think a co with ~$4m EBITDA would be worth more than a normal GP commit? Wouldn't it make fundraising quite a bit easier? Conservatively, a company that went from $0 -> $4m in EBITDA over 4 years - let's call it $4m and an 7x multiple - is $28m which is a lot more than a $5m GP commit? Especially since it's technically all up front instead of being tied to cap calls?
Don't you think it says a lot about the GPs and conviction in performance than your typical guys trying to get away with 1% - 2% in venture or 5% in PE? :)
"Does anyone take 3p valuations seriously?" This would be more for giving prospective LPs comfort.
"Why don't you think a co with ~$4m EBITDA would be worth more than a normal GP commit?" Because you don't really have skin in the game, you're playing with house money. LPs want to see you put in $$s along with them. I'm not saying that I necessarily agree with that sentiment here, but I suspect that is how they will respond.
I'd you're interested in the above idea, I am a principal at a secondary fund with strong dry powder and could do a deal like this...
Hey now, it was my idea... I get first dibs
Your username is close to mine, no soup for you
What you are proposing is quite complicated / unusual.
First time funds that have done some deal by deal (assuming the deals are going well) have proven that they can source deals, raise capital and work together as a team. You can use the marked up or realized track record to raise a blind pool fund. The size and scope of the fund does mean pension fund capital is out of the question (as you have said).
The cleanest thing to do would be to exit some of your positions that have had a good run and use the proceeds of that to fund an above average GP commit in cash. You can roll in those deals that have done well, ideally at cost + late penalty interest. This should provided a seeded portfolio which has an immediate mark up. You might be able to use this to ensure you get really good terms on the fund you raise.
franco CompBanker
One thing I don't get is how this is a "conflict" if continuation funds exist? I don't really see what's different? It's basically us seeding a fund with our best asset?
I know the attachment to this co is weird, but it scaled cleanly through COVID despite being in a space that should have faced severe headwinds. Growth is accelerating coming out of COVID which is exciting. I never want to sell this portfolio company unless it creates massive upside, which was my thought around using it for GP commit given I see it as a virtually guaranteed outperformer.
If LPs are unable to understand that, then I'll keep it and maybe just do the GP commit in cash...
I hate the idea of selling something that is compounding very well with deep moats. Have looked at too many companies to know how rare it is. This is actually the longest I've been actively involved in a company, and still feel like there's plenty of room to scale.
Unless I misunderstood, what you're essentially doing is selling a majority share of company you already own to your investor base as the first deal in a brand new fund / PE firm you're starting. Many LPs are naturally skeptical of self-dealing in the form of fund-to-fund deals so this will raise a red flag immediately, even though it appears to be 100% legitimate.
Listening to the way you describe the company is a bit worrisome. Saying that it is a 'virtually guaranteed outperformer' in particular. I appreciate that you have tremendous confidence in this company, but you're really betting your whole future on it. If you raise a fund in this manner and this particular company doesn't deliver, I cannot imagine anyone will ever give you money in the future. I'm all for betting on oneself, but just recognize that you're making a really huge bet here. If I were in your position and wanted to maximize my likelihood of success, I would hold onto the company and make a more modest GP commitment to your fund. Let's run the numbers:
You raise a $100M fund with a 2% GP commitment of $2.0 million. That capital is going to be called as you make investments, so let's just assume 20% per year for 5 years or $400k / year. Using the other investments that you mentioned, combined with cash dividends from this potentially $3M+ EBITDA business and your salary draw from the 2% management fee, you ought to be able to easily meet your capital obligations. This will enable you to hold onto the company and sell it a few years from now when the timing is better.
I may very well be missing something, but that is the approach I would take.
Yeah, if it creates too much complexity, then the cash route is quite easy.
RE: excitement around the co. I've been in the overarching industry for a while and have operated ~20 companies + looked a ton in the same space. This is in the top 1% when looking at underlying dynamics. The best part is that the product it sells lends itself to outperforming in a recession. It all sounds made up! Have sold a lot of positions in the past, and don't get attached to anything arbitrarily. :)
A continuation fund cashes out other LPs, you're only cashing out yourself, thats the big difference
Well, assuming LPs change in a continuation deal, there's a conflict there too? What am I missing?
A continuation fund crystallizes carry for the GP on that asset.
To be clear, continuation funds where the GP sells an asset to themselves is a conflict of interest as well. So you are right, there is no difference.
