What Does It Take to Raise a First-Time Fund?

Is now a good time for emerging managers to raise a first-time fund? The consensus is that there is never an easy time to do so. But the good news is that LPs, who are clamoring for returns, are seeking middle-market and lower mid-market managers for growth and higher returns. Here’s what it takes to get a new fund off the ground.

Track Record and Cohesiveness Count

The fundraising environment remains challenging, however the pools of capital focused on emerging managers has expanded in recent years, and high-quality new managers with a strong track record are seeing interest from investors. Track record remains the most important area of diligence on new managers and having a strong, relevant and clear set of prior deals to point to remains critical to fostering investor engagement.

Track records can be hard for investors to discern, as understanding who should get credit for deals at a new manager’s old shop can be murky — and oftentimes hard to confirm. But other times, an emerging manager might be leaving their existing shop with its blessing.

Such was the case with Palm Peak Capital. Three ex-Sun Capital execs spun out of the multibillion dollar behemoth last Fall targeting $350 million for its first fund. Some of its initial backers include Sun co-CEOs Rodger Krouse and Marc Leder, greasing the wheels for Palm Peak to get started.

In this instance, the track records were confirmed by their ex-bosses’ investment in the fund, and Palm Peak completed its first investment earlier this year, buying Shoring Products, a manufacturer of trench safety equipment. Palm Peak did not respond to requests for comment on the status of further fundraising efforts.

When looking at talent we look at the connectivity of the talent. LPs are saying ‘show me a deal that you’ve done together.’ Having a deal early on in the fundraise can act as a catalyst to get investors involved.

At AdCap, we think there are increased levels of capital and more investors who are looking to seed, either because they have a formal program, or because they know someone and are able to execute on a specific opportunity. LPs have more knowledge these days of the people they are investing with. This continued evolution of the industry, together with increased capital and innovation around structures, has created additional opportunities to get something off the ground.

The lower middle-market exhibits the widest dispersion of fund performance, thus making manager selection crucial.

AdCap agrees that success in the lower middle-market has different metrics. “You can’t use the same hammer on the lower middle-market the same way you can with larger companies because they’re just more fragile. These companies just aren’t as institutionalized and don’t have the management depth. You’ve got to be very sensitive to these teams and the good lower middle-market managers know that,” Dane Adelman says, Founder at AdCap Growth Partners.

The Top Performers Will Rise

Top performers are experiencing strong success, and investors are seemingly more open to commitments to new managers than they have been for the past 18 months or so. This is driven by expectations of greater liquidity this year and next, and we are seeing increased interest in the mid-market space in particular off the back of this.

A number of investors have continued to back managers that started in the mid-market but since grew out of the space, and many of these investors are now looking to rebalance their portfolio back towards the mid-market.

In addition, investors like lower mid-market emerging managers who have specializations. Technology and healthcare remain the top sectors of interest.

“We are starting to see sentiment towards tech improve, whereas healthcare has remained fairly consistent at the top of LPs’ priority lists,” says Eric Wolf, a managing director at Cleveland-based AdCap Growth Partners.

On the tech side, investors have been flocking to AI and data centers, while demand for healthcare deals has been driven by pharmaceuticals and medtech.

More Deal Opportunities

The lower middle-market is attractive to LPs because there are more deal opportunities that have greater growth potential compared to other asset classes. Higher volume.

For many LPs, the lower middle-market remains an untapped area in their current investment portfolios. Managers raise smaller funds and don’t market their funds broadly. General Partners in the lower middle-market frequently have proprietary dealflow and can truly add significant value to their portfolio companies by professionalizing management teams and adding tuck-in acquisitions.

Adelman says “the law of small numbers is creating that alpha where its relatively easier to generate four or five times returns on these smaller deals.”

“GPs can double the EBITDA in a business over a three-year period and then sell up into a market that’s more efficient. In some areas, there are more companies to choose from, so GPs have a lot more to choose from,” he says.

What Will Happen Next?

The smart money seems to see light at the end of the tunnel toward the end of 2025 when private returns normalize for emerging managers to get funded.

Given inflation has subsided and interest rates have declined, buyer and seller price expectations have converged, which has led to a slight uptick in M&A activity. This should lead to more exits and distributions in 2025. So, LPs should have more capital to reinvest bolstering fundraising.