Raising An Alternative Capital Fund Series - 2 Of 4

March 26, 2024

Raising an Alternative Capital Fund Series - 2 of 4

Happy Tuesday, friends. Today we continue our series on raising an alternative capital fund. You can check out the first installment here, where I talked about developing a thesis for your fund. Installment two is about fund the biggest unexpected hurdles and problems that I've seen impact emerging managers as they build their funds. If you listen to the podcast you’ve heard me talk about a lot of these. Here they are distilled into an actionable list though:

1. Your first few deals will take forever to close, and that will test your resolve. Why? Because you won’t know how to position your product and sell it to entrepreneurs. “But, Keith, it’s money — how hard can it be to sell to entrepreneurs who need the cash?” I thought like that too, but I was quickly disabused of the notion that it’s in any way easy. You will not know how to frame your product in the context of the market, you will not know how to beat the competition (you DO have competition, by the way), you will have ideas that lead you to believe that you understand all of these things and those ideas will turn out not to be true. You will be challenged to keep moving forward as a result of this reality, and you will need to have the courage and the conviction to just not stop. I’ve seen several fund managers and investors fail as a result of just not having the ability to keep going. It happens.

2. Deals are more important than anything else, so find a way to get a couple done early (read: don’t take bad advice about fund’s first close targets). Said another way: set your fund’s first close hurdle as LOW as possible. You need to get deals done to show track record, and if you’re aiming for a first close at 50% of your fund target, you’ll never get there. This takes a ton of creativity and courage — you may have to figure out how to get paid while you’re managing a couple million dollars (or less!) that you closed on just to get a couple deals done. You could also warehouse deals in a separate vehicle with cash from early believers and investors. But in any case, I’ve seen investors fail because they couldn’t get to a first close target their advisors gave them (usually 35-50%). They never had a chance. “But, Keith, that’s conventional wisdom.” It sure is; but unless you’re raising a VC fund like everyone else’s, conventional wisdom isn’t the best guide. Do what you have to do to get a deal done quickly to show that (a) you can source and (b) you can execute. Otherwise you will fail.

3. Tax and accounting are important, but farm it out to someone else. Look, novel investment instruments require novel accounting and tax treatment. That means you have to figure out how to manage not just a funding business, but also the technical nuances of how your instrument will be viewed by GAAP and the IRS (the latter being the most important, obviously). Take it from me: hire a firm who has experience in these matters, and take their advice. You can be as clever as you want, and you’ll end up discovering that all your cleverness got you to one of two or three potential answers no matter how much time you spend on it. Do not let this stop you from making progress on your fund. Over the years I have probably talked to 20 investors looking for answers to tax questions who never made any progress on their idea because they got hung up on it. I’ll tell you what I’ve told them: if your thesis is dependent on tax questions to be successful, you’re pursuing the wrong thesis. Hire a firm who knows how to handle novel instruments, take their advice, and move on.

4. Ordinary income isn’t a deal killer. When and if you find out that you will have to treat gains as ordinary income because of the novelty of your instrument, don’t quit. I’ve seen this too. “Keith, I keep hearing that no one wants to invest in something that gets taxed as ordinary income because of the taxes.” Sure they do. You just have to figure out how to make it work for your investors, and deliver the returns. People love yield. People love income. Don’t listen to the naysayers.

5. Start small and grow from there (read: without track record, you’re not going to get institutional backing. Stop trying.) As a capital entrepreneur, you have to build from nothing if you have no track record. That means small-ish checks from friends and family, people in your network, etc. Your first investors will likely be small checks if you are starting from zero. The beautiful thing is this: those small investors will never leave you; they will always support you if you deliver what you promised. From there you graduate to high net worth individuals, family offices, and eventually something institutional.

That’s it, folks. I hope you got something out of that and that it helps you as you build your funding platforms. Feel free to share your thoughts by just hitting reply!