Do LPs buy funds the same way we buy (or try to buy) TVs?

How LPs select funds

Laid low at home earlier this week, suffering from a thankfully improving bout of self-inflicted food poisoning, I found myself wondering about the thought processes that are involved in an LP making a commitment to a new fund.

In an earlier post, I mentioned the three arguments that I believe are central to any successful fundraising process. If these arguments are sufficiently strong, the fundraising process should run relatively smoothly. A fundraiser must always establish the following:

1. This market represents a great opportunity, right now and for a considerable time;
2. This strategy is the most suited to exploiting that opportunity;
3. This manager is the most able to successfully execute that strategy.

I may have given the impression that I believed that this was all that was necessary to secure an investment, but of course that is not true.

The fund selection process is more sophisticated and the biggest challenge for any fund (but particularly a new fund) is going to be convincing an LP that the time required to properly investigate the fund would be worthwhile.

It is all very well lining up watertight arguments and detailed corroboration, but what good is that if an LP doesn’t get past slide five in your pitch book or doesn’t pick up the PPM?

Not much good at all, of course. Stating the rational case for investment is probably only going to pay dividends once the emotional curiosity of an LP has been awakened.

I think it has a lot to do with awakening fascination, emotional curisosity in the investment opportunity, the investment strategy, or the management team.

You see, as much as the scrutiny of due diligence may reveal about the historical performance of an opportunity, a strategy and a manager, it cannot foretell the future. As everyone in the investment business knows:

Past performance is no guarantee of future results

In order to evaluate the likely future performance of a fund, an LP cannot rely on numbers alone. When an analyst is picking through 50 PPMs, which are the ones that are going to get the most attention and stand an improved chance of being presented to the investment committee? The fascinating ones, of course!

Now, an analyst that values his or her job is not going to present this as a selection criterion. Imagine the response to this statement:

I think we should invest; I’ve always admired Bono and his engagement with imprtant issues. We can trust him with our money,

In all likelihood this fascination with the fund will be rationalised into a more empirical analysis of the benefits of investment. In fact, as the selection process becomes more abstracted from the initial contact with the brand and due diligence begins in earnest, the emotional impact of the brand actually becomes less important.

We select the funds we want to invest in emotionally and assess whether we can invest in them rather more rationally.

I’ve set out how I view this process in a diagram, below:

How LPs select funds

In essence, the idea is that most investment opportunities progress by awakening an emotional interest that is then rationalised, before being checked against certain other criteria, including competing investment opportunities. The amount of time that passes between the individual steps can vary between simultaneity and years.

1. The LP becomes aware of the fund somehow
2. The LP has some manner of contact with the fund or a fund representative
3. The LP finds one or more elements of the opportunity, strategy or manager sufficiently fascinating to properly engage with the fund, its materials, or representative
4. The emotional interest in the fund is rationalised into a more empirical investment case
5. The LP conducts Due Diligence on the fund
6. The LP evaluates the fund against those that are perceived to be similar
7. The LP selects the fund for investment and makes a reccommendation to the board

That’s kind of how I would probably buy a new TV…

1. Matt hears about the flatscreen TV
2. Matt sees a commercial about the TV
3. Matt thinks that the TV would look cool on the living room wall. It’s so shiny!
4. Matt decides that buying the TV and fixing it on the wall would mean that he could get rid of the old CRT TV and the ugly TV stand…that would mean space for an extra chair in the living room and a more comfortable time when friends come over – how practical!
5. Matt checks out to see if the TV will be easy to mount on the wall and if it has a digital tuner built in
6. Matt checks out other, similar TVs
7. Matt tells Mrs C-G that family C-G simply must invest in this practical, space-saving, TV

Typically, my investment recommendation will be rejected by the committee (Mrs C-G) at this stage.

EVCA Placement Agent Code Spells Trouble for Dodgy Dealers

A firm should not make or offer to make any payment or other consideration with a view to enducing [sic] a third party to enter into contractual negotiations with a client

– that’s according to the Draft EVCA Placement Agents Supplementary Code of Conduct that was released recently.

Yikes. The thought that this goes on, as it clearly has, ought to be shocking. Well, it is shocking even if I feel naive writing that.

But is banning placement agents the answer? Surely it cannot be. Just because a few fraudsters want to line their pockets dishonestly, doesn’t mean that the role of an intermediary in the private equity fundraising process is unnecessary. Ask any GP running a small fund if he/she would prefer to spend more or less time raising money and the answer is pretty clear. If LPs want their fundmanagers to spend their time investing LP cash rather than trying to raise more of it, they had better accept that the placement agent is their friend or, at least, not their enemy.

Frontier Capital – Learnin’s from the ol’ West

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Traditionally, the Venture Capital industry has taken its lead from the West. Sure there are fine firms up and down the US and beyond, but think of venture capital and it’s hard not to imagine Google’s garage or a sarcastic VC cutting through some poor entrepreneur’s far-fetched American dream (or, if it’s 1999, funding it).

