How To Start A Private Equity Fund From Scratch

boom people welcome back to the show today we're going to talk about how to start a private equity fund we've had a lot of people ask us about this specifically in private equity so today's episode we're going to go through all of this what you can expect when starting a fund how to structure the entities how to go out and find investors how to pitch those investors how to build a track record how to build a team we're gonna do all that inside today now for some of you people that have listened to this show for a while they're avid listeners that have been through the journey with us a lot of this might be review so if it is you can just skip the next step but if you're new this is gonna be really valuable content stuff that i've learned over running funds over the last four and a half years i've learned from incredible mentors my dad who runs a deca billion dollar fund my brother who runs 100 million dollar plus funds as a securities attorney we've had a lot of experience in the fund space in setting up funds like this and running them and actually we have one of our students that actually they have a private equity fund they've just raised over 11 million dollars for their private equity fund should be pretty exciting to see their growth over the next couple years they're doing this let's dive into it [Music] first question bridger what even is private equity right what do you mean by private equity what's the difference between private equity hedge funds venture capital funds debt funds real estate funds let's walk through it so right here you have your public public market public growth cycle this is your private growth cycle over here on the left over here you have early stage companies so these are these are way early this is idea stage two you know very early implementation you these companies hopefully do well they come up they mature and then they're distressed if they're mature enough and do really well sometimes they can go public they can have an ipo event here they go public and now they're in the public markets so where does private equity play well it's in the name private equity deals with privately held companies private equity will work in the private sector and typically they're going to come in right around here as a company comes through idea stage you have venture capital you have early stage venture capital here a lot of times like a series a b c coming in here and then they will get to a point they can either sell to us a private equity firm or sometimes those vc companies will take them public or with a private equity company together we'll take them but that's some some cases that's the exit for this now that's typically what they people think of private equity you see huge funds like kkr you see blackstone uh use obviously bs blackstone good acronym right there for blackstone bs managing hundreds of billions of dollars doing this we have a massive scale however private equity can work in a lot of different ways i have seen a number of private equity companies that come in and they are not looking at high-tech a lot of this is kind of the tech you know silicon valley style right you get your your seed round series a b whatever and then you go ipo and you become billionaires there's a lot more that goes on the world than just that and so i've seen a number of private equity companies that come and they will find companies that have grown and maybe are distressed they're down here in this spot they will buy that company and work that company up and just treat it as a cash flow business they're they're going to take that company work it up either have it cash flow or work it up and sell it to a bigger private equity firm or if they really want to get ambitious can ipo as well i've seen other product companies have a good buddy his entire fund goes and buys up funeral homes they buy mom and pop funeral home some of you guys have heard this example before but they buy up mom and pop funeral homes they're about you know one to two million each they buy them up they found that they could sell those companies as a conglomerate about seven or eight of them to a larger private equity firm for almost double of what they purchase them for they'll buy up seven or eight different funeral homes group them together and they can sell them for 16 17 even 18 million dollars to a larger pe firm that's all they do that is under this realm i have another group they do just amazon businesses they go find these 20 year old kids that are running an amazon business they're making okay money they've already set it up they will use a private equity fund model to go and purchase and acquire 5 or 6 or 10 or 20 of these amazon businesses group them together and they because they're under one roof they can take a lot of the fixed costs down and they're actually pretty good at running these amazon businesses and can scale them to really good levels and cash flow those businesses pay off investors and i'll show you what that means in a minute but is that making sense where private equity fits in hedge funds typically play here hedge funds will play in the public space venture capital plays down here real estate funds obviously play in real estate but that's kind of your realm where you're at now first let's start off with how an actual private equity fund is structured okay how is it actually put together and how do you or me as a fund manager make money doing this by the way private equity fund managers are usually every time you meet one they're usually very very wealthy people and so let me walk you through how that structure however gets paid all right so down back to the white board here white board of truth and justice what we call it we've got our general partner now again i'm going to explain to you how 99 of all funds are structured there are other ways to do this i know you're going to have in the comments you could do another way yes but this is the most common