Private Equity Fundraising: The Fundamentals

Briefing

Q4

2013

Based on the Privcap thought leadership series “PE Fundraising Survival Guide”

Plus: Expert Q&A with Lina Russo, Partner, MVision

Sponsored by

Privcap Briefing • Private Equity Fundraising: The Fundamentals | Q4 2013 / 2

EXPERT TAKEAWAYS /

Private Equity Fundraising: The Fundamentals

Key Findings

1. Emerging managers need vision and focus2. Want to impress LPs? Show a pipeline, do a deal3. Investors can forgive bad luck, but not bad investment processes4. Downplaying bad deals makes the situation worse5. When adding new strategies, don’t look like an “asset gatherer”

Mounir Guen CEO, MVision

The Panelists

Hussein Khalifa Partner, MVision

Muhannad Qubbaj Managing Director, Gulf Capital

Lina Russo Partner, MVision

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EXPERT TAKEAWAYS /

1. Emerging managers need vision and focus.

GPs are, by nature, confident people. But many manag-ers new to private equity worry: Will I be able to raise my first fund? My next fund?

LPs assess a number of qualities when evaluating a new manager. One of the first is vision. “If you don’t have a vision of what you want to do with your firm, what your investment strategy is and what you’re going

to build, it’s difficult even to get a meeting with an LP today,” Hussein Khalifa of MVision said. “This is a very crowded market. Without an established track record, you have to have something that will inspire excite-ment and allow an investor to take a risk.”

Not every new firm has such a vision. Plenty of smart people who want to work together aren’t sure of the best approach. That kind of indecision can be damag-ing. Lina Russo, a partner at MVision, said she looked for groups that could focus on a particular area of expertise. “Someone may not have the most exciting investment strategy we’ve ever seen,” she said, “but if they have a laser focus, know exactly what they’re good at, and have an ability to execute on it, that is actually quite compel-ling to investors.”

2. Want to impress LPs? Show a pipeline, do a deal.

Russo added the caveat that any emerging manager, grand as his or her vision may be, would have a bet-ter chance of raising a fund with a track record, even a brief one. “Even limited partners entirely dedicated to investing in emerging managers have a difficult time stomaching GPs who come in with a white sheet of pa-per,” she said.

If there is no track record, hypothetical deals can help. “Come to us with a deal that needs to be done and let’s figure out how to get that deal financed,” MVision chief executive officer Mounir Guen suggested. “That would be proof of your model.”

Gulf Capital managing director Muhannad Qubbaj said that when his firm raised its current fund, it at-tracted international institutions that had never in-vested in the region by proving its thesis ahead of time. “We said, ‘This is our focus area, these are our focus sec-tors, and we can find deals.’ And as a highly capitalized firm, Gulf Capital was able to invest from its balance sheet and find, during the marketing period, two deals which fit the criteria geographically and sectorally. So when LPs came, they did due diligence on two deals that were live and were going into the fund. It didn’t have a black-box feel.”

Few newly minted GPs are as flush as Gulf Capital.

What does it take for first-time managers to successfully raise a fund? It takes a proven ability to find and finance deals, even if man-agers have to use “shoestring, bubblegum, and bandages” to do it, Guen said.

“What people fail to realize is that the fund-raise can easily take 24 months,” he said. “And by the time you close your fund, it’s going to take another six to 12 months to do a deal. That’s not going to cut it.”

The onus is on new managers to be resource-ful and do deals however they can. That’s the only way to make LPs comfortable with a new fund. “We had one client that borrowed from anyone they could to put together the deal fi-nancing,” Guen said. “They did refinancings; they had in-laws chip in; they invested their own money; they pushed the sale price down as far they could.”

Shoestring, Bubblegum, and Bandages

Mounir Guen

Privcap Briefing • Private Equity Fundraising: The Fundamentals | Q4 2013 / 4

But even managers of modest means can show they have potential. A seed investment, for example, can demonstrate the team’s ability to make decisions and implement a strategic plan at a portfolio company.

The idea is to just do it. Borrow money. Pass the cup to friends and family. Guen recalled a Texas GP he once worked with who put out collection boxes on his end tables at home. “He leveraged every penny he could get, bought a bottling company, and never looked back.”

3. Investors can forgive bad luck, but not bad investment processes.

Dry holes are a reality in private equity, particularly when the economy tanks. Guen noted that even heavy hitters strike out. “Some of the household names of today’s business have had challenging investments. They’ve had bad investments that were large portions of their portfolio.”

LPs understand that empty deals happen and forgive them. But they don’t accept systematic flaws in a firm’s investment process. “The problem comes when it’s bad judgment,” Guen said, “when a GP goes recklessly into a sector or company that had very limited upside because they believed the world would transform itself. At that point, you start touching on intangibles. The nature of an investor is to walk away, because it’s not as if they’re lacking in choice.”

4. Downplaying bad deals makes the situation worse.

As with most bad news, it’s best not to hide it.“Communication is key, and it has to be immediate,”

Qubbaj said. “In today’s world, the press is quite vicious. And if anything happens to a company—if it goes belly-up, if there are issues with the management—it could leak to the press. You want to make sure your LPs hear everything firsthand from you as soon as possible.”

