The First Fund is the Deepest
This isn't your typical fund closing announcement. We sent out the typical press release and had the typical calls with reporters who cover the industry. The private equity press has been super nice to us since we launched ParkerGale and we all appreciate their coverage. This blog post is a chance to go way deeper into our experience raising our first fund. We hope it helps others who might be thinking of raising a fund someday, all the GPs out there doing the hard work of raising money, trying to stay persistent without being a pest as you slog your way to the finish line. Keep your chin up, this is the stuff that builds character (like Chicago winters). Oh, and nobody really wants to hear you whine about it. So consider joining our support group. We meet the first Thursday of the month at the Billy Goat on Lower Wacker Drive. First round is on us.
We're not going to claim that fundraising was easy for us. That wasn't our experience and there just isn't much to learn from news like that. So, now that ParkerGale has officially closed our first fund with $240 million in commitments we want tell you how we got there.
We have already talked about starting ParkerGale before on the podcast, and the PE press has covered it pretty well, so I won't go too deep here. Way back in 2014 our team (Devin, Jim, Kristina, Ryan and Corey) decided to venture out on our own after running the technology sector group for Chicago Growth Partners, a fund with a long history dating back to William Blair Capital Partners. We were confident in our unique approach to small, bootstrapped technology company buyouts, our team was in-tact and we were focused on a segment of the market that others were leaving as they raised bigger funds. Howver, we weren't a name brand in the market and our track record was still largely unrealized at the time so we expected that fundraising would take a while. We spent the summer of 2014 talking to placement agents about the fundraising market for a story like ours. It was time well spent because we learned a lot from their experience with first time funds. Now, very few of these placement agents had any interest in taking on a $200 million first time spinout fund, but they were nice enough to take the meetings and give us feedback. We decided to spend the fall building out the data room (PPM, DDQ, track record, references, all that) so when we launched we did it with a fully armed and operational battle station. We set out thinking it would take two years to get the fund raised and we would have to cover all our costs out of our pockets. We didn't have a Plan B if it didn't work out and, looking back, that was a key part of our success.
Before we launched, we spent a lot of time thinking about the ideal fund size, the LP terms, portfolio construction, and what kind of firm we were trying to build over several funds. We chose to set the fund size below what we had invested at our prior fund in order to show investors that we weren't stretching out of our comfort zone. We launched with a $200 million target and a $225 million self-imposed hard cap to reassure LPs that we were committed to staying small. We also launched with a lot of "LP-friendly" terms -- not quite full ILPA but pretty close. We know LPs are looking for reasons for quick turn down given how many options they have and we didn't want terms, size, strategy or deployment to be easy reasons.
All our LPs are in the same fund. We don't have an executive fund, an offshore fund or any of that. We kept things simple and restricted our LPs to Qualified Purchasers. That caused us to turn away some great people who wanted to support us but we also wanted to have as few moving parts as possible on the fund management side of the house. We did not meet with LPs outside the US given some of the new fund regulations in Europe and due to the cost of trying to pull together a successful trip over there. Had things dragged out longer, maybe we would have changed our mind and gone through the registration process there, but in the end that wasn't necessary.
We believe a straightforward, transparent approach helps convince skeptical LPs we were worth a look. One big way we demonstrated this was in our DDQ we laid out everyone's comp, everyone's carry, our GP commitments, and our thoughts for what all this will look like in future funds, too. Not a lot of funds do this, but we think laying it all out across our team and for LPs to review demonstrates our commitment to transparency. Over the long run, we think it worked. We also believed if we did these three things well during fundraising we could build momentum: 1) take care of our portfolio companies from the prior fund; 2) find a deal (or two) for the new fund to show that we can source quality investments; and 3) get a few LPs to say yes and drive to a first close.
There are plenty of challenges for first time funds (and maybe we'll do a series on objection handling for fundraising), but here is the big one you need to consider before walking into any prospective LP meeting. Most every LP keeps a forward calendar of how much money they will commit and a general view of how it will be allocated across sectors or strategies or fund sizes. A lot of LPs call these "slots." A lot of LPs look ahead as much as 18-24 months as they track their current GP coming back to market, new relationships they want to add and new funds they want to keep on the radar. While you might think you've picked a great time to launch your fundraising, it's not so easy to synch up your timing with prospective LPs' forward calendars.