way to do it so let me explain to you first thing you have is your general partner okay this is an entity all right and then you have a limited partnership okay i'm gonna do lp limited partner ship this is also an entity these have these squares here these are entities what happens is you have investors or limited partners will put money their capital they will commit to the limited partnership okay and now this is true for hedge funds for venture capital so if other people that have watched this channel you've seen this before this is true for all of these types of funds but today we're talking specifically private equity so we're gonna use private equity examples okay limited partners will put money into the limited partnership and you as the fund manager over here on your general partner you are the managing general partner of a fund okay this is you over here and the general partner gets discretion over what happens inside of the limited partnership and that's all described in two governing documents called your lpa and your ppm okay lpa stands for limited partnership agreement ppm stands for private placement memorandum you don't have to memorize those but these are the two governing documents of your fund we call them the bible and we call them the bible because just like the bible it has all the rules all the bylaws all the covenants that you need to keep and obey inside of your fund now the amazing best thing about funds okay this is why most successful people in finance and other places end up running a fund this is why a lot of people end up into this space is because inside of your lpa and ppm it will say limited partners put in let's say this guy puts in 20 million and this person puts in let's call it 5 million and this person puts in 25 million okay a 50 million dollar fund this will say the general partner has control and can do what it likes with that pool of money okay and you these guys are are truly limited partners you as the fund manager are the general partners so you can decide down here you can go hey we're gonna go buy up uh company a and we're gonna buy company b and we're gonna merge with company c or whatever it is and you have say over it one of your biggest limited partners this guy right here 25 million dollar partner could call you up bridger i don't like your decision here i don't i don't think this is right um blah blah blah you say thank you for your opinion but you're a limited partner i really value your opinion i thank you so much but we with our you have hired us to make decisions on behalf of you now if we did something illegal if we broke our lpa or ppm that's a different story right maybe we have some legal stuff there but if we've done everything right they have no say over what happens inside of your fund you have a hundred percent control over that money that's the reason eight guys on wall street eight guys and gals on wall street can manage you know let's call it 10 billion dollars and they have 100 control over that money even if their investors are yelling and mad and whatever you saw in the big short right you saw michael bury all of his investors were yelling at him so you got to get out of your short position he said no he said i'm staying in my short position i believe in what we're doing and i'm going to stay right that's the same thing that happens it's a beautiful thing that and that's why most people most successful people in finance end up in the fun space are you with me so far is this making sense okay you got your general partner your limited partner ship and your limited partners now there's another entity you'll set up called your investment advisor or registered investment advisor okay investment advisors if you're under 150 million dollars registered investment advisors if you're over 150 million dollars this is another entity yo it's usually the same owners so you'll own part of that and part of the general partner both are managing entities of the limited partnership and i'll explain why they're separate in just a minute um this is where you file with the sec and uh you are an invest you give investment advice to the limited partnership and they pay you a fee a management fee uh for doing so let's talk about that actually right now okay i hope you guys are with me we're moving fast here if you want you can go re-watch this or go wind back i'm not going to keep going over stuff so you guys can watch it again so now let's run through how private equity managers make so much money how does it actually work how is everyone paid when the assets or business make money so i'm gonna draw a timeline here from zero to let's call it uh 25 okay uh zero right here let's put like we'll put 10 here we'll put like 15 here okay and we'll call this just return okay yeah you could we can use irr or your yield api is a lot of metrics we can use i'm just going to make it simple and just call this a return okay um so we got a 10 return a 15 turn or 25 return or a zero percent that's what we're looking at on this timeline and for this example let's say your fund got a 22 return this year you guys did pretty good you got a nice return and you now need to decide how that's all going to be split up to investors now a lot of people right now but bridger it's just that it's a 2 and 20 fun blah blah it's a little more complex than that and let me walk you through what's inside of actually a 2 and 20 model a lot of funds up front we'll do something called a prep now in my phone this is what we do we have an 8 it's a preferential rate of return meaning the first eight percent of all returns goes to my limited partners it goes right to my investors so for example if this year we only got a seven percent return we were right here my investors would take all seven percent because they get what's called a pref a preferential rate of return for risking their money in the fund after the pref and my fund we do a two percent catch up is what it's called so the next two percent of all dollars come to the general partner okay if we hit that certain benchmark so for example if this year we only hit nine percent the first eight percent would still go to the limit partners and the next one percent would just come to me as the general partner is that kind of making sense now in my fund once we get above a ten percent return we start splitting 80 20. 