Steps and challenges to becoming a "sponsor"

Not saying that everyone in REPE, acquisitions, Asset Management, etc has an "end game" of starting their own shop, syndicating deals, raising a fund, etc. But I am sure there are many of us who are looking at that as the goal down the line.

Given the many nuances and factors involved, I wanted to get some feedback, in as general a sense as possible, as to what the board feels are the biggest challenges and points to consider when making the conscious decision to leave a steady paycheck in exchange for becoming a deal guy/principal/entrepreneur.

For sake of this discussion, I'm not talking about the MDs at Blackstone or Starwood or Oaktree who can walk away from their job and bring equity investors along with them overnight. I am talking about guys like me, i.e. mid 30's, analyst-associate-VP of acquisitions progression. I seem to notice, at least where I am based in Los Angeles, that more and more guys like me are "starting their own thing" over the past few years. Keep getting LinkedIn updates from contacts who have left the cushy REPE job and are now a "founding principal" at XYZ Capital Partners.

In terms of putting one foot before the other, is one more important than the other in terms of locating a deal vs locating capital?

I was discussing this concept with a friend of mine who works in "pure" private equity, and he effectively said that what I was proposing was similar to the "search fund" model used in PE (Wikipedia has an entry for this). It's not exactly transferable, but the concept of effectively raising small equity to search out deals, and then have those same investors contribute equity capital into the individual real estate deals as they are sourced. I would think that in terms of real estate, keeping your overhead low during the search process is important. Most of the guys I know who started out spent money on their website, logo, and basically rented an individual executive office for $500-$1000/month in the beginning. Once a deal was located, then they began sending out the deal pitch book, soliciting equity, etc. I'm not sure how being a "company of one" would be viewed upon by a potential investor/investors.

The other question I had was with respect to deal structuring. I'm guessing there are plenty of smart capable first time sponsors who don't have the personal funds to co-invest in the 90/10 joint venture scenario. I have heard of different ways around this, including deals where effectively the sponsor has very little skin in the game, or rolls their 1% acq fee into the deal as imputed equity. Again, just curious what the board has seen in this regard, strategies to make equity capital comfortable investing with a first time sponsor.

Thanks.

 

If you can put together a good deal im sure you can raise money for it. I would tie up a deal, put down the deposit and then hit the streets.. if you dont have control over the deal you could be wasting investors time.. do that enough and people dont take you seriously.

As for issues being a first time sponsor.. forget about the institutional world, find a few high net worth guys that are unsophisticated in RE or have big balls

 
Best Response

First and foremost, you really need to identify your equity source(s) before you leave your steady paycheck or get the deal, be it real estate or regular pe AND you need to have enough money to cover your expenses for a good amount of time. By identify I don't mean that you simply know a bunch of rich dudes or institutions who could fund your deal, but that you've had multiple and decent discussions with them about what types of deal they will do and you've gotten confirmation from them that if you bring x,y & z they'll do it (which they could still say no to, hence why you need multiple sources of capital). And unfortunately by the time in your life and career that you have enough knowledge of and network in your business and can get equity to trust you you're most likely older and have pesky shit like a family you need to feed and a mortgage you need to pay. You may (and I stress may) get an investor to stake you in the due diligence and soft money aspects of landing a deal but it would be very difficult to get that investor to cover your living expenses that you've accumulated while making a few hundred grand a year.

These are the largest challenges to going out and doing your own deals (call it sponsor, search fund or whatever you want) and why everyone doesn't do it. If it were easy to do everyone would. You could be the smartest, most hardworking person in your field but if you can't collar capital and cover your own nut, and be someone who's willing to take a large risk (leaving a good, steady and well paying job and blowing through your savings) nothing else matters. The rest-how to structure it, co-invests, fees, carry, etc-can be negotiated once you cover the above.

 
Dingdong08:

You could be the smartest, most hardworking person in your field but if you can't collar capital and cover your own nut, and be someone who's willing to take a large risk (leaving a good, steady and well paying job and blowing through your savings) nothing else matters.

