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The four steps to starting a private equity fund

26 November 2020

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There are some important hurdles to overcome when starting a private equity fund – but with the right knowledge and expertise, the opportunities are vast.

Private equity funds have been a successful asset class in recent years, typically outperforming the S&P 500 Index and attracting widespread interest from institutional investors and high-net-worth-individuals (HNWIs).

No one had planned for a global pandemic, and companies in every market need capital to stay afloat. There’s a wealth of opportunities for ambitious private equity firms to complete well-priced deals for ‘Covid-resistant’ businesses, such as logistics firms and tech start-ups, whilst a range of other businesses still have strong prospects as they look to reshape and restructure to increase their resilience.

There’s been a strong resurgence in M&A activity, with private equity firms putting a record amount of dry powder to good use. According to Refinitiv, the combined value of deals over USD5 billion rose to USD456 billion in the three months through to September 2020, making it the busiest third quarter on record. September was the most prolific month, with 73% year-on-year growth reported.

Commentators expect this trend to continue into 2021, so now’s a good time to consider investing in businesses in addition to your stocks and real estate. Raising capital comes with many benefits, not least the long-term mindset of building up an investment company as opposed to hustling to try to get that one big deal.

Before you get started, you need to ask some important questions:

  • How do you build your fund out?
  • How do you make it make sense for small businesses?
  • How do you make sure that your investors are getting the returns they want?
  • How do I build relationships with fund administrators, placement agents, and the other partners that help to unlock success?

Intertrust Group can help you to answer these questions. We’ve been supporting the private equity industry for over 65 years, and currently work with 40 of the top 50 private equity international firms. We offer a tailored service, helping you to accelerate the possible by adapting to changing market conditions and stakeholder demands.

Here are some tips to help you kick off the process of setting up a private equity fund.

1. Define your business strategy

Firstly, you need to create your strategy and differentiate your financial plan from those offered by competitors. This requires significant, in-depth research into a defined market or individual sector. Finding market patterns is extremely important. Most investors are interested in one thing and one thing only: returns. Where are you seeing the highest returns? Make sure that you measure this in years, or even decades.

You need to find the ‘secret sauce’. Learn everything there is to know in your chosen area so that you’re familiar with the history but can also predict future outcomes. In this way, you can position yourself to investors as a source of real expertise and thought leadership.

2. Establish the right investment vehicle

Once you’ve nailed down your winning business plan, you need to establish the fund’s legal structure. In the US and Europe, limited partnerships or limited liability firms are common. As the fund manager, you’ll be a General Partner (GP) and will be responsible for the investments that make up the fund.

The investors you attract will be Limited Partners (LPs), and it’s important you conduct due diligence and AML/KYC checks when onboarding them – something that Intertrust Group can drive with our proprietary technology. LPs are only accountable for losses attributed to their individual investment, while you’ll be responsible for additional losses within the fund and any liabilities to the market.

Liaising with your legal team is key to the fund’s success. Your lawyers will draft the Limited Partnership Agreement (LPA) and help you to understand and meet all regulatory requirements, as well as helping you to navigate complexities such as data protection, disaster recovery, and cybersecurity. We can introduce you to the top fund formation law firms, with whom we have extensive relationships.

3. Set the right fee structure

This determines how much you and your investors make. As a GP, you should determine provisions related to management fees, carried interest, and any hurdle rate for performance.

Typically, we’ve seen that a GP receives 2% of committed capital from investors. So, for every USD10 million the fund raises from investors, the manager will collect USD200,000 in management fees annually. However, it’s worth noting that less experienced or emerging fund managers may receive a smaller management fee to attract new capital.

Carried interest is commonly set at 20% above an expected return level. Should the hurdle rate be 5% for the fund, you and your investors would split returns at a rate of 20/80. It’s crucial to establish compliance, risk, and valuation guidelines for the fund.

4. Raise the capital!

My favourite part. Now you sell the fund! You’ll need appropriate marketing material to raise capital, and first-time fund managers also need to make sure they’ve received a severance letter from previous employers, which gives them the green light to highlight previous experience and track record – remember, a good track record of working on previous funds will boost your ability to raise capital.

Convincing others to invest in your fund can be tough – you need to show the investors your expertise, which goes back to my first point on preparing a solid business strategy. You can also use a placement agent to help you market the fund. We can make the right introductions.

Ultimately, starting a successful private equity fund is a complex undertaking – but working with Intertrust Group, you’ll have an experienced global partner who’s committed to you for the long term.
You can learn more about our services here, and get in touch with one of our experts today.