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.

Does Private Equity “get” social media?

I’m not talking about venture capital, because those guys definitely get it (well many of them, at least). I’m talking about small buyout houses, mid-market buyout houses and upwards.

1. Fundraising
In markets where LPs and consultants are overloaded with information on new funds coming to market, one would think that a new channel of communication (this is all social media, collectively, are) would be pounced on. And it is free. Have you seen anyone outside of the venture space really doing anything interesting?

2. Deal origination
Particularly in a time when operational expertise is prized over financial engineering, one might expect that a medium perfectly suited to the demonstration of expertise would be a key weapon in the arsenal of any deal origination team. I was fortunate to speak with David Teten on this topic recently and he definitely gets this, too. There is so much that COULD BE done. And so little BEING done. The first team that grasps this and runs with it is going to steal a considerable march on the competition.

I think I am going to give a little more thought to this topic and I ‘d be interested in anyone else’s views.

Frontier Capital – Learnin’s from the ol’ West

Image via Wikipedia

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.

Insert your own Apax Partners fundraising gag here…

Martin Halusa, chief of Apax, chef de brigade

It’s not always good news when your private equity backers descend on your offices at short notice…and it doesn’t always bode well when the “party” includes the worldwide CEO. Of course, nothing says “this is the good kind of party” like a silly hat, and the visit was received with extremely good humour, even if Apax was demanding money…

The Apax team had brought with them a crate of sandwiches, which they were looking to flog to the excited and hungry denizens of IE Consulting towers and our cohorts at Unquote” for the benefit of Great Ormond Streat Hospital and the poorly lads and lasses it serves.

Well done Apax for putting in some personal effort to raise money for such a good cause. Not so well done on the quality of the sandwiches…I’m looking forward to Bridgepoint trying the same thing…

Fairly ropey tuna sandwich made by APAX partners

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.

Why should I invest in your fund?

I’ve been thinking recently how successful fundraisers stand out and I keep coming back to the importance of clarity and focus. If an LP is to invest, the following must be explicitly established:

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 thought this was so central to the selection process that I even drew a diagram to illustrate it:

The three things you must demonstrate for your fund to be successful

With legally required disclaimers the only exception, I believe these are the first three ideas an LP should see when opening any fundraising materials. These three concepts should inform the content throughout. And that includes the cover.

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…

European Fundraising Review

In case you weren’t already aware, my good friends over at Unquote are about to launch the European Fundraising Review, to which my team has been contributing.
Quite apart from the excellent data and analysis you’ll find therein, the foreword by John Campbell at advisory group Campbell Lutyens is, as always, a joy to read.
No dogs or ships this time, but a well-considered piece, to be sure. More details soon!

Private Equity Haiku III

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

Ouch. #privateequityhaiku