Starting your own shop: LP / debt fund vs GP (dev co, value add)
Would like to hear people's general thoughts on this. Let's consider value add or development, for example.
If Im looking to start my own shop, my opinion is that I'd rather be the LP equity in the deal, rather than being the GP or sponsor.As the LP equity, I'd build connections with HNW individuals / family offices / etc and raise money from them. Id structure a waterfall with these HNW individuals in which I would be the GP to them and they would basically by the LP equity for my shop. I'd connect with merchant build / value add shops that execute deals on a syndication basis and essentially be the LP equity slug (just as Carlyle seems to do). In this instance, I have to raise the capital and have the relationships with GP's to source opportunities.
on the other hand, if I was the sponsor, I'd have to source the deal, put up my balance sheet for the loan (balance sheet I don't have), secure debt, raise LP capital, and manage the day to day execution, all while being exposed to the risk in terms of my promote blowing out and being exposed to the loan being callable.
to me, if I was to start my own shop, being an LP seems to be much more feasible. Yes, you have to raise more aggregate dollars, but you have to source debt and equity as a GP too. As an LP, I'm more confident in the returns I can generate (as Im somewhat protected by the pref) and thus have a lower risk of losing credibility with my investor base. As an LP, I can place capital with top tier sponsors. I work at a top tier sponsor right now and when times get hard (as they are now), we take LP equity from smaller groups / LP's and we are a price taker of their terms.
Yes, the Gp collects their development fee. But they are exposed on the back end in terms of promote.To me, it's not about generating a 15 versus a 20. It's about delivering consistent returns and protecting yourself against risk and maintaining credibility.As an LP, I can also collect a management fee. Basically, the only difficulty I see is that, as an LP, I have to raise more money. But at least I don't have to put up my balance sheet and worry about that when it comes to securing debt, while also being removed from the headaches of day to day management.
If we take development for example, I wouldn't have the personal balance sheet to fund pre development spend, especially on a long entitlement deal. But LPs often look to come in when a deal is closer to shovel ready. Again seems to be another benefit.
Broadly speaking, would also apply the LP logic to starting a debt fund.
I can’t read the entire post without formatting. But yeah, it would be nice to be the founder of an LP equity fund. Good luck raising $500 million for a discretionary fund. Way way harder than raising $30mm to do a deal that has already been identified / fleshed out
Typed it out on my phone at the gym lol. That's a fair point. But wouldn't you say the difficulty of being a GP (sourcing the deal, managing the execution of it, needing the balance sheet to secure a loan or finding a sugar daddy to sign) is possibly more than having the sole responsibility of raising more money. And maybe you don't need to start off with a discretionary fund. Could connect with a HNW individual, family office and start off on a deal by deal basis.
Both are really hard work so I guess it comes down to which “hard” is more interesting to you and keeps you motivated. Often it comes down to what you’re already good at, like to do, your risk tolerance and frankly your existing relationships. Also, your ability to build a support team because you can’t go it alone. Whether you choose to be a GP or LP, you have to have a deep understanding and appreciation for what your investment partner in a deal does in order to be effective at what you do.
For me, I really like the acquisition, renovation and management elements of value-add MF deals and I think I’m pretty good at it, so becoming a GP was a natural progression in my career. I also like being close to the real estate, being responsible for executing the business plan and the day-to-day problem solving. My partner is an exceptional underwriter and capital markets pro so we make a strong team. We have talked about leveraging some of our capital relationships to focus more on LP investing but we like being close to the real estate and feel comfortable with the risk/return structures we have in our deals. So, short answer is it really comes down to what you think you’ll have more fun doing.
Thanks for the answer here. Do you think I’m wrong in assuming that LP track is easier than GP track just because there appears to be less hurdles? Referenced those hurdles / challenges that need to be overcome in my post above. I’m not saying that either track is EASY, but what I’m saying is, I think LP track is easier / more feasible on face value.
I think you need to change your thinking from a strategy execution being easy/hard to instead being feasible/not feasible based on your skill set, network and interest level. The best LPs I know work their asses off and have a much broader understanding of multiple markets and asset classes than I do so I don't see anything they do as "easy". Here are a few things off the top of my head that you need to solve for to be a good LP investor:
This list is just off the top of my head and not exhaustive so I know there is a lot I missed. Whether you want to be a GP or LP, both are a lot of work and require being good at multiple things.
Raising nine-to-ten figure discretionary LP funds requires an incredibly amount of reputational capital to acquire over a 15-30 year period doing exactly that. So, in a sense, doing that is harder than finding a deal. Good luck starting an LP fund as a young professional.
It would be really nice to be able to raise $100mm to make JV investments with vs looking at these deals, but I’m not capable of that and you prob aren’t either
Well, not right now of course. But am making baby steps toward that. And am using this framework to partially shape my decision making as to which route to pursue. One step at a time. Thinking 10-15 years down the Line
Yes, the process of writing a sponsor a check is easier than that sponsor executing an opportunistic real estate opportunity.