80 to the limited partners 20 to the general part now in my fun i added one more thing one more tier of this waterfall so we do an 80 20 split until a 20 irr once we hit that return 20 return we then split 50 50. so it incentivizes me as the fund manager to get even higher returns if i get over a 20 yield or return to our fund i then start taking 50 instead of just the 20 and the idea there was to align our incentives with our investors so back to our example if we had a 22 return first 8 percent would go to the limited partners next 2 would come here from 10 to 20 we would split 80 20 so that would be another eight up here another two down here and then up from 20 to 22 we would split 50 50 and that would be one up there and one down here so at the end of the day in this example my investors would take home a 17 cash on cash return they would take home and i as the fund manager would make five percent is that kind of making sense you guys following me so far now you might be saying well bridger i'm not in this whole game to make five percent like that's so small no yes you are okay you're not making five percent on your money okay you are making five percent on the entire fund so if you look at steven schwartzman and these other big fund managers that manage let's call it a hundred billion dollars who would like to make five percent on a hundred billion dollars right i would right that sounds great right this is the ultimate leveraging other people's money opm model out there is that kind of making sense that's why fund managers make so much money now before i go any further you might be asking well bridger what about management fees and i didn't forget i wanted to save that for the very end a lot of funds as well will also down here charge usually about a two percent management fee and they take that right off the top before they go out and make you know all this this waterfall sequence is called a waterfall what i'm explaining here the management fee typically will go to your investment advisor or registered investment advisor remember what i talked about earlier that other entity so that will take the management fee just for giving financial advice and the other stuff here which is called carried interest that's a key word carried interest goes to the typically the general partner will take this now you as the fund manager participate in payton both so with a management fee that takes up this to probably about maybe six and a half percent after you adjust for everything now the reason i left this off the beginning my funds currently i do not charge a management fee and i did that because one of my mentors advised me said bridger when you're just starting out you're starting your first fund people are skeptical people don't believe that you're going to go on do you do so to catch attention one strategy is you don't charge a management fee then when i was starting my first fund i went out to investors and i said hey i don't make any money i make zero dollars unless you make eight percent first there's no management fee there's no hidden fees i literally will not make a single dollar until you make back at least eight percent first and that was a compelling pitch for investors and they saw the confidence that i had for this fund and they decided to put money into what i was doing all right is this making sense so far now you're probably sitting there like bridger hold on okay i get it that's kind of the structure i understand the structure but how do i actually start the name of the video is how to start a fund and what's been interesting is over the last couple years you know i've ran my funds and i've started to interview other people on this channel and show that have all actually gone out and started their own funds and i i try to only interview people that did it unconventionally where regular people like me and you don't they don't have the ivy league degree they don't have the big wall street experience they're just regular people that decided to use this incredible business model to go out and scale their business and what was funny is i after listening to a lot of these entrepreneurs found a pattern for how they went and launched their funds and we we coined this pattern the fund launch formula because time and time again every entrepreneur that had a successful fund followed this formula almost to a t to get their fund off the ground the fun launch formula is a little counter-intuitive as well to what traditional wall street will teach you of people on wall street if you go watch other videos of their content they will tell you all right so if you're going to start a fund you've got to hire some lawyers first thing is get some lawyers you're going to spend anywhere from 30 to about 60 000 on legal fees go set that up first then you go pitch investors um you hopefully have you know investors you're building your team you're building up all the stuff there and if investors don't like it well shoot you're gonna have to go back to the drawing board and you still have to cover your 30 to 60 000 legal fee this thinking is why a lot of funds have failed in the past and i've actually seen some of these funds fail is because they follow that so i want to show you a new way a better way to go about launching a scaling fund i use this to launch my funds my dad uses to launch his funds and a number of other entrepreneurs have used this for me to do it you guys ready to get into it get a little drumroll here let's dive into the fund launch formula and what's inside so when i was starting my first phone i went to one of my mentors i asked him i said hey i don't