Starting a first-time fund can be likened to opening an asset management startup. Most aspiring fund managers face an uphill battle to close their first fund, with the process taking, on average, nearly two years. Like founders, they need to find product-market fit for their investment thesis, have a compelling story, a deep understanding of the market and know how to differentiate themselves and stand out from their peers. Most first-time funds fail, as they are unable to reach a sustainable AUM or secure the funding they need to cover their business costs.
But it’s not all bleak for first-time fund managers. Many limited partners (LPs) are drawn to the “hungry” energy and drive to excel exhibited by aspiring fund managers, along with their perceived financial outperformance and as a result, have slowly started to show increased interest in allocating capital to first-time funds. Here we dive into the landscape for first-time fund managers, exploring some current market trends and best practices for success.
What is a first-time fund manager?
A first-time fund manager is any person who is raising a fund for the first time. However, first time fund managers are almost never first-time investors. Most commonly, they have built careers at large, established firms before spinning off to launch their own fund. The majority of first-time fund managers have a long track record of leading deals and investments and honing their craft.
The market landscape for first-time fund managers
Gaining the trust and commitments of LPs is traditionally a hard undertaking for first-time fund managers. From an LP’s perspective, investing in a first-time fund is typically a much riskier endeavor than allocating to more experienced managers, whose investment team has a tested and proven framework for assessing deals and sourcing winning opportunities.
But that story may be changing—slightly. LP interest in first-time funds has slowly started to gain some momentum, with first-time fundraising occurring at a higher pace in recent years—especially in venture funds. However, while it may be easier to raise a first-time fund than it was a decade ago, the landscape for first-time fund managers is still extremely competitive. There are more managers competing for the same LP and founder attention, and with the market volatility and downturn experienced to date in 2022, LPs are already showing preference toward reupping existing relationships or allocating to trusted names.
In the current environment, gaining the confidence of risk-averse LPs requires extra diligence and the ability to showcase not only your track record as a successful investor, but also your vision and how it’s different from that of other general partners (GPs). Below are some top considerations to keep in mind when raising your first-time fund.
Top tips for first-time fund managers
Plan for operational challenges
First time fund managers essentially have two full time jobs: investor and business owner, which means managing employees, payroll and administrative duties at the same time as sourcing deals and identifying lucrative opportunities. Running the business side of a fund comes with a lot of operational hurdles, and these administrative challenges are often overlooked.
If you have the resources, it can be helpful to outsource administrative tasks, like accounting, onboarding, investor reporting, distributions, etc., to fund service providers. This can allow you to focus solely on sourcing LPs and securing your first close.
LPs are aware of these operational and administrative hurdles, and it’s likely they’ll come up in meetings. Typically, they will want to know if they can trust you to focus all your efforts on identifying and executing deals, or if you’ll also be running the back of shop. Being able to tell LPs that you have a fund administrator handling your operational needs can be advantageous to gaining trust.
Determine your fund structure and portfolio strategy
As a first-time fund manager, it’s essential to consider the structure, jurisdiction and reporting framework of your fund, and ideally optimize your choices to be “LP-friendly” and tax favorable. For example, you may choose to restrict your fund to certain geographies to reduce complexity or limit your fund to US-based investors to avoid the extensive regulations associated with opening a fund to investors outside of the US.
Setting up shop before knowing who your LPs poses its own challenges. It’s hard to optimize a fund for the right LPs when you don’t know who they will be, but LP shopping can be more challenging without having a structure or established term sheet.
You’ll also want to define a clear capital allocation strategy and portfolio construction, determining factors, such as the ticket size of your investments, target ownership percentages and your fund size. You should also be able to articulate your expected fund performance, detailing the assumptions behind your model based on industry benchmarks or performance criteria on similar funds.
Identify the right LPs for your fund
Maybe the most important consideration for first-time fund managers is identifying the best LP prospects for their fund. When you’re starting out, it’s tempting to cast a large net or take every meeting and hope for a check. This isn’t a very strategic approach and tends to result in unnecessarily wasted time and resources. What’s the point of pitching to a pension fund that’s never committed to a first-time fund, doesn’t write checks in your size target or doesn’t invest in your sector?
Aspiring GPs need to be intentional about creating their LP network and audience. LPs take on a broad spectrum, ranging from family offices to big institutions with AUMs in the high billions. Different LPs have varying investment ethos, risk tolerances, strategies and goals. Setting yourself up for success in the fundraising process means taking the time to diligence LP prospects and identify suitable targets for your fund. Not every investor will be a good fit—and that’s okay.