This, and this alone. Most people simply are not the types willing to dive into risk. It's funny because all of our jobs revolve around risk management in one way or another, but accomplishing what we want always requires unprecedented amounts of risk. Most people dream but simply do not have what it takes to reach their goals.
 

Its really not that tough, you just need a little knowledge and big balls. I would recommend doing your first deal while you still have your corporate job or move to a smaller company where you can see the whole process. Doing your first deal while your still employed will allow you to capitalize on the acquisition fee you need for initial over head and Asset Management fees to keep the ball rolling. When I moved from the institutional relm to a small shop the transactions seemed so different b/c you see everything.. its not your stereotypical underwrite, offer, negotiate PSA, order 3rd party reports, talk to eager lenders trying to blow you to put debt on your deal, transfer equity out of your bottomless bank account, have a closing dinner with a bunch of immature brokers.

Its more like break your back trying to find off market deals that actually work (if your getting a broker om, your 6 months to late, sorry), put together a debt /equity pitchbook and beg banks/equity investors to give you money.

  1. Build your team - lawyer and accountant that understand the equity syndication process. Your lawyer can help you set-up all of your entities, structure partnerships, work on PSA's, etc..

  2. Solidify capital relationships - Both DEBT and equity. Equity speaks for itself, if you cant raise money you cant do deals. If you have no money you can do a 95/5 split and you could also break up the GP entity again 95/5 and have some one put in the 95% of YOUR share of the equity. The lenders who give debt to small 1 man 'shop's are usually not the same lenders that give massive institutions capital. You need to build relationships with local and regional commercial banks.

  3. Grow a pair - dont be like the rest of the guys in your office and climb the ladder, anyone can do that.

 

Great post, I wanted to share my two cents as I am in a similar position.

If you can lay the foundation while you still have a steady job, by all means you should. However, I have found that if you want potential investors to take you seriously, you cannot juggle both your day job and "side job". Think about it, you believe someone will fund the lion's share of equity into your maiden project if they think you are going to be distracted by your 9-5 job? Also, a guy who has a 9-5 has a fall back position, how hungry is he really? If he puts together his own deal and it falls through, he has a safety net. If his 9-5 job suddenly requires him to devote more time, will the side project suffer as a result? These are all questions and concerns a potential LP would have.

I would also say to find some form of a niche focus. If you present yourself as a generalist (targeting all commercial types, apartments, hotels, self storage, etc etc), you will spread yourself thin and seem all over the map. That's not to say you only need to focus on one type, but make sure you have experience in those types and can show track record buying and managing those types of assets throughout your career.

As far as sourcing deals, for us entrepreneurial types, it almost HAS to be a seller direct, off market type of deal. Hard to justify your worth if you are simply taking the latest CBRE mass marketed deal and presenting it to an investor. Having a relationship with the seller is also important, not just to access the deal, but because you will need some degree of latitude with respect to timing, it may take longer to secure equity, and if you have a seller that understands that and isn't going to demand a hard money deposit upfront or something else akin to that, it will make things a little easier.

Pitching deals is an art form. It helps to have a little "broker" inside you, as you will need to make a compelling case, even on a killer deal. Good news, everyone is still buying real estate, and everyone is still starved for deal flow, so you shouldn't have a problem at least setting meetings with potential investors to listen to your pitch.

Focus on the positive, people will tell you that you don't have a chance, just smile and tell them to keep walking. Like a previous poster said, if it were easy, everyone would be doing it. You are selling a deal, and yourself, to an investor. One of the issues within the PE world today is how much LPs are paying in fees to these larger fund managers, so if you can make a compelling case to provide them with a more robust return, direct access to a deal, and enough safety mechanisms in place so that they feel they are protected, you will be on you way.

 

REValuation is on point. Locate the capital and have your "small firm" internal infrastructure set up to give investors a level of comfort that you know what you're doing. I would also suggest engaging a third party fund administrator like Cortland Capital Market Services that will put the remaining professional touch on your one person show. This keeps you focused on the real estate and puts the reporting in the hands of some professionals which reduces your risk of exposure for those things that you may not have an expertise.