There are only three ways to land a Limited Partner: First, win one of their open slots. Second, take away a slot from another GP. Third, convince the LP to add a new slot just for you. Here's how you can find out where you stand in the first ten minutes of a meeting. Ask them about their program and finish up with "how many slots do you have this year?" They might say, "we want to invest $100 million in PE this year and we invest $10 million per fund." So now you know they have about ten slots. Then you can ask how many slots are already taken including expected re-ups with existing managers. That will give you a good sense of what you are up against. If it's June and eight of those ten slots are already committed and a couple of them went to funds that look a lot like you, that is going to be a tough LP to get. And it has nothing to do with you, so don't take it personally. Your goal with fundraising is to get in as many rooms as you can to find the LPs who have open slots for funds that look like you and then convince them that they should do some work on your fund. Problem is, you won't know what kind of room you are in until you sit down and start asking questions.
We stayed away from LPs until December 2014 when we held a few meetings with LPs who could write one big check that would put us in business, the ones who like to take big pieces of small funds. We didn't get any of those firms to bite, but we did make it a few rounds with one of them who put us through the diligence ringer and (even though we got a no) that helped to build our confidence. We also front-loaded these meetings for practice because no one was going to ding us for not landing a big whale LP right out of the gates, so we got in some reps before we really hit the road hard. And in January 2015, we hit it hard -- no placement agent, no advisors, just a PowerPoint, some plane tickets and a dream.
One of the side benefits of spending our collective careers being nice to LPs, taking meetings even when we weren't raising money, and having been through several fundraises over the years is that we were able to schedule a full slate of meetings that kicked off the fundraising process. One of them, a large family office, got behind us right out of the gates with a $20 million commitment. Wow! Were we in business or what? Now we just needed to get a few more tickets like that one and here comes the first close, right? Well, not so fast. We spent the next several months slogging away in intro meetings while keeping the new deal prospecting process as productive as we could.
To soothe our concerns, we kept coming back to those original three goals -- take care of the old portfolio, get a deal done, and drive to a first close. In April 2015, we found our first deal. It lined up well with our model -- a profitable, founder-owned, technology company that needed a CEO and some operating help. Just one problem. We didn't have any money to invest. Up to this point, everyone with an opinion on fundraising had told us, "just find a deal and the money will come." Well, this was our chance to test that theory. While the diligence was proving out and we were getting more committed to the deal, we had to do our best to keep the banker and the seller confident that we could get the deal done. In addition to vetting the deal, we had to raise the money. We also had to use the deal to drive some LPs (who were intrigued with our pitch but not yet ready to commit) into a first close. We got some great advice from some sagely folks to avoid the trap of the "pre-fund" deal. "No," they said, "get the deal into the fund no matter what. Sure, it's great to get a deal done, but a deal in the fund is worth way more than one outside the fund in the end." They were right.
This is one of the many dilemmas your face while fundraising. You are trying to raise a fund; LPs want to see a deal; you find a deal; LPs want to co-invest in that deal but they aren't ready to commit to the fund; you have way more co-invest interest than you need to get the deal done but little if any of that of that is ready to close in the fund; if you close the deal outside the fund, sure you've got a deal done, but future LPs will ding you for not having money to work in the fund and what about the j-curve, and the blind pool risk and the blah, blah, blah; but you can't close the deal in the fund if you don't have a first close done; oh, and nobody really wants to warehouse a deal for you as much as people talk about wanting to warehouse a deal for you; and it's just a vicious cycle and you want to pull your hair out.
In our case, we were able to use the first deal as an incentive to come into the first close. But it wasn't easy. We ended up with two warehouses, four LP co-investors, about one-third of the equity in the fund with the rest as no-fee, no-carry co-invest with LPs.
