Startup PE Fund / Private Placement Structure

I'm about to setup a fund that will buy stakes (both control and non-control) in a niche market my to-be partner has a great network, deal flow, and operational expertise in. I come in with the financial & business background (founded and managed a couple of single-digit $mm hedge funds, prop trading, and various business ventures, modeling, negotiating deals, etc.). We both have access to some capital and are looking at around $5mm of capital coming in from our soft-circle on launch for the initial fund, in addition to whatever we can raise outside of that.Tiny, I know.

Ultimately I'm looking to scale this, and we have real and actual competitive advantages, niche know-how, and contacts to fill in part of the equation. I'm currently interviewing lawyers, fund administrators, and auditors, to setup the fund and a scalable infrastructure that will be attractive to larger investors.

Feel free to chime in on any aspect. It'd be *much appreciated* and not expected, at all. I've gone through the hedge fund startup and mgmt process twice, but if you've done this stuff, you understand that hedge and p.e. are two different animals. They were basically long/short equity and equity-derivatives trading funds.

On structuring a private equity fund, I'm less knowledgeable. I'll lay out a bunch of points, and I'd love to hear any input or suggestions.

1) Fee Structuring
a) Our current investors want in on our deals so much that we have a lot of flexibility in structuring and fee arrangements.
b) Because of this my partners want to not only take the mgmt fee/carried interest, but also want to have a small piece of acquired stake equity diverted directly to the mgmt company (Which would obviously have to be part of a claw-back clause).
c) If we took a piece of deal equity, I'd probably insist on reduced or eliminated carried interest.
d) Example: my partners want to do something like this - $1mm for 50% of a company translates to, for instance, the fund buying $1mm for 45%, with the other 5% equity piece as some sort of deal fee to our mgmt company.
e) This would likely only fly on fund #1 since it's our small circle who will be in either way, and are ok with this in exchange for access.
f) In the real world of outside investors, and at some point institutions, I imagine you can't be doing both the 2/20 AND take a piece of deal equity. Nor am I confident that even just the latter would fly. Any input on this? We could go aggressive on fees on fund #1 - assuming we're comfortable that we'll still hit net IRR targets, then return to conventional standards for fund #2+.
g) Any ideas how I could incorporate my partners' desire to pull a piece of the equity in deals, in a non-conflict-of-interest way? Besides for just doing it and being very clear in disclosures. I'd like for investors and our interests to be aligned, but at the same time, we do have unique access to these small deals (0-5mm) in our niche and so on the other hand ought to be able to command an aggressive fee structure.

2) Timing / Capital Calls / Commitments / Staged Closings
a) We will probably be operational in 8 weeks.
b) We'll have a few $mm of deals ready to close at that time.
c) We'll have a few $mm of investor contributions ready to deploy at that time.
d) One one hand I need to do a closing and deploy that capital so we don't lose those deals.
e) On the other hand it'd be nice if we could have a 3-6 month total fundraising/closing process - with the ability to deploy from initial closings during that time. Is this common/uncommon/never done/how might this be achieved. I've been under the impression that you first have the commitment period, and then separately the investment period. Can they overlap? If so, how does this work?

3)
a) The attorneys / consultants I speak to all seem to gear their advice toward whatever they're used to and to wtvr suits their own business interest. Fund formation attorney says do a fund (and then some say no way to taking equity too, for obvious reasons, others say ok with clear disclosure). Then there are PPM/RegD "consultants" who say "hey, why waste money setting up a "p.e. fund" with an attorney, just go and do a 506b RegD private placement, and we'll get it done much cheaper. Can this method be used for a private equity fund since it's also a form of RegD, or is there something different about the way these sort of guys do Private Placements?

b)These consultants also make reference to sending our private placement (non)/conduit broker/dealer routes and maybe we'll pick up some investors there as well. Any thoughts on this - I know nothing in that department. A random example of this route would be to use any number of ppm/reg d consultants similar to regdresources . com (not affiliated, never used, can't vouch in any way). This route would definitely be cheaper than an attorney, and perhaps it is not the standard route, but perhaps it gets the job done for fund #1, on a budget, and to that b/d private placement route for some extra possible fundraising? I have 0 issue spending for attorneys if deemed the best route (which is the route I'm headed on). FYI, quotes I've gotten on the p.e. formation from attorneys: 18k, 25k, 25-35k, 50k, 75-250k. Private placement "consultants" like the one above: 5k-15k. This will be for accredited investors only.

Feel free to respond, "dude, go pay someone to answer these questions". If you share any input on any points, or on issues I ought to be thinking about, I'd be much obliged!

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Comments (4)

Feb 11, 2015 - 6:50pm

Coming from a large institutional LP, these are my views. Happy to go into detail or answer more sensitive questions via PM.