 

I can relate to almost everything that everyone has said here. I did exactly that, started working five years ago for a small PE shop (now a mid size investment and development firm with ~500 million in aum) on the East Coast. I did everything from running the Asset Management unit for a couple of years, then transitioning into acquisitions and eventually moving up to vp of acquisitions. In my third year as analyst, I bought an investment property for little over a million, did two more deals around that size and recently left the firm because I was spending a lot of time on my own deals and it didn't make sense to stay unless I was being made a partner or making a killing, neither of which happened.

I would agree that it is important to have the fall back when starting out, do at least one or two deals before you even think of leaving your job. As far as rolling in the acquisition fee into the deal, I would be cautious in doing that. If your investors are comfortable enough then stick to a 95/5 deal, or if you are contributing 10% of the equity, perhaps syndicate out 5% to smaller group of investors (maybe family/friends money) so that way you still have some skin in the game and it doesn’t look like your investors are funding your portion of the equity contribution.

Do not tie up the deal and then try to raise the money. Make sure you are extremely comfortable with the deal and get to know your investors first before you front any deposit money, doesn’t matter whether that is soft or hard money.

 

There are lots of one man sponsor shops out there. As for what other said, focus on one property type first. Get really good at it. You pretty much have to quit your day job otherwise no investor will take you seriously. My suggestion is to save enough money to buy smaller deals and build up a small portfolio, then you have income, which allows you to leave your job and focus on raising capital. As others said, raising LP capital for RE is not that complicated and difficult as long as you are flexible on promote terms and such. The hardest part is simply just building a track record and proving your worth.

Array
 

Great posts. There is no clearly defined path to do this, and like anything, luck plays a role. Without sounding too assured, LP capital is as plentiful as ever. And while most of these larger institutional types will always tell you they prefer to partner with a big outfit (i.e. operators with 10+ year track records and sizable existing portfolios), the truth is, deal flow is coming from the small start-up/emerging manager types as well. One of my friends (who does third party equity raises for developers) told me in so many words, if LPs really want to put their money out, they will have to consider smaller sponsors without individual track records and just structure the terms appropriately. In other words, the small guys have more leverage than they used to, if they have access to a deal that someone likes and wants to put money into.

 

I think as important as raising capital establishing relationship with potential JV partners while your still working is critical. By having JV partners who trust you and can write large equity checks it gives you tremendous credibility to go out and raise capital and helps magnify your potential buying power after said capital can be deployed.

I think you can really harvest relationships with large JV partners when you are working your way up the ladder.

 

Thanks to everyone who responded to my original post. Really appreciate the feedback.

I guess my next question, is it more important to have access to the deal before locating the capital? It seems like a chicken and egg situation, capital wants to see the deal before they commit, and an off-market seller wants to know you have a capital source locked and loaded before they are willing to "open their kimono" and provide Argus files and financials.

I have seen one-man sponsorship groups BS their way through these hurdles, but it would seem it is a risky proposition.

Also, absent any personal funds to commit to the deal, what options would an "emerging sponsor" have in order to capitalize a deal? In other words, is it possible to contribute the acquisition fee, or portion of, as imputed equity and have the LP fund the balance?

I have been able to work with relationships on the principal side who are willing to let me put together a purchase on some of their assets, but frankly I don't have capital or a balance sheet and would need to rely on investors putting up essentially 100% of the equity. Am I spinning my wheels trying to structure this?

 

Greenflame answered your first question, "Do not tie up the deal and then try to raise the money. Make sure you are extremely comfortable with the deal and get to know your investors first before you front any deposit money, doesn't matter whether that is soft or hard money."

The acquisition fee question was also addressed above. You should never openly include your acquisition fee as your equity in a transaction, it will appear like you have no skin in the game. However, if you get your mom to front you the equity capital needed to close, you could always pay her right back.. its about perception.

 

REValuation, I understand your points.

Let me rephrase. Let's say I have no skin in the game, period. Let's say I am a single guy with $30,000 in the bank and no wealthy family members. In other words, I simply do not have the capital to put any meaningful co-investment in ANY deal.

