The Guidebook to Spinning Out

Spinning out can be a vertigo-inducing proposition even for the most seasoned private equity professional – the process is highly complicated and fraught with risks. From the outset, anyone thinking of spinning out will have to make peace with the associated discomfort and realize that these challenges come with the territory.

All that being said, there are certainly steps that you can take to make the process as seamless as possible and land on your feet once you have spun out. Broadly speaking, the process of spinning out can be broken down into three major categories – each representing a different stakeholder in the process:

  1. Internal Dynamics: In the early stages of spinning out, it is crucial to gauge whether or not your existing partners will be supportive – or at least not disruptive – to your plans. This is a delicate process and the ensuing negotiations will have a meaningful impact on your future fundraise once you have spun out. In an ideal world, you should aim to come out of these negotiations with formal attribution on the deals that you led, or at the very least a referenceable unofficial track record. Both parties – you and your firm – have an interest in making the split amicable, and in that vein you should keep in mind that they do not hold all of the cards. Items such as which partners leave with you, how you manage the existing portfolio, and messaging to LPs after you spin out are all important to your firm and should be managed in a cooperative departure.
  2. Finding a capital provider: Finding a reliable anchor LP is another important piece in the process of spinning out. Having a blue-chip partner to anchor your fund will allow you to negotiate with your existing firm from a position of strength while giving you the conviction to move forward quickly. This will also serve as a testament to the quality of your new firm when you officially launch your fund. A quality advisor will be able to hold a discreet “whisper campaign” to specific LPs that could be interested in anchoring your fund. Feedback from these early meetings are an invaluable way to validate your story and find the holes that need to be filled before departing (or soon after). While having these conversations, be mindful of the fact that for a first-time fund, anchor LPs will often demand attractive terms around the investment period, fund governance rights, GP stakes and prioritization on co-invest opportunities. Also be mindful of any non-competes and non-solicit restrictions. A quality advisor can guide you to multiple LPs who will be interested in anchoring your fund in order to create some competitive tension around the terms.
  3. Team: At the end of the day, the success of your spin-out will be wedded to the quality of the team that spins out with you. Remember that your new firm will be equally judged by the quality and track record of your partners. The size of your team should be determined based on the size of your fund – generically speaking you should target having two or three partners spin out with you. Beyond track record, having significant professional overlap with your new partners is key to improving your chances of success. LPs are very mindful of “GP Risk” while underwriting first-time funds – the risk that the senior members of the team will not be able to work well together – so having a long history of working together will help allay these concerns. Don’t limit your search to just your existing partners – ex-colleagues from other firms, operating partners or previously departed colleagues are also good candidates to join your new spin-out. Overlap matters less for junior professionals – LPs are mainly concerned about the senior team.

Spinning out is a notoriously complex process, so take time to find a quality advisor who has experience raising first-time funds. Endeavour to be cooperative and constructive upon exit. As you venture to make possibly the boldest move in your career, take comfort in the fact that it has all been done before. With the right care and discretion taken throughout the process, there is no reason why you should hold yourself back from at least exploring the possibility of spinning out.

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