have the crazy experience i don't have the wall street you know whatever no one's going to invest with me i i don't have what it takes he says bridger i want to give you an example i said okay he goes imagine we just found a lamborghini aventador okay a lambo we found it in billings montana we can buy it this weekend for 50 000 and let's just go with me as an example let's say everything checks out on this lamborghini we've had a mechanic look at it we've had other people look at it this is a legit lamborghini the lady she's selling it she just is she's gonna go into bankruptcy she needs the cash by saturday morning and she's willing to sell for 50 grand additionally we have already found a buyer on monday morning that'll buy the car for 200 000 in california it's all checked out it's all guaranteed the only problem you have is you can't use any of your own money you need to go raise 50 000 by saturday morning this was the situation he proposed to me he said bridger could you go find 50 000 by saturday morning and i thought about it and at first i said no way he said no really you're going make a hundred and fifty thousand dollars this weekend could you go find 50 grand by saturday i thought about i thought about a former boss college professors an aunt a grandpa a great uncle a friend from high school anybody i could find i thought through and i said you know what i'm gonna make 150 grand this weekend like dang straight you know what like i'm like you know what i'm in i was like i actually i think i could find 50 grand by sorry and i said again it's 100 percent guarantee there's no chance i lose he's at 100 guaranteed and i said yeah i think i could do fifty thousand dollars he goes what about a hundred thousand dollars let's say let's say she had to raise her prices a hundred thousand dollars you've got to raise by saturday morning still you're gonna make a hundred grand spread on this deal by monday morning could you find a hundred grand and i said yes so dang sure i'm gonna stay up late i'm gonna be i probably won't sleep for four days straight but yeah i i you know what i could get a hundred grand if it's a hundred percent guaranteed and he goes why and i said well it's it's a hundred percent guaranteed you just told me this is foolproof there's no way anything falls through the cracks and he goes aha there it is and i went what do you mean he goes you just said it yourself he said three minutes ago you were telling me that you were so worried that you don't have the track record of the team or all this stuff and all of a sudden you're telling me you could raise a hundred thousand dollars by saturday because why the deal was so good the deal was foolproof he said more often than not the reason people can't raise money is because they do not believe in the deal enough themselves they have not found a good enough and good enough deal and when i say deal it could be a business you're buying it could be a trading strategy whatever it is and private equity be a business you're buying they are not confident enough to go forward with that deal and scrape and stay up all night like you were with that lamborghini deal he said bridger step one of any fund you're starting or anything you're doing step one is find an incredible deal and i put deal in quotes here but this this could be the company you're gonna buy if you have that good of a deal and there's a lot of them out there a lot of the other things will fall into place so i said okay well i got a great deal lined up let's say hypothetically what's next and most people at this point want to go and set up legal fees okay i found the great deal i found the company let's hire some lawyers let's spend the 30 grand and hold on before you go out and spend the 30 000 to go set up your your legal team and all that kind of stuff step two is frame the deal out so you're gonna get on an excel spreadsheet you're gonna put out all the numbers you're gonna you're gonna put together your pref and your catch up in that 80 20 splitter maybe it's 70 30 split what kind of management fees you're going to charge all that kind of stuff you frame out you start putting your pitch deck together which leads you to step number three which is go and pitch investors but wait bridger i can't go pitch investors i don't have my legal docs done this is actually how my dad raised their first hundred million dollar fund this is what he told me they did they went out they would go find investors and typically investors are used to hearing the harvard guys pitch this is how harvard guys pitch they go hi you know so and so mrs johnson we're very sophisticated we're from harvard we have a great idea over the next 18 months over the next 18 months we're going to go out we're going to find great businesses and bring them together and we theorize that we can go do all this mr johnson says great thank you so much have a nice day my dad would walk into that same room say hi mrs johnson we're not from harvard however we have just found an incredible deal here's our entire pitch deck we need to close on this business or this real estate deal whatever it is by the end of the month now you're smart you've seen things before you've worked in business you're obviously have a successful career you won't be where you're at do you want to get in or out you can poke holes yourself in the deal we're closing on this deal by the end of the month and mrs johnson would sit down and look at the deal and say hey bring on a friend or whatever consultant you need to we believe this deal is bulletproof and she'd sit there and look through all the stuff and all the documents and all the all the stuff you framed out and they would say hi mrs johnson we haven't done our legal docs yet it's going to be done in a couple weeks but if everything checks out can we put you down for 500 000 has a soft commitment that you'll go towards this deal and she'd say one of two things either yes yeah put me down for a soft commitment for five