Strategic Insights: Building a Firm and Not Just a Fund

There are two very distinct types of private equity sponsors: portfolio managers and business builders. For our purposes, portfolio managers are defined as managers that almost exclusively focus on raising pools of capital for a particular strategy during specific points in the cycle. Business builders, on the other hand, are more long-term oriented and look to create a diversified investment platform that is built to execute through multiple cycles and survive well past the founding generation. There is no preferred model for generating near-term success and returns, but in this piece we will focus our insights and recommendations on those sponsors who seek to build a long-term, institutional fund platform.

Team/Human Resources

The success of any buildout relies most heavily on the group of people responsible for the execution of that effort. It starts with a thoughtful partnership group that has the requisite incentives and motivation to maintain long-term alignment of interests with its investor base. GPs are frequently asked about their financial commitments to a particular fund vehicle, but what is more meaningful over the course of time is the commitment of time and resources into the development of the firm itself. Investment by the partnership into the highest quality professionals at all levels can create a dynamic work environment that rewards each individual’s contributions and rewards those efforts with career enhancement, promotion and meaningful economic incentives. Oft overlooked, the back office and support teams are the engines upon which a fund platform is built. As a firm grows, the professionalization of the firm’s legal, accounting and fund administration divisions are key components to the firm’s success. LPs have come to recognize this fact as well and have carved out a greater share of their fund diligence to cover this topic. These professionals are often speaking with investors frequently and the quality of those interactions can be very impactful in the reputation that a firm builds in the market.

Investment Strategy

A major part of expanding a fund platform is being able to venture into naturally adjacent investment strategies. This has been one of the most challenging aspects of growing a business for sponsors because there have been so many spectacular failures over the course of time. In order to gain the credibility and capital support to move into adjacent strategies, you must first be successful in the firm’s core area of focus. Capital frequently chases those that outperform and can cause some groups to pursue opportunities outside of what they are most well-suited to address. Firms have achieved significant success by moving into strategies where they already see investment opportunities and where they have a team internally, or an identified external team with whom the partners have historically worked well . Navigating issues around investment decisions, roles/responsibilities and other areas of potential conflict can be particularly difficult for groups unaccustomed to these issues. Sponsors often feel that conflicts of this type are not important and are then very surprised to find that this is a hot button issue for investors. We have seen equity funds complement their strategies with debt, minority equity or “small buyout” areas of focus; some North American focused groups have partnered with Asian groups to pursue certain geographically oriented synergies.

Unique Capability

Firms that prove themselves to be successful over a long period of time typically have some unique capability that cannot be easily replicated and has value to investors that endures over time. An ability to differentiate oneself from the rest of the industry is probably the most difficult part of building a fund platform that has lasting impact, but without this quality longevity will rest squarely on the team’s ability to continually outperform its peer group. Consistent outperformance is the unicorn of the private equity universe, so firms that seek long-term investor support must offer something else that is compelling if they are to survive a subpar vintage, etc. Among the unique capabilities that firms have been able to develop are internal human resource expertise, technology sophistication, sourcing/business development know-how or deep operating networks. The best firm platforms have devoted considerable time and resources to the growth of these capabilities within their firms and have spent considerable time learning how best to leverage these resources to drive value in their portfolio companies. These differentiating qualities also enable them to attract talented professionals to their platforms and to win deals against their competitors in this tough transaction environment.

Expanding a fund’s platform is not for the faint of heart, but the private equity industry has a strong culture of entrepreneurial spirt, so we expect platforms to continue to expand. We encourage groups to be thoughtful in how they look to expand their efforts and to maintain a sense of self-awareness throughout the process. The hardest part of any expansion is trying to hold on to your core identity while fulfilling a vision for the firm’s future. Building a business while protecting it can feel like standing with your feet on two floating logs as they slowly drift a part, but when executed well, it can mean the difference between managing capital and building a business with longevity.

Sixpoint has had the good fortune of being able to assist numerous firms with expanding their fund platforms and expects the current market conditions to favor these expansion efforts with groups prepared to make the necessary investment of time and resources.

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