Early-stage and venture capital investment is hot right now in Asia and beyond, as institutions large and small look to take stakes in companies – particularly in the technology sector – early in their business cycles, in search of the next unicorn.
But while more money may be prepared to take a punt on start-up funds, such strategies remain a riskier proposition than committing capital to well established managers.
One man well versed in the challenges faced by new general partners (GPs) and the limited partners (LPs) who invest in them is Kirk Sims. He became head of the emerging manager programme at the Teacher Retirement System of Texas on March 1, after running a similar unit at the Illinois teachers’ pension fund for about five years.
Texas Teachers has invested $5.7 billion in the programme since its inception in November 2005. The scheme now has $3.5 billion allocated across 169 emerging managers: 50% in private equity firms, 27% in real estate and 23% in public market managers, including hedge funds.
And the $155 billion fund committed a further $2 billion to the programme in January for deployment in the coming three to five years.
This expansion will enable Texas Teachers to invest more in different types of deals and new niches, Sims told AsianInvestor. These might include joint ventures, fundless sponsor deals and possible seeding opportunities.
The programme does not have any Asia-based managers as yet – most are US-based – but it might consider that possibility as it expands, he said.
AsianInvestor asked Sims why and how the pension plan backs startups and what the main pitfalls are that GPs and LPs should avoid. His comments add to views aired recently on this topic by two Hong Kong family offices and the European Bank for Reconstruction and Development.
AsianInvestor: What do you see as the benefits of investing in first-time funds?
Kirk Sims: Normally first-time funds offer the opportunity to generate significant alpha, such as from a niche area or one where being smaller can help it outperform. When you’re trying to raise $50 million rather than $200 million, you can identify and target a more specialist niche more easily than a larger manager can.
[First-time funds] also allow you take advantage of building a relationship from a very early stage and then helping to grow it. It’s good to start out with a manager when capital is very important to them, and at a time when you can talk directly to their dealmakers.
Q. Which are the most common sectors and asset classes for first-time funds to focus on?
In terms of first-time fundraising, I’m seeing most growth in private equity – particularly in the venture space – and in real estate. The benefits of those asset classes are that they are multi-layered, with different areas you can focus on.
Real estate especially lends itself to opportunities for first-time funds. You can go into sectors like multi-family or into different geographies. You can be a great manager in [the US state of] Georgia or on the east coast [of the US]. You can be a great manager that only does suburban office.
Q. What are the key criteria you look for from first-time managers?
The first one is, of course, performance. You have to demonstrate that you have a clear idea of how you will outperform in this particular strategy.
You have to be able to show you have necessary deals, the necessary network and in some cases the necessary staff, to execute at a high level in that particular niche.
You also have to show that you see the opportunity for growth in that particular area. You may see that you can manage and deploy $50 million to $100 million a year, but must [be comfortable that you will] have the opportunity to manage and deploy $250 million.
And you need to be clear that your organisation will be able to cope with that growth and expand with it.
Q. What are the main typical shortfalls or pitfalls that first-time managers (and their investors) face these days?
The overriding concern and challenge [for us] is the business risk; whether it can be an ongoing entity.
Most first-time managers are very successful in whatever area they decide to focus on but, normally, within a much bigger organisation. A lot of times all they have to worry about is making money; executing on the investments.
So the biggest challenge is about going from being just an investor to being a business owner and all the challenges that come with that.
You must be comfortable as an LP that they are looking at the fund as a business and not just as a trade, as they would within a bigger organisation.
Q. What advice would you give first-time fundraisers to maximise their chances of success in fundraising, particularly from institutional investors?
Firstly you need to keep in mind that it’s more than likely we as investors have seen a similar strategy, and multiple versions of it.
Secondly, you need to have an idea of how you will get out of the investment and communicate that to the allocators. It’s not just that you can put the money to work; it’s about when and how you’re going to get the money back to the LP. A GP may present what looks like a great opportunity, but when I ask how they are going to exit [the deal], sometimes there’s silence.
The manager also needs to have a clear vision of the growth trajectory of the firm. After the first fund, what do they expect to happen with fund two, as far as staff and infrastructure goes?
It’s helpful for us to know that you understand the hurdles you face and how you will overcome them.