The Capital Roundup

Leveraging Networks
How effective general partners are in leveraging professional and personal networks to raise capital can depend on the strategies and tactics they use. Only 18.1% of respondents are employing a systematic process to identify and leverage these relationships. The more common approach is being opportunistic rather than relying on a regimented, goal-driven methodology.

Meanwhile, 43.6% of the general partners report that they customize their presentations to each individual prospect. The majority relies on the same presentations to explain their hedge funds’ investment philosophy, styles and so forth.

What can prove beneficial in raising capital when leveraging professional and personal networks is to take a highly systematic approach to maximizing the value of the networks and communicating the benefits of investing in the hedge fund.

A case study of one fund-raising effort sheds some light on the process. The scion of an exceptionally affluent family worked in the family office and planned to launch a new hedge fund. He planned to assemble the investment team and manage assets, with seed capital of about $40 million from family members. This individual was responsible for raising an additional $160 million from external sources.

After about six months of knocking on the doors of institutional investors, third-party marketers and people he knew, he hadn’t brought any money to his hedge fund. This lack of success led to the adoption of a capital-raising approach based on a bespoke street-smart networking methodology. The following is an outline of the networking approach employed:

Preparations. Before approaching anyone, three actions were taken:

1. His very extensive list of contacts was evaluated and high-potential individuals were identified.

2. A customized assessment instrument was developed.

3. A “template narrative” was constructed.

Evaluations. Using the customized assessment instrument, likely investors were assessed from his high-potential list.

Solicitations. The evaluations, coupled with the template narrative, resulted in individualized narratives for each “probable” investor.

This approach raised capital for the hedge fund and led to introductions to other potential qualified investors. The hedge fund closed having raised about $500 million (including seed capital), an amount way beyond what was originally thought possible.

What is critical to understand is that the success of this capital raising was mostly a function of the inheritor’s extensive, powerful and unrecognized personal/professional network. Admittedly, this is an extreme case that was chosen to emphasize the power of having a systematic process to leverage relationships for raising capital.

Many hedge fund general partners likely have extensive networks that can also be similarly monetized. However, as noted, few are approaching the matter in a systematic way. For example, while usually overlooked, it is often vital for the general partners to identify and consider second-order and third-order relationships (i.e., the contacts of one’s contacts), and not just the people they directly know. Long-term success is often dependent on their ability to customize the positioning of the hedge fund depending on the needs, wants and preferences of each prospective investor.

Beyond The First Two Years
Going out beyond the first two years, the expected sources of new capital shift dramatically. It tends to move away from professional/personal relationships to institutional investors (Figure 3). This is a function of:

• The expectations of having “tapped out” professional/personal relationships.

• Having the size (i.e., assets under management) and investment performance track record that makes the hedge fund attractive to institutional investors.
 
• The level of interest in obtaining more sizable “chunks” of money to invest.

More than three-quarters of the general partners expect to be able to source funds from pension funds. Two-thirds see endowments and foundations as viable sources of capital. Also, slightly more than half are expecting to work with third-party placement agents, fund-of-funds or capital introductions professionals.

Family offices, meanwhile, are seen by a larger percentage of general partners (about seven out of 10) as high potential source of funds. With the number of family offices rapidly multiplying and their increasing institutionalization, more hedge fund general partners are seeing them as very good sources of new capital. As previously noted, a major complication for hedge funds is accessing family offices.

The most commonly identified sources of new money—business associates, friends and family—become significantly less important to most of the hedge funds. The same can be said of the clients of investment professionals.

This shift to the expectation of institutional capital raising is dependent on the anticipated success of the hedge fund over the previous two years. However, if the agendas of the general partners are achieved in those two years, the groundwork is set to gather significant money from pension funds and institutions.