Now, let's say I am friends with an owner who gives me the opportunity to buy his value add $40M office deal off-market. It's a good deal that underwrites well. I put together my institutional quality underwriting package, deal pitch book, and start sending out to capital sources. My pitch? I have exclusive access to a great deal, I have the experience to transact and asset manage this deal, and have experience creating the value embedded in the deal.

So, with respect to your points, I have zero zilch nada capital to put into this deal. Forgot about fronting deposit money, I have none to front. When I pitch the deal to equity, it will be under the premise that they commit and effectively put up all due diligence dollars in order to get the deal under contract and closed. My upside in the deal is my 1% acq fee and my $40,000 plus/minus annual asset mgmt fee. There is no promote if there is no JV structure, and if I am not rolling my acq fee into the deal as imputed equity, then that eliminates that aspect.

I am not trying to represent to the equity that I have the 10% coinvestment covered. I would rather be direct and upfront and be honest, I am a young sponsor starting out looking to develop a track record, and I need deals in my portfolio and on my website in order to gain credibility.

The popular option I keep hearing people tell me is simply to flip the deal to the equity/buyer, collect a the 1% finder/broker fee, and repeat that process until I stockpile enough cash to coinvest for my own balance sheet. Unfortunately, the broker game is hit or miss, and doesn't really get me closer to my goal of being a principal.

 
egold70:
When I pitch the deal to equity, it will be under the premise that they commit and effectively put up all due diligence dollars in order to get the deal under contract and closed. My upside in the deal is my 1% acq fee and my $40,000 plus/minus annual asset mgmt fee. There is no promote if there is no JV structure, and if I am not rolling my acq fee into the deal as imputed equity, then that eliminates that aspect.

The popular option I keep hearing people tell me is simply to flip the deal to the equity/buyer, collect a the 1% finder/broker fee, and repeat that process until I stockpile enough cash to coinvest for my own balance sheet. Unfortunately, the broker game is hit or miss, and doesn't really get me closer to my goal of being a principal.

But it does. Perhaps moreso than doing some sort of 'fee Asset Management' without any equity in the asset whatsoever ...
 

"My upside in the deal is my 1% acq fee and my $40,000 plus/minus annual asset mgmt fee. There is no promote if there is no JV structure, and if I am not rolling my acq fee into the deal as imputed equity, then that eliminates that aspect."

Since you have zero upside besides your guaranteed 1% acquisition fee and your $40,000 Asset Management fee (also guaranteed) then you have ZERO skin in the game. If this deal goes awry, you'll just start over again if and when it does---you'll be perfectly fine whereas your LP goes busto. Put your $25,000 grand into the deal for the DD process and roll that into 0.5% GP share with a 2% promote or something very small. You MUST have skin in the game--upside or downside. In the LP's eyes, you should live or die by this deal.

"The popular option I keep hearing people tell me is simply to flip the deal to the equity/buyer, collect a the 1% finder/broker fee, and repeat that process until I stockpile enough cash to coinvest for my own balance sheet. Unfortunately, the broker game is hit or miss, and doesn't really get me closer to my goal of being a principal."

I don't understand what this means: "the broker game is hit or miss". If you broker this $40mm deal for say 50 bps then that's a $200k fee-- split that with the house (after hanging your license at a local brokerage) and you have tripled your bank account to $130k and you are prepared to do a real JV with a real LP with real skin in the game.

 

There is a younger guy I keep running into that has been trying (successfully) to do something very similar to what you are proposing. His strategy has two important parts. He has found himself plugged into a pipeline of pretty sweet off market deals. However, much like you have described, he does not have a ton of cash himself and he does not have any wealthy family members to tap for capital.

He has targeted two groups of investors. The first are large providers of capital. He uses them as the LP for all his transactions. These are traditional sophisticated/experienced real estate investors, REPE shops, and some developers. He brings them deals and agree to terms, usually somewhat along the line of 90/10 with a back-end split.

Once he has an LP locked down he has a handful of fairly wealthy professionals with whom he has a developed a good working relationship. He gets them to invest the 10% necessary for his GP portion at terms they can agree too. He pitches in whatever money he can when he can, it varies from deal to deal. After he has an agreement with an LP he works on securing his GP money. He said he has a very good idea of what these investors appetites are before he even approaches them.

