and in which general partner economics
are fairly distributed. They want to see
a strong commitment demonstrated
by their managers, including a material
personal investment in the fund and
no outside business activities. There
should be significant reinvestment in the
business to build out the infrastructure
consistent with industry best practices.
underperformers, focuses on special
situations, provides growth capital, or
something similar is not enough.
Finally, a manager needs to address the
terms of the partnership agreement.
At a minimum, the terms should be
market; off-market terms demonstrate
poor judgment. Although limited
partners will not invest solely based
on favorable terms, an “LP friendly”
partnership agreement helps overcome
some of the organizational risk
associated with first-time funds.
An example of a differentiated strategy
would be a turnaround manager who
focuses on software businesses that
have strong recurring revenues and
a product that is deeply embedded
with its customers, who would incur
high switching costs to replace it.
These businesses often are part of a
larger parent company, lacked growth
potential vis-a-vis the core, and
are largely abandoned. The general
partner stabilizes such a business and
then sells it to a strategic investor.
Providing seed capital is not enough.
Seed capital launches a fund, but
the manager still needs to meet the
investor community that invests in
smaller managers. Often the manager
forgoes valuable economics to a seed
partner without solving the problem of
finding the right investors. Ultimately,
a manager needs someone who is
focused on the fundraising effort if
he wants to continue to spend the
majority of his time investing.
Limited partners respect that a manager
needs to generate sufficient income to
properly capitalize the management
company and pay overhead. They
understand the importance of proper
compensation to attract quality
personnel. However, there are ways to
structure the partnership to improve
the alignment of interests between the
manager and the investors. An example
would be a European-style incentive
structure, in which a limited partner
receives all of his contributed capital
plus a preferential return before the
general partner receives his carry.
Another example of a differentiated
strategy would be a manager who has
a track record of identifying industries
that will experience significant growth
and investing in companies that will
benefit from that growth. Another is a
general partner who brings a venture
capital mindset to mature companies.
He determines how he may transform
a business to maximize its growth
potential. The important point is that
these strategies are unique, repeatable,
and materially improve earnings
before interest, taxes, depreciation, and
amortization (EBITDA) and therefore
the value of the portfolio companies.
Funds of funds with a specific mandate
to invest in a manager’s strategy are
natural partners. Also, the endowment
and foundation community is most
likely to take on organizational risk
by investing in a fund managed by
an “emerging” manager, expecting
higher returns as a result. The pension
community generally focuses on broader
platforms in which its members can
put significantly more capital to work.
Also, a fund size should be consistent
with the opportunity set and the
manager’s historic investment pace.
At the Fund I stage, it is important
to gain critical mass as early as
possible. Once the manager has
proven his success, new terms can
be addressed in future funds.
These funds face a unique set of
challenges. The obvious positive is that
they have track records. Still, there are
hundreds of domestic middle market
private-equity funds, and it can be quite
challenging for investors to differentiate
one fund from another. Clearly, the most
effective way for a fund to differentiate
itself is with an outstanding track
record. Realistically, however, these
funds are still relatively young, and
their prospects for long-term success
may not be so obvious to the investor.
Finally, the issue becomes determining
which investors to approach. The
landscape of active institutional investors
is quite dynamic. The manager is
seeking an investor who has made the
decision to allocate to his strategy and
is willing to accept the risk associated
with “smaller” funds. Identifying and
interacting with those groups is a full-time job. A value-added partner, such
as a manager’s financial partner (i.e.,
platform, fund of funds, family office,
etc.), placement agent, or internal
investor relations personnel, often
plays a critical role in this regard.
A small subset of institutional investors
seeks Fund I exposure. This subset
constantly evolves. Partnering with a
placement agent or platform can help
a manager efficiently navigate this
process. Again, however, a manager
must be realistic about where he
falls in the life cycle of private-equity
funds. Investors will focus their time
on proven teams with strong track
records and differentiated strategies.
Until then, managers should focus
on making great investments on
terms acceptable to their financial
partners. After developing a track
record, the manager will be in a
position to ask for market terms. J
A manager should focus on what
makes his firm unique and clearly
and succinctly articulate this to
investors. It is important to provide
supporting evidence through
portfolio company examples.
Simply stating that a fund purchases
Rafael Astruc, CFA, is a managing director at Garrison
Investment Group, a $3 billion middle market
distressed/credit fund focused on turnarounds, small-balance loan portfolios, real estate, and direct lending.
Typical investments range between $5 million to $50
million and substantially higher with co-investors.
Astruc is responsible for strategic development,
including partnering with independent investment
managers to help grow their businesses by providing
fundraising, working capital, and strategic advisory
services. Prior to Garrison, he co-founded a $3.5
billion fund of funds that focused on middle market
private-equity partnerships and hedge funds. Astruc
served on the advisory boards of more than a dozen
private-equity partnerships. He may be reached
at (212) 372-9545 or email@example.com.