Gather as much information on potential LPs as possible. Who have they worked with in the past? Have they committed to a first-time fund before? Benchmark the returns of that fund—was it successful? If it has a strong IRR, maybe they’d be willing to invest in a first-time fund again. What stages, sectors, geographies and check sizes do they prefer? Commitment sizes are a biggie. Many LPs want to write larger checks, and most first-time fund managers can only take on smaller commitments.
In short, gather as much information as possible before making a pitch. The goal is to construct a targeted list of LPs that align with your brand as a fund, so it’s easy to advocate for your strategy and its unique attributes because you know your pitching LPs who are aligned with what you have to offer.
While all LPs are different some groups share common characteristics, here are a couple of general attributes to consider with common LP types:
- Family offices: Family offices have historically been an important LP for first-time fund managers, as they are typically the most active backers of first-time funds, provide flexible capital and are not restrained by traditional investing practices.
- Funds of funds: Funds of funds are typically ready and willing LPs, making them another popular option for first-time fund managers. They will often write checks faster than other LPs—however, funds of funds are unique in that they too, are raising their own funds, which can make timing an issue.
- Institutions: Endowments, pension funds, large corporations, etc., have typically been the hardest LP group to get on board with first-time funds. Institutions tend to want to write larger checks, and their investing methods are more traditional—requiring extensive due diligence. But institutions can anchor funds and are increasingly attracted to the favorable economics and co-investment rights that can be associated with first-time funds.
Pitching to LPs
Once you’ve identified target LPs for your fund, it’s time to sell them on your vision. Pitching to LPs is a lot like pitching a pre-seed startup—there’s a limited track record to go off, so the pitch needs to tell a strong story and showcase the value of the team. Differentiation is key—aspiring managers need to demonstrate what makes them special. What’s your story, edge and investment thesis, and how are they different from the competition?
Cover the nuts and bolts
Summarize the framework of the fund. Provide investors with your estimated fund size, what stage, geography and sector you’ll focus on and preferred timeline to close. Your track record and history will be top of mind for LPs. Show your success as an investor in the past, discussing experiences and deals in your chosen market and niche that have shaped your investment approach. If you have a team, be sure to articulate your collective experience and history working together. One area LPs tend to have concerns is with partners—they want to feel confident that you’ll work well together.
Showcase your investment thesis
You need to pitch a well-defined investment thesis to LPs. This should cover anything from your broader view on market opportunities and approach to investing to specific underlying principles and frameworks that will guide how you assess prospects. Detail the type of opportunities and companies you will focus on. Discuss the verticals, business models and market space you want to target and explain why you are uniquely fit to do so. If you are focusing on a particular market, show LPs why now is the right time to commit capital to that opportunity.
Differentiate yourself from the crowd
As a first-time fund manager, there’s a high bar to get LPs to invest—and you’ll need to stand out more than your veteran peers. With no shortage of other options for capital commitments, differentiating your fund to LPs is key. PE managers selling just another middle market buyout strategy or VC managers pitching SaaS roundups in Silicon Valley won’t leave LPs sitting on the edge of their seat with their checkbooks in hand. Do you take a geographical focus, investing in companies near you, becoming more of an operational partner rather than financially engineering their success? Think about your edge in the investment value chain. What is your “special sauce” when it comes to identifying, supporting and ultimately winning investments? Demonstrating how you personally resonate with your investment ethos will go a long way in a crowded market. Do you only invest in businesses of a certain size and scope? Find what makes you special—and own it. #CrescentBitCapital
Include your terms and any special fund economics
Lastly, you’ll want to outline your fee structure and any deal sweeteners or preferential economics you’re willing to offer to LPs. Using selling points like co-investment rights, warehousing options, seed structures or anchor carry fees and discounts is an effective way to create a sense of urgency in your fundraising and speed up the process. However, the pros and cons of offering preferential economics should be weighed over an extended time horizon to ensure you’re entering a good deal for you—a topic discussed in detail in our analyst note Seeding and anchoring PE managers: options for accelerating the first-time fundraise.
CrescentBitCapital guide for first time fund managers
From determining whether to take seed or anchor deals and portfolio construction to pitching LPs and securing commitments, this guide examines top strategies for success in the emerging manager ecosystem.
Download the guide
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Watch our webinar Private market fund performance: Spotlight on first-time and emerging managers
Learn how the first-time fund landscape has evolved since the Global Financial Crisis
Read our analyst note First-Time funds before the GFC