In recent years, private equity investments have been a profitable asset class, beating the S&P 500 Index and gaining broad interest from investment firms and high-net-worth individuals. As demand for alternative assets in private equity continues to rise, new managers will have to emerge to give investors better chances of earning significant returns. Most investment firms are small to medium-sized businesses with two to several hundred people. Here are the five procedures managers should take before launching a private equity firm.
1. Define Your Strategy
To begin, develop your strategy and separate your investment plan from your rivals. This necessitates an extensive, in-depth study of a certain market or industry. It is critical to identify market patterns. Most investors are only concerned with one thing: profits. Where do you see getting the highest profits? Make sure you quantify this in years.
You must discover the ‘secret recipe.’ Learn everything you can about your chosen field so that you are not only knowledgeable about the background but can also forecast future events. In this approach, you may promote yourself as a source of true expert and thought leader to investors.
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2. Create a Business Plan
The second stage is to create a plan which analyzes cash flow forecasts and sets the timeframe for your private equity fund, including the time it will take to raise funds and exit strategies from portfolio investments. Each fund typically has a 10-year life cycle; however, timings are ultimately up to the fund manager’s decision. A good business plan includes a strategy for how the fund will expand over time, a marketing plan for attracting new investors, and a summary that connects all of these parts and goals. Another critical step is to create a company and fund name.
After creating the business plan, establish an external team of advisors, including independent accountants, lawyers, and industry consultants, to give insight into the markets of the firms in your portfolio.
3. Determine The Ideal Fee Structure
This influences what you and your investors earn. As a general partner, you should make provisions for administration costs, carried interest, and other performance hurdle rates.
We’ve found that a GP typically earns 2% of pledged cash from investors. So, for every 10 million dollars from investors, the fund manager will receive $200,000 in private equity fund administration services fees yearly. However, less skilled or rising fund managers may be paid a lower management fee to draw fresh capital.
Carried interest is typically 20% higher than the projected return level. If the fund’s hurdle rate is 5%, you and your investors will divide profits at a 20/80 proportion. It is critical to create guidelines for the fund’s risk, compliance, and valuation. This way you are prepared for any unfortunate financial occurrence.
4. Determine Your Investment Vehicle
After operations are set up, create your fund’s legal framework. A fund in the United States is often structured as a limited liability company or a limited partnership. As the fund’s creator, you will serve as a general partner, which means you will have the authority to select the fund’s investments.
Your investors would be limited partners with no say over which firms are included in the portfolio. Limited partners are solely liable for losses associated with their particular investment. In contrast, general partners are responsible for any extra losses within the firm as well as liabilities to the larger market.
Finally, your attorney will create a private placement memorandum as well as any additional operational agreements, like articles of incorporation or limited partnership agreements.
5. Raise Funds
To raise capital, you’ll need appropriate marketing materials. As a first-time fund manager, you should highlight your track record and experience – remember, an impressive track record of working in investment companies will enhance your ability to raise funds.
Convincing people to join your fund might be difficult; you must demonstrate your knowledge, which relates to the first point about developing a good business plan. You may also hire a placement agency to assist you in marketing the fund.
Over the previous two decades, private equity holdings have outperformed the larger US markets. As a result, investors looking for innovative ways to achieve greater returns have raised their demand. The five procedures outlined above can serve as a road map for building a successful fund.