September 24, 2024
Raising an Alternative Capital Fund Series - 3 of 4
Happy Tuesday, friends. I'm thrilled to share the next installment of my Raising an Alternative Capital Fund series with you - we're now at part three! For those new to the series, you can catch up on parts one and two here:
Today, it’s going to be about the fascinating world of how LPs think about investing in funds with a different approach - and I'll be sharing some valuable lessons I've learned along the way. Off we go!
- LPs are different from other investors. A key difference is that they want to mitigate risk by investing in a portfolio. They are first going to want to be confident that you will not lose their money. If you can prove to them that your new approach will, at worst, return their capital, you will be off to a solid start.
- Some LPs (HNWs in particular) will appreciate exposure to an asset class they would otherwise not know how to approach. Lean into that. For example, if you are building a vehicle that places capital into local businesses, you can sell that offer by making it clear they will not have access to these businesses in any other way. Sometimes, selling that access works.
- LPs will reason by analogy. That is, they will equate you to the thing you are nearest to in their experience, and probably VC funds. If they have exposure to VC funds, you might represent too much exposure. In any case, if you are different from a normal fund, your thesis and vehicle will be pattern-matched to whatever is closest, and that’s how decisions will be made. Gather feedback from the market to understand how different LPs react to your offering. Once you understand that, you can craft a pitch and approach that takes off the table (or leans into, if that’s a better approach) the thinking-by-analogy that LPs will conduct. Once you understand the analogy, you may also be able to find similarities between what you do and what they really like or what they’re looking for in their portfolio, e.g., real estate, fixed income, etc.
- LPs might struggle with a blended portfolio. If you are going to invest using multiple structures, be prepared to be judged to be non-committal or too opportunistic. The common thinking is this: you can’t be good at all of these structures; they necessarily require different underwriting. (I actually believe this is true, too, which may be a function of my own limited capability set and intellect.) Can you invest and make money with both an RBF and a standard VC approach? LPs will wonder if you can do both.
- Track record matters, but synthetic track record doesn’t. LPs want to see that you’ve been able to prove that your thesis works so that they know you’ll make money for them. You can build a model of the “here’s what I would’ve done” portfolio as many times as you like, but it won’t matter. Don’t expect that to get you very far at all.
I hope you enjoy these lessons from the trenches, and that you can use them. Feel free to drop a line and let me know what you think, especially if you disagree! And, of course, please share with people you think might enjoy the newsletter!
Have a great week!
Love,
Keith