Just as GPs should never try to hide their mistakes from LPs, they also need to learn from them. “There has to be trust,” Russo said. “If there is no trust, there is no fund. And creating trust means clear communication, transparency, honesty, and commitment to change.

EXPERT TAKEAWAYS /

That’s where you get credibility with the LP communi-ty—because you have that self-awareness. You’re trans-parent; you’ve given the mea culpa; you’re not trying to hide.”

Most private equity firms have a few skele-tons in their deal closet. And those old bones will come back to haunt a firm when it’s time to raise the next fund.

Even the biggest names in the business have had their share of challenging investments. What counts is how they communicate those failures to LPs. Should firms admit they made a mistake and vow never to invest in that sector again? Should they explain to investors in detail what happened and never do a deal of that size again? Or should they just fire the partner who was responsible for the bad deal?

Many firms choose the last approach, but that can backfire with LPs. “It’s very diffi-cult to fire the person responsible, because ultimately everybody is responsible,” Khalifa explained. “Generally a fund is a team that works by consensus. So the people doing the firing tend to be the people who were origi-nally involved in that decision. So they need to think very carefully about trying to pin the blame on one person, because that’s a story that LPs just won’t buy today.”

The Blame Game

Hussein Khalifa

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EXPERT TAKEAWAYS /

5. When adding new strategies, don’t look like an “asset gatherer”.

A lot of GPs have an ambition to expand into new strat-egies, perhaps from buyouts to real estate, then from real estate to credit. Or into new regions. But many are not sure how to pull it off and how how to convince investors to back the move

“There are many new groups that come to us with ideas,” Khalifa said. “Some of them make a lot of sense, because they’re matching the opportunity with their skill set. And some of them, quite frankly, are outland-ish.”

He recalled a group in Italy that wanted to do deals in China when China was a hot new market, even though five of the six general partners had never been to Chi-na. Similarly, a U.S. firm tried to raise a Latin American fund because it had a large Mexican population in its state and figured this naturally bestowed insight to the Latin American market.

LPs won’t sanction a new strategy unless they are confident that the GPs truly have the appropriate skills. “If the GP has something unique, or approaches the op-portunity from a different angle, or has an ability to source opportunities that differentiates them from the other folks in the mix, that’s great,” Russo said. “If it’s for asset gathering—and we know there are folks out there who are just looking for a platform for the sake of a platform—that is quite dangerous. And frankly, LPs see right through it.”•

The PE marketplace is increasingly competi-tive. To raise a new fund and survive, man-agers must have vision. They need a clear in-vestment strategy and to know exactly what type of firm they want to build.

“Our CEO and chairman had a vision that they shared,” Qubbaj explained. “Instead of following current trends, they took a unique approach. They focused on a certain geogra-phy, and then they focused again on a cer-tain strategy within that region.”

Rather than concentrate on 20-plus coun-tries around the Middle East and North Af-rica, Gulf Capital focused on the Gulf region and on specific asset classes within it. In-stead of investing in minority opportunities, Gulf took majority ownerships in companies where it could add real value.

“The demand was there, the raw materials were there, the demographics were there. That all came together in a very nice story and a great vision,” Qubbaj said. With that vision, Gulf Capital was able to lure interna-tional institutions to make their first invest-ments in the region.

The Vision Thing

Muhannad Qubbaj

MVision is the sponsor of this briefing and the corresponding thought-leadership series.

Expert Q&A with Lina Russo,

Partner MVision

Please contact Lina Russo at lr@mvision.com • www.mvision.com

We spend an enormous amount of time getting to know the general partner, understanding the team, their track record and conducting

the same diligence that a limited partner would conduct. Making refer-ence calls, and building that knowledge base allows us to understand the GP. Our knowledge and insights that we have from the LP community, engaging with them and transacting with them globally, allows us to cre-ate very targeted fundraising.

From a limited partner’s perspective, we’re able to then share all of the information that we gleaned during our own diligence process and allow them to then facilitate and accelerate their diligence process.

We have lots of our managers come back to us fund after fund, and that’s because we’re more than just an agent that’s helping them with a particular transaction. We’re an advisor that works with them to help them build their business, to help them in between fundraisings, and to create a very transparent communication link to their LPs, both existing and prospective.

What is unique about the waythat MVision approaches the

fundraising market?

The sight of geese flying in a ‘V’ formation is familiar around the world. They do so to increase their flight efficiency; in fact, their performance is 71% better than that of an individual bird flying alone. The birds also encourage each other while in formation to maintain their speed.

At MVision, we command streamlined execution tactics evolved over a decade of resourcefulness, investor relationships and knowledge to achieve our clients’ goals.

To us, performance is everything

Learn more atwww.mvision.com

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Series / Fundraising

Watch the series in its entirety at Privcap.com

How to Fundraise with a Challenged Track Record Adding Strategies, Expanding the GP Franchise Wanted: Emerging Managers with Vision Lina Russo Expert Q&A

This thought-leadership series is sponsored by MVision.