The interview below is part of a series from The McGuireWoods Emerging Manager Program featuring impressive emerging managers, as part of our ongoing commitment to the emerging manager community. The McGuireWoods Emerging Manager Program supports emerging managers throughout the most critical stages of a fund’s evolution with a differentiated and proprietary approach to connecting emerging managers with limited partners, providing intelligence on market terms and preferences, and advising emerging managers on all components of building a durable brand as an investor. To recommend an emerging manager for a future interview, email Jon Finger at [email protected].
Q: What led to the decision to raise your initial fund? What were the indicators that you were ready?
Matthew Koven: I was part of a prior platform that raised subsequent successful funds and grew rapidly. When you move upmarket to a larger fund size, your strategy must adapt. You tend to invest larger checks into larger assets. If you’re an operationally focused firm, it can be quite different running new playbooks in those larger assets. My desire to step away was driven by a passion for the lower middle market, where there are fewer assets under management (AUM) chasing a larger number of opportunities, and a belief that our playbook was exceptionally effective. These were the primary motivators, along with an embedded entrepreneurial desire to “hang our own shingle” and pursue investments with a very active and process-driven sourcing model.
One other factor I would emphasize is the current, competitive landscape. There has been a tremendous amount of capital coming into the growth equity market. Much of that capital has been at the $750 million to $1 billion-plus fund size. We felt like there was a void in the lower middle market in $500 million and lower-sized funds.
Q: How did you think about assembling your team?
MK: The culture of our team is by far the most important part of what makes our strategy work. In the lower middle market, you must evaluate a lot of opportunities and have significant proprietary deal flow and volume. The only way that happens is by having a well-oiled sourcing engine that continues to pump out opportunities programmatically.
A firm must have a culture of people who prioritize, get excited about and have a personality for sourcing. From the most senior person down, our team needs to have that sourcing DNA embedded within it. We look for people who have that quality. The technical chops and horsepower come first, but we won’t bring anybody on board who is not intrinsically excited about sourcing or who doesn’t see the upside in sourcing for their own career and development.
Another factor is our operational involvement. This is an area where we’re trying to be significantly different. Those firms farther upmarket are doing more of this work, especially in growth equity. For sub-$500 million funds, I think it’s a barren wasteland. A lot of folks talk about helping with operations but have few resources. We’re jumping ahead, investing in the talent and delivering skill sets that help businesses solve their most pressing pain points for growth.
Next to these qualities, we’re looking for people with specific personality types and from backgrounds that suggest a higher level of “scrappiness” and desire to bet on oneself. That is important.
Q: What were the most important considerations for you when choosing LPs to pursue for partnership?
MK: We’ve had a group of legacy investors who have supported our pre-fund investments. Several of those groups are family offices and high-net-worth individuals who have known us for many years. They’ve been fantastic relationships.
We realized early in the fundraise that it is extremely important to attract an institutional LP, especially in your first close. It’s an important signal to the ecosystem that we have been through true underwriting and diligence as a fund, as a team, with our track record. I think that scrutiny lends additional confidence to other LPs that our firm will successfully complete their underwriting process.
As we think about additional LPs coming into the fund, we are looking for a couple of characteristics. One is a long-term perspective and desire to grow with us. I think the data speaks for itself in terms of performance for first funds through fund three or four. We want partners who want to take that journey with us — who want to benefit from those “excess” returns relative to more established funds.
We also want LPs that can scale with us. Ideally, these institutions can scale with us as we continue to deploy into the lower middle market well into the future.
Q: What did you consider and prioritize when developing an investment strategy for your initial fund?
MK: A big part of our current strategy comes from our heritage and where we spent time at prior firms. I was a huge believer in our strategy, our founder Gene Yoon and the broader team at Bregal Sagemount. The strategy was originally born inside Goldman Sachs by Gene and backtested through the prior credit crisis. We had a very strong, risk-adjusted approach to investing in growth and technology companies. We achieved equity returns that outperformed buyout returns with less volatility, less leverage and, we believed, lower risk.
Per my prior comments, I simply had a passion for the lower middle market and saw opportunity given the higher volumes of opportunities being chased by less AUM and competition. I felt there was an opportunity to essentially relaunch where we started. So, we leaned into our heritage and built a new platform to focus on finding opportunities we know how to underwrite. This is our risk-adjusted approach of investing in recurring revenue-only business models benefiting from very strong secular tailwinds that are 15-years-plus in length with low macro volatility. We only focus on companies that are truly mission-critical with high value proposition, true system of record and no customer concentration, and we only invest through asymmetric securities to reduce return volatility in downside situations. That whole mix is exactly what we’re looking to do. Our experience, armed with performance data through economic cycles, drives our conviction that this strategy consistently generates excess returns.
Q: With emerging manager programs on the rise, what do you foresee with respect to LPs’ willingness to invest with emerging managers?
MK: What we’ve seen in the alternative asset space, specifically private equity and growth equity, is the successful platforms get exceptionally big. It’s difficult for professionals inside those platforms to step out and launch independently because their track record is based on working with very large assets that are not suitable for a typical emerging manager/fund I profile. There’s a mismatch of expertise and experience relative to what’s needed to succeed. That’s why I think the emerging manager community is somewhat biased toward managers with lower middle market exposure and track record. Returns from emerging managers have proven strong, relative to more mature firms. This will draw more interest from LPs.
It’s difficult to comment on the pace that’s going to happen. The fundraising environment is challenging due to overcommitments from 2021 and misallocations. The interest rate environment and low merger and acquisition volumes make everything more difficult and challenging right now. That said, if the economic cogs start humming a bit more, you’ll probably see more activity in this space.
Q: What advice would you give to someone planning to raise a first-time fund?
MK: Who you spend time with is key. There are so many ways you can spend your time and so many groups you can spend your time with. You could go years before you find the right fit and match. There are people within our firm who came from shops that took 4-5 times longer than it took us to get to half the size because they didn’t know who to go to and who to spend time with.
If you’re raising a fund I, that already narrows the ecosystem of LPs that are going to be interested. When you get down to your critical first close, the institutional landscape of LPs who will step into a commitment is a relatively small universe. Building a relationship with those groups — knowing who they are and what they like to see — is the next challenge. There are some things you can control in terms of what you build, how you present yourself, your track record and the story and strategy you’re bringing to the table, but then there are other things you can’t control, such as what kind of strategy the LP is looking to allocate toward and gaps that may exist. It takes getting out and having conversations, but having conversations with the right set of groups that participate in that space.
I think the other piece is people must know there’s real spend involved in getting the infrastructure up and getting the right people in the right seats in terms of the team to put points on the board while maintaining a sensible budget.
About Matthew Koven
Matthew Koven is the managing partner of LoneTree Capital. Prior to founding LoneTree, he was a principal and member of the founding team at Bregal Sagemount, an operations-focused growth equity firm. Koven focused on majority and minority investments in the middle and lower middle market across the software, healthcare IT, financial technology, business services and consumer services sectors.
Prior to Bregal Sagemount, Koven was an investment professional at Welsh, Carson, Anderson & Stowe focusing on majority and minority investments in software, business services and healthcare investments. He began his career at Morgan Stanley in the investment banking division within the global financial sponsors team focused on leveraged buyouts. Matt received a BA in economics from Williams College.