Sketchy First-Time Funds - Red Flags?

What are some red flags to look out for when evaluating whether to join a ~$100M fund? 

Emerging market focused fund looking at $3M EBITDA firms. It's in a geography I like and I respect the fund's seed investor. The two managing partners have solid backgrounds working in MF PE but this is their first fund striking out on their own. 

The firm is still very sweaty as they've only raised 5% of the fund's target so no one is drawing a salary yet. It's just the two partners right now and then potentially myself + a few interns.

I've been offered to come on part-time (currently enrolled in a FT MSc. in Finance program so the time commitment works well for me) but this position is unpaid. Presumably I'll be working on things like drafting PPMs, LP lists, presentation materials, building out internal systems ... and if things go well with their fundraise... then actually analyzing opportunities. I'm actually the only one on the team who is actually from this region so I will get facetime with potential LPs and potential investees (good optics for the Partners).

If they hit their first-close target then they will be in a position to offer me a FT role (no guarantees obviously)

I'm a big believer in learn before you earn but my gut is telling me the value transfer here is a bit one-sided. What love thoughts from others. Am I just being an entitled millenial? As far as title's go, they're open to having my position, on paper, be "Associate". So at least I can have that on my CV if this experiences amounts to nothing.    

I care very little about 'prestige' ... my long term goal is invest in this particular emerging market region .. so I'm interested not only in building PE experience, but doing it with a fund that has this region as a mandate (which is very rare). 

Apologies for the long thread - hoping to hear feedback from more experienced folks. Thank you.

 

It's a high risk for sure but since you're in school, it sounds like it mighttttt be worth just doing it and seeing how it goes.

FWIW, I joined a first time fund and am drawing a salary. We are working towards a first close on a fund but I guess we have some fees coming in since we did a handful of independent sponsor deals.

 

What are your thoughts on the independent sponsor model in general? Have you encountered scenarios where the independent sponsor only acts as a broker (of sorts) connecting the opportunity to capital (and taking some type of success-based fee / % of the transaction and rolling it into equity) or  are the independent sponsors typically playing a more active role in the investment post-transaction?

 

From what I've experienced, no. The independent sponsor is very much like a normal PE GP but without the committed capital fund which makes the actual financing of deals a key hurdle in closing any investment. It's not like a broker because we still manage the investment/company on behalf of the LPs who've funded the deal.

But in general, the independent sponsor model is hard to pull off long-term. We only do it because we are trying to raise a first fund and you gotta show LPs that we can 1) find attractive deals, and 2) execute them. There's a lot of other perceived and actual negatives. Sometimes you get perceived as an inferior PE investor (despite most of us coming from respectable names) and most of the concerns from the seller perspective is the certainty of close, which makes sense. You can run a deal down to the finish line and then have the financing fall out for a variety of reasons.

Other than that, a lot of my other grips stem from not having a sizeable amount of management fees which means I don't have a budget to invest in stuff like software, very picky on which cities to visit, no meal stipends/expense polcies, and other general perks that I had at my previous firm. Some of these are obviously trivial but I do think the lack of having a technology budget, for example, makes my day-to-day more tedious but not impossible.

 
Most Helpful

I've been at an early fund and worked closely with a pre-raise fund, just like the one you're describing. A couple of things I'd look out for:

  • You mentioned it already, but partner track record is huge. Also, just because they have MF backgrounds, doesn't mean they'll be the best for LMM/MM opportunities. Getting a deal done is theoretically the same, but it's a different style of investing. Things are much less polished and I would make sure the Partners understand that. I've seen MF guys struggle when they realize that instead of $5M in deal fees they have to allocate they have $50k, haha. That means being much scrappier, limited 3rd parties, etc. The way I'd do this is ask questions around why they are going out on their own, why this strategy, why this Geo (it doesn't sound like they have many ties), what their growth plans for the fund are, etc. 
  • Carve out what their expectations will be of us both in responsibilities and in time commitment. Again, going back to the MF partner thing, often times these guys can be asses, they can the cheap/free labor and haven't rolled up their sleeves in a while, so they want to just fundraise and take calls and then push everything else down. Again, not terrible, especially if you're learning a lot, but make sure you don't sacrifice school/social without getting something out of it. Think about the experience you want and make sure you get that.
  • Fundraising will take longer than they think, whatever the target is, I'll add 3/6 months. That's always the way it goes, especially with 1st time funds.
  • Do they have a lock on a cornerstone LP or a cornerstone 1st deal? Having one or both of those is huge. Honestly, I don't think I'd go and fundraise $100M without knowing at least where you can rely on 10-20 of it to come in. Same with the deal, it's really nice to be able to hit a 1st close and then already have a deal lined up. Or better yet, take something the partner has done perhaps personally, and roll that in as a 1st fund type of investment. If they have neither, aren't from the region, are pivoting to a different stage of PE investing, and don't have strong enough connections to pull at least a decent portion of the capital pretty quickly, I'd be more concerned.

With all the being said, you're in school and have little to no experience, so hanging around them for 15-20 hours a week, or whatever you can commit, should be valuable either way.  Do it for 3/6 months and see how it plays out.

 

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