hundred thousand dollars or number two well i don't know if i'm ready to invest yet and if they got the second option they'd say well why not what's holding you back from doing this deal and she'd give them a few different reasons maybe maybe she didn't like the frame maybe she didn't she wanted a different type of deal and you can take those notes and say well mrs johnson if in a couple months if we come back and we bring you a different frame to be different management fees or different split or we find you a different deal at that point would you invest in the zeal what else would hold you back and she'd maybe give you a few more reasons you can get direct feedback from your investors before you go spend the 30 or 40 thousand dollars to go set up your fund so at this point step number three go and pitch investors get soft commitments of five hundred grand a million five million ten million dollars go and soft pitch investors when you have an adequate amount of money that you feel is good enough that you've soft raised then and only then go to step four and set up your legal docs okay and what you'll do here is you go and you hire a lawyer and they yes you got to spend the 30 grand right to go and do it and actually inside of our we have a mastermind program we help our students do it for a lot less a lot of our students are spending anywhere from eight to maybe 12 grand a set of their fund but typically off the street you're running from 30 to 60 grand if you're not in our programs but that's what you do you go set up your legal docs then you go back to your investors and you say hey time to put money in and the 30 grand you just spent is a reimbursable expense to the fund it's a it's a startup cost and so you put money down what you just did is you investors paid you to build a fund for them they paid you to go out and structure and put together a fund that will benefit them boom baby that is the fund launch formula in in about five minutes let me put this together again step number one find that incredible deal okay two frame it out three pitch investors four legal docs now questions at this point is bridger well wait okay the step one how do i find that incredible deal there's a lot of great sites out there bizbysel.com empire flippers that are actually brokerage services for businesses even small scale businesses that are being listed to sell it's a great way to get your feet wet however if you're like me at this point you say well bridger okay i get the idea i get the frame i understand the general partner limited partnership i understand the split but i just don't know if i have the network to raise money if i don't know if i have the expertise to go out and find and buy private equity businesses that's okay no one does this game by themselves there's three distinct circles or positions inside of a fund over here you have your money raiser okay this person is a natural salesman already has an incredible network has spent spent the last 10 years building out an incredible network of investors the middle circle you have your fund manager this person is very good at operations audit legal accounting sec compliance all funds goes under this circle and then finally you have your expert investor this is your chief investment officer this person has done real estate or bot businesses for 25 plus years however they have no clue how to run a fund and they have probably no clue how to raise money currently in my fund for right now we've we've soft raised on that fund for about 18 million we're gonna be setting up in the next few weeks myself i'm very good at fun managing this mental circle and i've brought on another partner that's very good at is an expert investor we're doing real estate deals i don't know the first thing about real estate deals that's okay because i'm pretty good at running a fund and i'm actually pretty good at raising money and so i can compensate where he is not good as on that side of things again no no one does this alone it's not the how stop asking yourself how do i go and find these deals change your question to who who can i find that can raise me the money or who can i find that can go be my expert investor partner to go help me do this or who can i find that can help you run the fund and that's what we do inside of we have actually a lot of content stuff online we're trying to build an online community of people that we can connect these dots one guy in our group they actually met inside of our program our group he's he was an expert investor the other guy was a money raiser they came together they've raised i believe already over five million dollars for their fund they're going out and doing right now so again no one does this alone so there you have it that was a crash course on how to start private equity funds uh if you're interested we have a lot of other videos that go in in more depth than this video we have a one hour free training if you want to click below we have a facebook group we have a bunch of other stuff online online programs and stuff shoot me a dm or message if you want want more of that but go check out other stuff on our channel subscribe all this stuff and we have a podcast everything else is out there to help more and more people understand what's happening behind the curtain on these private equity and hedge fund space hope you guys enjoy and i'll see you next episode bye

Channel: Bridger Pennington

Views: 262,995

Keywords: private equity, private equity fund, how to start a private equity fund, what is private equity, how does private equity work, get started in private equity, how to invest in private equity, Bridger Pennington, investment fund secrets, private equity vs venture capital, private equity fund manager, private equity explained, how to start a private equity fund from scratch, private equity day in the life, private equity vs hedge fund, private equity interview

Id: FF_PVtHITLI

Length: 29min 24sec (1764 seconds)

Published: Tue Mar 02 2021