One quick note on charging fees and carry on co-invests. Sure, you can ask, and you probably can get away with it if you have an attractive deal with scarcity value, but if you are playing the long game and want to raise funds rather than just do deals, we think it's better to have your LPs in alongside you without always clipping a coupon off of them each time you bring them a deal. Will we personally make less money when we sell this first investment because of this approach? Absolutely. Were we feeling a little broke after funding the start-up costs and deal costs out of our own pockets? You bet we were. But always taking the last dollar you can get away with from our LPs is antithetical to our approach so, in the end, it was an easy decision for us for forgoe the economics. We had a few investors who would have given us great economics in the deal, but would never have come into the fund. But those weren't the kind of LPs we really wanted. We also didn't give any LP preferential treatment -- no fee breaks, no carry breaks, no contractual co-invest rights. We believe we should all be in this together on the same terms (and the LPs who joined us agreed) but this approach definitely cost us a few LPs and it definitely slowed down the fundraising process.
Our first close in September 2015 was a whopping $47 million. That big family office for $20 million, a fund-of-funds for $10 million (who just needed to see that first deal to get conviction), a small managed account for $5 million and whole bunch of individuals (CEOs, GPs from other funds, banker and lawyer friends). That helped us get our second deal done a month later. We gave away some co-invest on that one too, but about two-thirds of the equity from that deal was in the fund and we didn't need a warehouse this time. It took a lot of courage for our first-close LPs to say yes and it was not a long line of LPs who even considered it for us. So thanks first-close LPs! You're the best!
With two deals and a first close, we actually had a real update for LPs, so we hit the road again. By December 2015, we got to about $80 million behind $25 million from our biggest LP from the CGP days. We were kind of expecting it (hoping for it really) all along but what a great boost for us to get a returning LP and it gave us a great answer to that question all LPs were asking us: "So which of your LPs are coming back?” You'd think LPs would start piling in now, right? Wrong.
Why not? Because LPs already know what they are looking for. They are just trying to decide if you are worth spending any time on. Just like you know what kind of deals you are looking to invest in. You don't spend any time on the ones that don't fit. While you are out on the road fundraising, telling your story, you can't help but get wrapped up in the narrative. We call it "sucking your own exhaust". When you are in the zone telling your story, you actually start to believe it. And when LPs give you the blank stare from the other side of the table, or when they screwed up their schedule and you are standing in Charlotte for a meeting that they forgot to put on their calendar and the partner you are supposed to meet with is on a trip to NY instead, it hurts a little (ok, it hurts a lot). You gotta get over it. Courtney Barnett has a great song called "Nobody Really Cares if You Don't Go to the Party." That's how fundraising is. This isn't about you. Sure, it feels like it's about you. But it’s really about what the LPs are looking for at that moment. We didn't convince one LP to invest in a small, technology buyout fund. Instead, we convinced a couple handfuls of LPs who were already looking for small, technology buyout funds that, given the current options in the market, we were a good choice. Now, that is still really hard to do. But, no LP cared so much about ParkerGale that they changed their investment thesis just to fit us into their portfolio. Nobody really cared if we didn't show up to the meeting. There were probably ten other meetings that week and we would not have been missed.
After that second close in December 2015, sitting on about $80 million and eyes on about $100 million, we decided to bring on a placement agent. Our team spent that fall debating whether or not to do it. The advice from friends and the team's own feelings about the decision were about 50/50. We had only been in the market a year, we met some really great LPs and even convinced some of them to join us, we had a couple deals we could point to and the old portfolio was getting liquid. But, we were getting worried that we might not be able to keep up the volume of LP meetings while trying to do so much other stuff. Now that we had a fund (sure it was only $80 million, but it was officially a real fund at that point), our main objective was taking care of the investments. The decision to bring on a placement agent was ultimately about taking a critical, but time-consuming, activity off our plate. We had some momentum and we needed to keep pushing and we couldn't ensure that we could do a good job booking enough LP meetings to get us to the target.
A short detour on the placement agent business . . . we met some great people at a bunch of firms. We got some great advice. While they were generous with their time, few seriously considered taking us on as a client. I can't blame them -- we were an unknown team with an unrealized track record with no past LP support to kick start the raise. Other than that we really had a lot to offer! Now, fast-forward a year and we were halfway home with a couple deals, big support from a past LP and a pretty tight story. The problem for placement agents was they couldn't make any money on us now. Had they taken us before we launched when the risk was big, they would get to make a big fee, but now the fee opportunity wasn't interesting enough to commit the resources. You can imagine how excited we were to have those conversations. But we did bring one on that was boutique-y like us, that was just getting going on their own like us, and who had a similar approach to hitting the process hard, taking all the meetings and just getting this raise over the finish line. They were also great about keeping us focused on the high-likelihood names and following up after our meetings so we could stay focused on our business. They were a huge asset to us and we would not have succeeded as quickly without them.
