Fundamentals of Private Equity and Venture Capital - PEI Media

GETTING THE MOST OUT OF THIS MODULE
Welcome to Module 3 in the Fundamentals of private equity series. This module
focuses on structuring and raising a fund. It is designed to work both as a stand
alone section and as part of the whole series. It necessarily draws upon topics
reviewed in earlier modules, and seeks to avoid repetition of their content.
However, for the benefit of the stand alone reader, a comprehensive glossary has
been incorporated, which explains the background and use of private equity terminology.
All terms which may require explanation or expansion are printed in
bold, to indicate that there is a glossary entry for them.
Terminology
It is difficult to avoid confusion in the use of generic terms such as management,
investor and investment when discussing private equity at the fundraising level.
The private equity fund is the core part of the process. It raises money from
investors (who in turn are themselves managers of investment funds), and is managed
by a private equity firm, often referred to as a general partner, but also as a
manager or a management team. It then makes investments (hence becoming an
investor) in private companies which in turn have their own management teams.
We therefore need to be careful in our choice of terms for the various participants.
By institutional investors, investors or limited partners, we mean the
pension funds, insurance companies and the like who allocate capital to private
equity funds. By private equity firm, fund manager or general partner, we
mean the specialist teams who raise private equity funds and are responsible for
making and managing investments in individual companies.
Raising a new fund is an event of singular strategic
importance for a private equity firm. The
firm’s future is, in effect, placed into the hands of
the institutional investors; the pension funds,
insurance companies and endowment trusts
whose capital allocation decisions, as we saw in
Module 2, are a key influence in shaping the private
equity industry. These investors will, by
choosing whether or not to participate in the
fund, either provide a mandate for continued
growth or cast a collective vote of no confidence
from which very few managers will recover.
The complexity of the fundraising process matches
its strategic significance, as every aspect of the
firm’s investment focus, track record, competence,
people and processes is laid open to
intense scrutiny and questioning. In many
respects this represents a mirror image of the
approach the private equity firm will itself use in
appraising investment opportunities, although
they differ considerably in detail.
The combination of these two factors – the strategic
importance and the extensive demands of the
process – requires that the fundraising exercise is
planned, launched and executed on the basis of
extensive research, a compelling business case
and close attention to detail. This module
reviews the process by starting with the strategic,
commercial and marketing aspects before moving
on to consider the various ways in which
funds are structured and the terms under which
they are managed.
Fundraising – making the case
Every year, more than 400 new funds are
launched, 1 of which typically less than half reach
a first close (i.e. raise the minimum amount
required). Superficially this would indicate that
the sheer volume of funds seeking capital will
make it difficult for any single one to draw attention,
and that there is a medium risk of failure.
However, all funds – and geographies – are far
COPYING WITHOUT PERMISSION IS UNLAWFUL
THE FUNDAMENTALS OF PRIVATE EQUITY 5