Yes, writing a cheque is easier than executing, but what skillset are you developing in your current role? What connections?
The reason most entrepreneurs become GPs is because it's a lot easier to start out sourcing $5-$20M deals and learning as you go then going out and raising a $100M+ fund with no real experience (there's a reason 99% of REPE funds are started by guys who are already senior management at successful funds or who have extremely strong family connections).
I mean, if we're just fabricating our dream scenario, why even bother with a fund? Why not skip right to the part where the rich uncle you never knew leaves you $5b after returning from the jungle?
Trying to source equity as an LP is way harder than doing it as a GP. Because a GP or a sponsor has a deal, has a pitch, has something that can be independently evaluated on a one off basis. An LP doesn't have that; you are convincing people with lots of money that you'll do a better job allocating it than literally every other person on the planet. Or at least every other person in your asset class.
And it's somewhat fallacious to say that GPs are exposed on the back end and LPs aren't. GPs still get asset management fees, development fees, acquisition fees, etc. Just the same as an LP. But they get the leverage of the LP's equity. There is more money to be made in being a sponsor than in being a capital allocator, and more money to be made earlier. Sure, if you've got 10b of AUM then you're on easy street because your fees are enormous. But only a tiny, tiny, tiny percentage of people who start LP funds end up with that kind of AUM. Whereas it's not at all crazy for sponsors to make tens of millions of dollars a year, because their returns are much higher
Ok, then what about starting a debt fund? Is that equally impossible? And no, not taking about starting with 2 years experience. I am talking 15 plus years down the line.
I personally don’t enjoy the day to day management and if I were to pursue entrepreneurship, would prefer to be on the LP equity or debt side. I find it hard to justify your rash generalization that being a GP Sponsor is pretty much the only path to starting your own shop and anything else requires a rich uncle and is a complete fairytale.
I'm not saying either of them are impossible. But your original post (I assume it was you due to the similarities in the anon account title) jumps right into this assumption that building connections with high net worth individuals/offices is easily doable. If that was something that your average person could achieve, your average person would be doing that! Saying "in this instance, I have to raise the capital and have the relationship with the GPs" is yada yada yada-ing over some extremely difficult tasks.
Well, I hate to break it to you, but "day to day management" is part of being an entrepreneur. You are going to have to wear that hat, no matter where you are. And what's your pitch to all these hypothetical rich friends and family? Hey guys, I'm not big on managing things and probably won't be paying attention on a day to day basis, but you should still definitely give me lots of money"?
The point is that pursuing entrepreneurship on the LP side is far more difficult, because you're running up against a whole host of people and firms that have more of a track record, more support staff, more money at the moment, more everything than you. Why in the word is anyone giving you, the random 40ish year old person, tens of millions of dollars (way more for an LP fund, frankly) when there are plenty of best in class existing LP funds who would gladly take that money and deploy it well? Why not give it straight to a GP and cut out the middleman? You've handwaved away all the actually difficult parts of having an LP fund, which is raising the money and finding trustworthy sponsors with good deal flow. Your "dream" of entrepreneurship is simply a description of what an LP fund does, and ignores the entire "entrepreneur" part. You've basically said "I want someone to hand me a company which doesn't need much oversight and which doesn't require any work from me but which will also spit out tens of millions a year." Which is why I replied with some equally ridiculous fantasy.
I could also say that I want to find a little old lady who owns several square blocks in midtown Manhattan, charm her and win her love and affection and have her leave me all these juicy development parcels at basically zero basis which I can then build on as a developer. If you want to discuss fantasy, and what we'd do if we won a billion dollar Powerball, I'm all for that, those are fun daydreams... but if you want to discuss entrepreneurship then skipping the part where you work your ass off, wear multiple hats, take a shitload of risk and try to compete with firms that have decades of experience and orders of magnitude more resources kinds of defeats the purpose of the conversation in the first place
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Having been in both, I’d say credit is closer to being an LP in a dev / value add deal than being the actual GP executing the business plan (permitting, managing construction, lease up, etc). Sure credit is intensive, but nowhere nearly as much as a sponsor carrying out an entire ground up or value add execution.
This may be the least logical thing I’ve ever read. Please expand. How would a lender possibly be a more rigorous investment role than an LP, let alone a GP executing a business plan?
... I don't think that is what he said at all. What he said was that lenders and LP investors are closer to occupying the same space than either is to a GP. On it's face, you'd expect the two parties on the equity side to be more aligned, but I agree with the other guy that LPs and lenders are more closely aligned, both in what they do and in what they care about. They are both essentially valuing the creditworthiness of a sponsor and the risk adjusted returns on a deal. Once they provide their money, whether it be in the form of LP equity or debt, they're out of the conversation
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