How To Start A Private Equity Fund
According to great financial advisors, you should make your money work for you instead of you working for money. This is the main reason why we explore for ways to earn money passively. One way of doing so is to start a private equity fund.
If you are interested, then let us dive into the wonderful world of finance and learn all about a private equity fund!
What Is A Private Equity Fund?
If you are looking for other investment options besides public exchange, you can try investing in one of the best alternative investment classes: private equity. Investors in private equity directly invest in private companies or participate in buyouts of previously public firms that had their public equity delisted.
Capital invested in private equity is generally used to fund research, acquisitions, business expansions, or just to contribute to a firm’s stronger balance sheet.
In a private equity fund, an investor can be categorized into one of two investor relationships: Limited Partners (LP) or General Partners (GP). LPs have limited liability and own 99 percent of the shares in the private equity fund, while GPs have full liability and own the remaining 1 percent of the share-owners. GPs are usually those who plan, execute, and operate the investment fund’s assets.
Private equity investors are generally institutional or accredited investors who can afford to set aside money for long-term investments and are capable of risking huge amounts of money.
Private equity funds often require longer holding periods than other investment options and short-term investors may not be satisfied with it.
The reason for a private equity fund’s longer holding periods is to allow liquidity events to occur. An example of a liquidity event can be Initial Public Offering (IPO),an event where a company launches its assets on the stock market for public trading and also a profitable event for investors of that certain company.
Starting A Private Equity
Before you start investing for a private equity fund, you must understand that size of a firm is not an absolute indicator of success for this investment option. Firm sizes can range from just 10 employees to 1000 employees. Out of these firms, here are a few that have been largely successful: Goldman Sachs Capital Partners, TPG Capital, and Blackstone Group
Here are a few steps that fund managers—and even you—can follow to start a private equity fund successfully.
Define the Business Strategy
It is important to start right and do some relevant research. Spending time on books about investment markets or industries that you would focus on would help you define a crystal-clear business strategy.
Aside from the necessary research, you also need to set your fund’s objective and goal. Keep in mind that a private equity fund is not publicly traded so it is better to focus on achieving one outcome at a time.
A clear business strategy would be your guide to every step along the way. It is crucial that you have a unique plan so that you can get ahead of your competitors and the usual short-lived trends. This would also help you attract investors since they would be well-guided on the goals and can set expectations accordingly.
Business Plan, Operations Setup
The next step is drafting and finalizing the business plan. This would specify cash flow expectations, set the timeline for your private equity fund, and an executive summary. It is important to set realistic expectations and to give at least 10 years to the timeline for your fund to perform accordingly.
After the business plan, you should set up the foundations of your business operations. Start by thinking of a firm and fund name, then establish a board that can guide your business operations. This can consist of a board of advisors who you can consult for business development and provide investment insights about the firms in your portfolio.
After registering your firm and fund name, you establish the top-level roles. You must set up your C-suite: the CEO, CFO, CTO, and COO. Then, you can coordinate with your C-suite for business continuity strategies or disaster recovery strategies.
Moreover, you also have to acquire the necessities for your operations, such as office space, communication systems, and data infrastructures. Lastly, you need to fill the lower positions in your workforce. Be sure to plan and coordinate with your C-Suite about the workforce’s compensation package and hiring details.
Establish the Investment Vehicle
Once the roots of your operations are firmly planted, it is time to set up a legal structure that would allow your fund to yield great results. For example, private equity funds in the U.S. have a limited partnership or limited liability legal structure. After a legal structure has been decided upon, your lawyer/s would have to draft and finalize a binding agreement such as a Limited.
Partnership Agreement that would state each stakeholder’s responsibility for the fund and the business operations.
As the owner, you will be a General Partner or GP, which means you have the decision-making power over which assets your fund will invest in, but you will have more liabilities. Your fund’s investors would be Limited Partners or LP, which means they will not have any executive power over your operations, but they need to get their Return on Investment (ROI), and they would only be liable for losses at their own expense.
Raise Capital
The last and probably the hardest step in starting a private equity fund is attracting investors to pool their capital with yours.
Aside from committing a significant amount of your money as capital, it would help if you got like-minded investors on board to contribute to your fund’s goals, which are, ultimately, your goals. So aside from your investment background and strategy, you also need to rely on your marketing strategy to get investors for your fund.
And if this is not challenging enough, keep in mind that most governments have regulated the type of investors eligible for private equity funds. You can only get institutional or accredited investors to help raise your fund’s capital.
Institutional investors can be insurance firms or banks while accredited investors are private individuals who have legally obtained an annual income threshold of at least 1 million USD and their income has been verified by authorities.
Substantial capital can help you or your fund managers to strategize on which assets would be invested on. Furthermore, it can help to ensure the continuity of your operations and also to make it possible for your fund to achieve the investor’s and your expectations set upon it.
Something To Ponder On
Choosing where to spend your money is a tricky thing to do because of the risks involved, more so when you are selecting profitable opportunities. Although, your money will be as good as gone too if you would just treat it idly.
It is best to treat each risk seriously and then weigh them against your financial options especially if you are considering opening a private equity fund which requires long-term dedication to your investment.