For casual followers of Wall Street finance, a career in private equity can look like the ultimate job. Private-equity managers work on high-profile deals, they negotiate with high stakes and immense pressure, and, don't forget, they're ridiculously rich.
Some of you out there may even fancy starting your own private-equity fund one day. If that's your ambition, I salute you, because the road ahead of you is not going to be easy.
Write a business plan for your private-equity fund
Starting your own private-equity fund is in many ways not all that different from starting any other new business. You're going to need a business plan.
Your business plan serves two major functions. First, it forces you to face the reality of starting the company, including the costs, risks, and challenges you'll face. Second, your business plan tells potential investors exactly what you're going to do with their money if they choose to invest with you.
Your business plan should at minimum answer these questions:
- What's your investment strategy? (What's your market? Your industry? Your niche?)
- How will you find deals?
- How will you raise the money for the fund?
- How much will you charge?
- What will your start-up costs be?
- What will your ongoing expenses be?
The business plan will, of course, require far more than this, but it's a reasonable place to start. To really do a good job, though, you'll need some help.
Hire a lawyer. Actually, hire several lawyers.
Navigating the legal and regulatory requirements is a major barrier standing between you and your private-equity firm. There are regulations on whom you're allowed to accept money from and how you can and cannot advertise your fund. There are mandatory filings, registration fees, and so, so much more.
The costs involved in setting all of this up can easily run into the hundreds of thousands of dollars, if not more. You won't be able to do it alone. You're going to need help. You're going to need lawyers. Lots of them. And accountants. The expensive kind of accountants.
You'll also need help setting up your back-office operations, processes, and documentation procedures. Don't think the SEC is going to let up on you once you have your fund set up and running. There are ongoing responsibilities you must maintain, such as record-keeping, periodic filings of all sorts, and more. You're going to need some knowledgeable administrative help to keep this train on the rails.
Let's assume that you're still committed to starting your fund, even after all of the prep work I've just described. Once you have your legal, regulatory, and administrative systems in place, your next step is to raise money for the fund.
You can start with your own money. You can also accept money from accredited investors -- those who can document that either their individual income has been greater than $200,000 for the past two years, or their net worth is greater than $1 million, excluding their primary residence. If you know the right people, you may even be able to get some cash from large institutional investors such as university endowments or pension funds.
Raising money is a full-time job. You'll have to get on the road and pitch your fund to these potential investors over and over again. You'll have to convince them why you're a better place to park their money than the thousands of other alternatives out there in the investing world.
With millions of investor dollars now in the bank, it's time to finally get to work. This is the part you've been waiting for.
First you'll have to source some deals. You'll have to spot companies that have room to improve ,and then you have to buy them. In some cases you may have to persuade the current owners to sell, and in other cases you may be bidding against other private-equity firms. In either case, you can't overpay. If you do, you won't be able to hit your return targets.
Depending on how much money you were able to raise, you'll have to find at least a few companies in your target niche every year to buy.
Once you successfully source and then win a deal, you'll have to lead that company to higher profits and a higher valuation. You'll have to know how to improve the company's performance against the competition, and you'll have to decide which costs to cut and where to increase investments. You'll have to have a plan to grow revenue and improve cash flow.
Private-equity investing, if you haven't already put this together, isn't a buy-and-hold kind of process. There's a tremendous amount of work to be done before, during, and after an investment is made.
In private equity, you buy most or all of the company. You're it. You're the board. The CEO answers to you. You'd better know what you're doing.
Sell the company in a few years. Get rich.
Assuming that everything has gone well for three, five, or seven years, it's time to sell the company and mint some money. The selling process is full of legal, accounting, and potential regulatory obstacles as well, so you'll need more lawyers and accountants for this process, especially if you're thinking about an IPO.
Oh, and don't forget to pay your taxes.
The deal will close, you'll get a boatload of cash, and it'll be time to either give all that money back to your investors or start the investment process all over again.
Can we be serious for a minute about this?
The reality is that unless you're already in the industry, with a proven track record, and with a network of industry connections, the odds that you can start your own private-equity fund are next to nothing.
The start-up costs are too high. The regulation is too complex. The reality of raising the millions of dollars you'll need is just way too difficult. Impossible? No. But highly, highly unlikely.
In my view, the easiest way to play private equity for everyday investors is to model your investing on someone like Warren Buffett. Don't speculate. Don't trade. Use your money, your personal private equity, to buy shares in companies you want to own for three, five, or seven years, or longer.
No, you won't get a board seat, but your investment approach will be closer to that of a private-equity executive than you probably realize. Focus on value. Focus on companies with unlocked potential. Focus on a companies with a competitive advantage.
That's how you can really start your own private-equity fund.