Some continuation funds, have a sale process with a new GP diligence and price an asset, which the existing GP rolls a portion into. This type is preferred by LPs.
Mind expanding on this, "sale process with a new GP diligence and price an asset"?
You can get more favorable terms (as an emerging manager, avoiding the compression below 2-and-20 that's common; as an established manager, going above 2-and-20) for having a large GP commit. However, that GP commit is expected to be in cash.
Doing an in-kind contribution is way more common in venture, which is why I think (a) you're getting the feedback you're getting from some of the other great posters here with a career in buyouts / (b) why you with your venture adjacent experience may have had this idea.
I've seen VC partners write six-figure personal checks (maybe before they were a partner at a fund, or for something that looked like it was outside their firm's strategy), then when trying to bring those companies into their firm's fund, have to sell the personal position to the fund at cost in order to remove the conflict.
Contributing at cost is obviously incredibly unappetizing for you. If you own an entire company outright and it's experienced such amazing growth, you're depriving yourself of 100% of its growth profile to gain back 20% of that via a performance fee.
You'll laugh, but yes, it's because everyone has a committee and that for better or worse is seen as a mechanism to alleviate the concern around a GP self-dealing.
This is a great suggestion. NewView (Ravi spinning out of NEA) did this to the tune of a $1.35b first fund (2018), of which only $400 was fresh capital (versus existing positions at a new price).
Yes, however, the real concern is whether you want institutional capital for future funds. New investors considering Fund II will ask all the same questions about this scenario, should you choose to pursue it because family office investors will tolerate it today.
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I think you have a strong story without trying to shoehorn the asset into a blind pool vehicle. You know a space really well (evidenced by your track record). You're able to do a traditional GP commit (evidenced by cash produced by deals within your track record). You have a stellar asset you're really proud of that you'll continue to manage separately, and you're doing it that way because of all the obvious issues around self-dealing were you to try to roll it into the vehicle. In the future, you're excited to be able to contribute to your own funds significantly more meaningfully with further liquidity from continuing to operate or exiting that asset.
This gives you the best of both worlds. "Fund my vehicle so that I can do more deals like this homer that I can't include in Fund I" ... plus you get 100% of the upside of that asset.
You're way better off trying to position your track record to include that asset as a predecessor SPV than trying to shoehorn it into your first discretionary vehicle.
Congrats on your success so far, it's been fun watching your story on here over the years.
Always helpful, thank you!
"You'll laugh, but yes, it's because everyone has a committee and that for better or worse is seen as a mechanism to alleviate the concern around a GP self-dealing."
Who are these opinions typically obtained from? Investment banks?
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Given your feedback and the others in the thread, I might just stick to the IS route, recap some of our assets to do deals ourselves + bring in outside equity as needed.
Being an IS does make doing larger deals harder though; a lot of investment banks/companies do not take our bids as seriously because of it. Suspect this will only get worse as we go up market...
The other downside is that we can't scale as fast as we want to without a committed fund and some of the bullshit we have run into is nuts. Partner and I had to double our equity cheque into an asset because one of our LPs backed out last minute, can't build out quite the operating team I want, etc...
Also feel like I might be making a big mistake if we go the continued IS route because capital is so readily available ATM.
Last option, is maybe just doing a smaller fund and aiming to get Fund II up faster...
Other concerns = macro environment is great atm for raising capital + I don't have kids yet so my living costs are hilariously low. No salary for 5+ years is 100% sustainable.
You're not wrong, but think more 'fairness opinion' and less 'banking', so all the valuation or transaction advisory shops. Duff & Phelps, A&M, Grant Thornton, Baker Tilly, and the like.
I do agree completely with all your logic about choosing the funded sponsor route today. From everything you've shared, I don't see why you don't simply round up $4m between the two of you (that you'll fund in tandem with capital calls over the entire investment period of your fund, so (a) they're spread out and (b) they don't start for 6-12 months or however long it takes you to fundraise) as a traditional GP commit and go raise your $125m.
You have the track record. You don't need the headache of contributing this particular asset. You have actionable deals in pipeline I'm sure you can point to.
I see no pressing reason you need to pursue a smaller fund. I see nothing attractive about continuing to swallow the pain of the independent sponsor path. I see no logic behind continuing to cripple yourself with inadequate operational resources and bandwidth.
You've got the ingredients. What's holding you back?
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