Now that probes into the services that 3rd party marketing firms and placement agents offer are causing some concern, VCs need to wise-up on the marketing of their own funds. And it’s not going to be easy.

I’ve written before on certain similarities between the actions of some in the fundraising industry and of those in the Wild West. I wasn’t too complimentary, but I wonder what we can learn from the Ol’ West? Here are some quick pointers:

Firstly, if you can, it’s important to show some kind of track history. After all…

It’s better to be a has-been than a never-was.

But track history isn’t everything, of course; it might have been easy raising your last fund in ‘06: You delivered 30%+ IRR and most of the LPs were reckoning on funding their commitments with distribution in any case. But, in 2009, if you can’t show how your teams delivered those returns, you’re sure gonna hear this an awful lot:

Timing has a lot to do with the outcome of a rain dance

And honesty really is the best policy; let’s hear it for bad news, told well. The amount of DD LPs are putting in these days means that it is going to be increasingly difficult to exercise that special sort of creativity that some VCs are rumoured to be indulging in with the valuations of some slightly wonky Chinese portfolio companies. Much better to open the books and tell the story of what happened and what was learned.

Good judgment comes from experience, and a lotta that comes from bad judgment.

Of course, one of the most important skills is getting an upfront read on who might be ready to commit and who is still waiting before making new commitments. It’s like they used to say:

Never slap a man who’s chewin’ tobacco.

So:

1. Show what you have done
2. Show how you did it
3. Don’t just tell the good news
4. Wait for the right time to tell it

If you get all that licked, you might stand half a chance!

I’ll tail off now..:

Never miss a good chance to shut up.

1,000 up!

Well, a quick look at the fundraising group tells me that there are now well over 1,000 members, all interested in discussing how best to select and present private equity and venture capital funds.

A glut of you joined and were approved at the same time, but it seems as though the 1,000th member was either Alex Edwards who works out of China for C.P.Eaton the global placement agent or Chris Genovese at gatekeeper Portfolio Advisers.

Either way, it is great to have both of you on board, along with the many others of you that have joined the group since its founding two months ago.

Will you be the 1000th member?

Private Equity and VC Funds Group on Linked In

While I was approving new members to my Linked In groups this morning, I noticed that my first LinkedIn group is almost at 1,000 members. When I think of the modest expectations I had for it when I started it two months ago, I think that is quite a result!

Just in case you have been living in a cave for the last 5 years, LinkedIn is similar to Facebook, but is for business professionals rather than high school and university students.

The group is for private equity Limited Partners (LPs) and fundraising professionals (Placement Agents, Investor Relations teams at General Partners etc.) and anyone else involved or interested in this area.

1. LPs will find one of the largest groups of Limited Partners on LinkedIn
2. GPs will find LPs and professionals that can help them with their fundraising efforts
3. Placement teams will find both of the above

Discussion topics in Haiku-form are, of course, particularly encouraged…
I look forward to welcoming you to the group!

Tumbleweeds, ghost towns, prospectors? Welcome to the fundraising Wild West (on the East coast)…

South Western GPs /
Can’t all be cowboys, can they? /
Where’s the darn sherrif?

Just on the off chance that you haven’t heard….here are the details…

Private Equity Haiku III

Hey, placement agents:
Wear more “Simpsons” ties! Let’s put
the “fun” back in fundrasing.

Ouch. #privateequityhaiku

Another day, another private equity Haiku…

Limited Partners:
Though not so drawdown-happy,
Love distributions

Linked In Private Equity Fundraising Group

The whole world of LP/GP relations in your hands

I’ve been pleasantly surprised by the encouragement I’ve received after setting up a group on Linked In. Not only has the uptake been fantastic (348 360 members in less than two weeks – will you be lucky number 350 400?), but a number of members, clients and new contacts alike, have been generous enough to send messages of support for the group. Thanks to all of you for those, which are very much appreciated.

I’ve likewise been very happy at the relevance of the comments and discussions posted (and if I have had to delete a post it has always been accompanied by a private message to the forum member to explain the reason). Of course, it’s especially pleasing that members from both sides of the fence, LPs and GPs, have been very quick to recognise how a group like this and its membership can help them build and maintain strong relationships, both new and old.

If you aren’t already a member of the group, just click here to go to the sign up page. I’m usually pretty quick at approving membership (early experience has taught me the importance of not allowing membership with out a quick reference check) and you can expect a message from me to connect shortly thereafter.

I enjoy using Linked In because it is not too bothered about its appearance and it’s not unnecessarily complicated, fiddly or flamboyant (cf newer versions of facebook or shudder myspace) – a bit like me.

What am I doing?

In the extremely unlikely event that anyone ever reads this, here is what you might hopefully find inside:

Disjointed thoughts on events in the financial markets;

Anything else interesting;

Err…that’s it