Foundational Steps to Setting Up a Private Equity Fund

Foundational Steps to Setting Up a Private Equity Fund

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Have the right qualifications, experience and skills set

Private equity partners should undoubtedly have university education, often followed up with complementary post graduate professional qualifications. Private equity practitioners include chartered accountants, those with MBAs or actuarial degrees, or the global Chartered Financial Analyst qualification.

They can also include less finance-specific qualifications – for example, degrees in computer science/information technology, engineering, chemistry and agriculture.

Equally important is long, hard experience in the field, whether at an existing private equity firm, or at an investment house where doing deals and managing business assets is the central focus.

A credible private equity practitioner requires deep expertise in leading investment deals through all stages of the investment cycle, from sourcing and structuring deals, to value creation and exits.

Related: Private Equity Directory

A unique investment thesis must be clearly defined and demonstrated

A private equity business must demonstrate a unique investment thesis that matches the skills set and experience of its team members. For example, if you aim to specialise in start-up technology firms, African agriculture or infrastructure, there must be the experience, skills and networks to back up this vision.

Your target investments must also be consistent with the appetite of institutional investors. Various sectors come into fashion and then lose appeal, so you have to offer investment opportunities that resonate with investors at that particular time in the economic cycle.

 

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When the investment thesis is clearly established, only then should potential investors be approached. These discussions can be jump-started by highlighting your strong networks and business-building skills.

Get references from management of investee companies and professional services providers who have worked with you and the team in your previous positions. A private equity fund manager must also be able to demonstrate the rigour of its investment processes when assessing and then investing in target companies.

Don’t disguise failed investments you may have had; rather, transparently use these experiences to highlight how you have refined and improved your investment thesis and adapted processes.

Hand-pick your team – chemistry and passion are key to success

A private equity team is together for the long (long!) haul, so there must be complementary experience and chemistry, and a good combination of operational and finance skills. You need a passionate team to get through the gruelling fundraising process. And all key staff must have significant personal capital invested in the fund – so-called “skin in the game”, so be clear on terms that require the team to make monetary commitments to the fund.

Tap into the right investors

Private equity fund managers are ultimately accountable to investors, be they retirement funds, development finance institutions, sovereign wealth funds, or family offices, and these can be local and international. So the close alignment of the interests of investors to those of the fund manager’s investment thesis is crucial, to ensure longstanding and supportive partnerships.

Before you start talking to investors, decide on which agreement terms can be modified or changed, and which are not up for negotiation. The market for fundraising is a crowded one, with many players chasing the same financiers, so terms and structures may have to be altered in order to attract the attention of the finite pool of lenders.

For example, are you willing to offer economic or governance incentives to cornerstone or first-close investors? In rare instances, it may be necessary to turn away funding commitments if investor interests are not aligned with yours.

Nurture networks in order to build and maintain the deal pipeline

Sustainable private equity requires solid and dependable deal flow. Successes need to be replicated at regular intervals, and infrequent opportunities will deter investors.

A private equity firm must show that it will be able regularly to source attractive deals consistent with its investment thesis. This means building longstanding relationships with lawyers, advisors, placement agents, intermediary brokers, professional associations and experienced investors.

Set off with patience, and become a master of change management

Each step is likely to take longer than you expect. Private equity practitioners will admit to feeling overwhelmed and even disillusioned at times. The fundraising process can be challenging and disheartening.

Related: Private Equity vs Hedge Funds

 

Potential investments require extensive due diligence and many come to nothing. This is an industry with multiple legal and regulatory hurdles and requirements. And it can be a long journey and the time it takes to establish reputation, relationships and industry credibility should not be underestimated, and cannot be short-circuited. Have a clear short-, medium- and long-term vision for your business – while being flexible and adaptable when required.

Erika Van Der Merwe
Erika van der Merwe is CEO of the South African Venture Capital & Private Equity Association (SAVCA), a non-profit member organisation whose objective is to promote venture capital and private equity in South Africa. It has around 100 members, who collectively account for about R130bn in assets under management. Van der Merwe holds the Chartered Financial Analyst (CFA) accreditation and has a master’s degree in economics from Cambridge University and from the former University of Natal. She joined the board of the CFA SA Society in 2012.