So, how did we set up the agent agreement? There are lots of ways to do it, especially if you are already in the middle of a fundraise. Our goal was to get aligned with hitting the target and remove any situation where we weren't trying to win every dollar together we could. We carved-out a very short list of maybe five LPs from the agreement and we paid our agent on everything else. You can get really territorial with who gets credit for what and set the engagement off on the wrong foot. That was just too rife for conflict for us and isn't really our style anyway. We wanted to raise a fund and we weren't interested in arguing over credit. I won't get into the economics of our deal with our agent, but I will say it was fair, they earned it and we are happily paying them their fee.
It took a couple months to really get the meeting velocity up but by February 2016, we were hitting our stride and our agent was really delivering. Jim and I had one epic week with 25 fundraising meetings in three cities in four days with a management meeting in the middle for a new deal with Kristina in a fourth city thrown in for good measure. We went 0 for the first 22. We woke up ahead of the last day's meetings a little worn-out. But Jim knows when and how to give a pep-talk. Just before we walked into that first meeting, he reminded me of our fundraising mantra -- no matter how tired we might be, every LP gets the same show. We went 3 for 3 that day putting another $44 million in process.
We had a close in May that got us to about $100 million, we had another in July that took us to about $150 million and ultimately to our final close in October at $240 million. We asked, and received, permission to go above the hard cap to include one last LP, someone our other LPs knew and respected. There were a few more we could have chased, but we are committed to staying small and focused in our end of the market. We decided along with our LPs that anything more than $240 was pushing it, so we turned a few away at the end which was the right decision. In al, it took us the full year to get from first close to final close.
It was a total ParkerGale team fundraising effort and our placement agent helped in a few important ways. First, they kept the volume up. Like I said above, fundraising is about getting in front of the right LP at the right time and giving them a reason to dig in. You need volume to pull that off because you really don't know exactly when everything is going to click. Second, they saved us a ton of time by following up with LPs to get feedback and figuring out where we should spend time and when we should just move on. And the follow-up is way more time consuming than setting up the initial meeting. Third, just having them in the room with us created a sense of urgency for LPs. While we never invented fake deadlines or told LPs they had to move now or else, having our agent in the room gave everyone the impression that they needed to make a decision rather than just sit on the sidelines. Having a couple deals and half the fund raised at that point no doubt helped, but we noticed a clear change in the LP dynamic after we hired our agent.
Our final LP makeup is different than we originally expected. We thought we would look like most first time funds with a majority of funds-of-funds LPs. Believe me, we met with all the big FoF players early on and we made our best pitch for ParkerGale, but we just couldn't close the deal. Instead we have very few FoFs, and equal parts families, pensions and endowments. Here is how our LP list breaks out by dollars: 25% Endowments; 23% Pensions; 22% Family Offices; 14% Managed Accounts; 7% High Net Worth Investors; 6% Funds of Funds; 3% General Partner.
In addition to a balanced LP makeup, we have a really balanced group of personalities. Our LPs are long-time private equity investors who think deeply about the industry and where it's headed. They like working with smaller, newer funds with a tight investment focus. They have strong opinions about how people should run their firms and they are willing to help their GPs build their own businesses for the long-term. We have regular conversations with them about investments we are considering, people we are thinking about hiring, how to run better annual meetings and other ways to improve our own business. We love the give and take and we appreciate the feedback.
To close this out, we went back and ran the stats on our fundraising process. Maybe this helps you get a sense of the effort involved. Between January 2015 and July 2016 we had email exchanges with 31 LPs that never led to further conversations; we had phone introductions with 32 LPs that never led to a meeting; and we had meetings with 124 LPs that ultimately led to the final close. Our close rate on face to face meetings was about 19%. Total contact-to-close rate was about 12%.
We hope this sheds some light on a pretty opaque process and that it helps others in the same situation. Please reach out any time you need a shoulder to cry on, a pep talk or a high five for getting to your own final close.