1) Fee Structuring
a) Our current investors want in on our deals so much that we have a lot of flexibility in structuring and fee arrangements.
b) Because of this my partners want to not only take the mgmt fee/carried interest, but also want to have a small piece of acquired stake equity diverted directly to the mgmt company (Which would obviously have to be part of a claw-back clause).
c) If we took a piece of deal equity, I'd probably insist on reduced or eliminated carried interest.
d) Example: my partners want to do something like this - $1mm for 50% of a company translates to, for instance, the fund buying $1mm for 45%, with the other 5% equity piece as some sort of deal fee to our mgmt company.
e) This would likely only fly on fund #1 since it's our small circle who will be in either way, and are ok with this in exchange for access.
f) In the real world of outside investors, and at some point institutions, I imagine you can't be doing both the 2/20 AND take a piece of deal equity. Nor am I confident that even just the latter would fly. Any input on this? We could go aggressive on fees on fund #1 - assuming we're comfortable that we'll still hit net IRR targets, then return to conventional standards for fund #2+.
g) Any ideas how I could incorporate my partners' desire to pull a piece of the equity in deals, in a non-conflict-of-interest way? Besides for just doing it and being very clear in disclosures. I'd like for investors and our interests to be aligned, but at the same time, we do have unique access to these small deals (0-5mm) in our niche and so on the other hand ought to be able to command an aggressive fee structure.

If you want to attract institutional capital you'd have to do this through the GP commitment. E.g., if the total fund size is $100mm, assuming a 1% GP commitment so $99mm LP capital $1mm GP capital, and you issue a 10% capital call for an acquisition, the equity gets funded pro rata from the fund between GP/LP. GP commitment does not typically pay fees/carry.

If it's a really small fund, you could probably get away with a 2.25-2.5% mgmt fee (explain to family/friends you need to keep the lights on, etc.).

If you don't have the personal liquidity to commit 1-2% to the fund, it is common to see GP commitments through deferred management fees. Institutions still prefer to see it in cash though so it's truly skin in the game.

2) Timing / Capital Calls / Commitments / Staged Closings
a) We will probably be operational in 8 weeks.
b) We'll have a few $mm of deals ready to close at that time.
c) We'll have a few $mm of investor contributions ready to deploy at that time.
d) One one hand I need to do a closing and deploy that capital so we don't lose those deals.
e) On the other hand it'd be nice if we could have a 3-6 month total fundraising/closing process - with the ability to deploy from initial closings during that time. Is this common/uncommon/never done/how might this be achieved. I've been under the impression that you first have the commitment period, and then separately the investment period. Can they overlap? If so, how does this work?

You can turn the fund on whenever, really - commitment period and investment period are really used interchangeably. You can hold subsequent closings after you've made investments, it happens quite commonly. I'm doing diligence on a fund that has been raising for over a year and has five assets in the portfolio already. In fact, some investors may prefer this is as it will provide insight into the portfolio (reducing blind-pool risk) and can mitigate the j-curve if there are early mark-ups and they can come in at cost (this is more important to institutional LPs).

3)
a) The attorneys / consultants I speak to all seem to gear their advice toward whatever they're used to and to wtvr suits their own business interest. Fund formation attorney says do a fund (and then some say no way to taking equity too, for obvious reasons, others say ok with clear disclosure). Then there are PPM/RegD "consultants" who say "hey, why waste money setting up a "p.e. fund" with an attorney, just go and do a 506b RegD private placement, and we'll get it done much cheaper. Can this method be used for a private equity fund since it's also a form of RegD, or is there something different about the way these sort of guys do Private Placements?

b)These consultants also make reference to sending our private placement (non)/conduit broker/dealer routes and maybe we'll pick up some investors there as well. Any thoughts on this - I know nothing in that department. A random example of this route would be to use any number of ppm/reg d consultants similar to regdresources . com (not affiliated, never used, can't vouch in any way). This route would definitely be cheaper than an attorney, and perhaps it is not the standard route, but perhaps it gets the job done for fund #1, on a budget, and to that b/d private placement route for some extra possible fundraising? I have 0 issue spending for attorneys if deemed the best route (which is the route I'm headed on). FYI, quotes I've gotten on the p.e. formation from attorneys: 18k, 25k, 25-35k, 50k, 75-250k. Private placement "consultants" like the one above: 5k-15k. This will be for accredited investors only.

I can't really speak to the legal aspects here, sorry. In terms of fundraising, that will be very tough given the fund size you're targeting ($5mm total?). If you knock this one out of the park though you can probably throw $50-75mm on the cover for Fund II and it may be worth it to look into a boutique placement agent.

Hope this is helpful. Again, feel free to ask any follow-ups or shoot me a PM.

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