Fund Nuggets: Broad vs Narrow Funds & American vs European Waterfalls

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Wall Street Rebels, how are you guys doing today??

It looks like the world is kinda starting to go crazy again with all the news on the Delta variant, Afghanistan, fires, and who knows what else.

But today we’re not here to talk about the world’s problems. No sir, we’re here to discuss funds.

Today I want to shed a little light on TWO different fund “nuggets” that’ll make a world of difference for you when structuring, pitching, and launching your funds.

Let’s get into it.

Broad vs Narrow Funds

First things first, I hear this all the time from people I know.

Bridger, I want to start a fund that invests in Real Estate, the Stock Market, and Crypto Currencies.

And right off the bat you’re already going in the wrong direction.

This is a bad idea for a couple of crucial reasons.

Investors want to have the utmost confidence in the fund manager(s) to be an expert in their given field.

You’ll often see funds that are hyper-specific, for example commercial office buildings, and the reason being that the fund manager or investment committee are at the very top of the industry.

They have years of experience and no exactly what steps need to be taken to successfully acquire or sell that type of asset.

When you start to get more broad in your investments your investors begin to lose faith in you.

You’ll find that your credibility will rapidly shrink as it is highly unlikely that you – or anyone – has acquired enough experience to justify such a wide investment thesis.

The solution here is to simply start another fund.

That’s what my father has done and his investment group has successfully created a web of different LPs that all operate under one roof, which is what we call a family of funds.

The important thing to remember here is the more specific or narrow that your fund is the more likely investors will be willing to go in with you as it suggests an expertise in a given space.

American vs European Waterfalls

Waterfall structures in funds are basically the system by which you base your IRR.

This is in turn used to compensate both the fund manager(s) and investors.

The American waterfall is structured to evaluate the IRR on a deal by deal basis.

This means that once a transaction is complete, or the process of selling/acquiring a given asset with which you are working is over, that you’ll determine the IRR.

Using the American waterfall tends to favor fund managers, because they can quickly move on from deals that may go south on them, and capitalize on deals with high returns.

Whereas European waterfalls are structured to compute the IRR of a fund on a conglomerate basis.

Meaning that annually, or whatever predetermined period of time has been established in the LPA, all of the deals that have taken place will be clumped together to form one IRR.

This favors the investors because of the overall smoothing effect that the sum of all the transactions has.

As funds grow, the European waterfall structure is much more common.

In fact, it’s usually only with smaller funds or real estate funds with few transactions that you’ll see an American waterfall structure in place.

Wrap Up

Both of these nuggets are super useful to know when you’re getting going with your fund.

I leveraged my knowledge of American and European waterfall structures to get investors attention, and it has served me well in knowing what to do with my investors.

All in all, having a focused fund thesis will help you gain the trust of your investors, and knowing how to compensate them will help you retain them.

And that’s the name of the game.

All the best,

Bridger Pennington

Want to get direct guidance for your fund? Schedule a time with my Fund Advisors!

DISCLAIMER: This content is for educational and informational purposes only. It is not to be taken as tax, financial, or legal advice. You should always consult a legal professional before taking action. Furthermore, this is not a recommendation to buy or sell any security. The content is solely just the opinion of the authors.


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