I don't know all the exact terms of his deals but this was the process as he described it to me. I know it is a little vague. So far he has been doing very with this. In about 18 months he will be able to start realizing some of these investments and hopes to be able to cover his GP share alone at that time,

 

Getting his LP money (agreeing to terms, shaking hands etc) THEN syndicating the his 10% stake GP money sounds completely reckless (the other way around is the correct way of doing this).

What if he can't get his GP money from the wealthy professionals? What if he has to go back to the LP and say he doesn't have the 10% and the deal is off? That's how to successfully kill a relationship with "institutional money" (would like more detail on what kind of institution would agree to this 90/10 split without cracking open the GP's personal books to confirm that the GP in fact has the 10).

 

Not my company so I am just relaying how his situation was explained to me.

The source of his GP money is a smaller group of retired traders who want to invest in real estate. The principal has a very strong history in acquisitions. They have agreed to terms on what investment types they are open to and how much they are willing to put up per deal and total. They get a juicy part of the GP returns in exchange for providing their balance sheet for financing, guarantees etc. He is frequently in contact with these investors which makes him very confident the funds are available. Often he has more interest from these investors than he has need for cash. I still agree it seems like one day he could find himself in a very awkward situation.

The LP's are often family offices, smaller REPE shops, and local/regional developers in the markets he is familiar with. The majority of these are long standing relationships. He hasn't been doing his own thing for very long, but so far he has a solid track record.

Your questions are very good ones. I wish I had more insight into his operations.

 

I wanted to add another comment. Most of the guys I know who started doing the one-man shop setup were former acquisitions guys on the equity side. In other words, their #1 skill was on the deal origination side. They weren't asset managers, per se. They weren't debt guys. And they weren't capital market pros. They were deal guys. They had relationships and institutional level backgrounds in locating, underwriting, structuring, and closing deals.

Point is, everyone needs to be a sharpshooter at something. Guys who claim to be expert originators, asset managers, and capital markets gurus are typically overinflating their resume.

My advice would be to develop some form of strategic alliance with a capital markets pro. Either a third party affiliate/advisor, or someone independent like yourself, who can now focus their efforts on bringing in capital for YOUR deals. It is very hard to juggle both, because the moment you stop deal sourcing and start trying to be the investment banker/equity raiser, those deals you spent months sourcing start slipping away. Think of it like this. You are trying to be the chef, the waiter, and the host all at once. You spread yourself thin, instead of focusing of cooking a great meal and letting the waiter serve it, you are doing both, and as a result, the product suffers in quality.

There are plenty of one man shops that do debt and equity raises. Find someone who has the rolodex, and offer them a partnership scenario. If they don't want to go under your company, then develop some form of strategic relationship so you can each maintain your own brand name.

 

My only anecdote is not to downplay the difficulty of raising funds. A guy I know took a firm from $20 million AUM to $700 million and has a transaction value nearing $2 billion. He was only a VP, though, so he decided he wanted to go out on his own. What he didn’t expect was how difficult of a time he would have fundraising. After all, he didn’t have to worry about that before, and the connections weren’t “his.”

Commercial Real Estate Developer
 

No LP is going to take you seriously without skin skin in the game (0.5% isn't going to be enough) and the capital in reserve to back up the investment.

If you have to pass on a deal to someone else and just collect a fee for now, then do it; don't try and box above your weight class - there will always be other deals.

In my residential flipping days (during college), I wholesaled a lot more deals than I actually rehabbed myself. Not because I wasn't successful rehabbing, but because I knew what I could and couldn't take on and what my reserves could handle (given, that wasn't the case for my first deal ever, but I was risking 35k that was a combination of savings and credit cards, not millions).

 

one thing about co-GP is that a lot of LPs will have requirements that you (the sponsor) will have to fund a certain amount of the GP share yourself, sometimes all of it.

on the other end of the spectrum, I've seen deals where LP didn't require ANY up front investment from the GP, but there was still a significant promote (like 95/5, 90/10 over a 12%) and some other income-based incentives for the GP.

not black and white out there

 

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