June 23, 2022
The interview below is part of a series from McGuireWoods featuring impressive emerging managers, as part of our ongoing commitment to the emerging manager community. To recommend an emerging manager for a future interview, email Jon Finger at email@example.com.
Q: What led to the decision to raise your initial fund? What were the indicators — internal and in the market — that you were ready?
Jack Waterstreet: We always intended to raise a fund from the moment we started the firm. We felt strongly that having a committed capital fund would be a competitive differentiator when trying to buy businesses from families, and we also wanted a consistent fee income stream to support our team.
After discussions with potential limited partners (LPs) and placement agents, we thought completing one pre-fund deal would be very helpful in the fundraising process, so we did a pre-fund deal. However, during the fundraising for that pre-fund deal, we communicated to potential LPs that we would be raising a fund shortly thereafter.
The feedback from potential LPs and placement agents suggested we would be successful raising a fund after completing that first pre-fund deal, which ultimately was the case.
Q: How did you think about assembling your team?
JW: This was absolutely the most important thing to me when I first started thinking about leaving my previous firm to start a new one. While I think I bring several skills to the table, I do not think any one person can be successful in running a fund with several portfolio companies. There is just too much that needs to be done, and I think it is critical to have diverse perspectives when making investment decisions.
I appreciate I have both strengths and weaknesses, so I wanted a team that augmented my skill set. I was very fortunate that my two partners were excited to start the firm with me as I think the three of us together have the perfect skill set to run the firm. Given our aggressive growth goals, we knew we needed a full team to support us. We were very fortunate to have several individuals we previously worked with join us at or near the start of the firm. Then we had some great recommendations to add junior team members from our friends in the industry. There is no doubt in my mind that our firm's success has been driven by the contributions from all our team members.
Q: What were the most important considerations for you when choosing LPs to pursue a partnership with?
JW: There were several factors we prioritized. Among the largest was the LP fully understanding and appreciating our strategy. We are strong believers in pursuing lower middle market manufacturing companies owned by families that are looking for our assistance in taking their company to the next level of performance. We think we have the right skill set to deliver superior returns in that space, and it is also what we enjoy doing. We do not plan on changing our strategy, so we wanted investors that understood and believed in our strategy.
Another important consideration was finding investors looking for a long-term partnership. We plan on running the firm for a long time. Ideally, we want investors that can stay with us on that journey.
Being true partners was also imperative. We are maniacal about making sure we live up to everything we promise to others — whether LPs, families, management team members or anyone else — so we wanted to work with LPs that appreciated this and acted the same way.
Fair economics is also a big part of the partnership. There were a lot of LPs that wanted economic interests in our partnership, or zero fees or had other questionable requests. Ultimately, we felt that was not in the best interest of our team and the long-term future of our firm, so we are very thankful to have found a group of LPs that believe we can still deliver them substantial enough returns without requiring those types of economic concessions.
Q: What did you consider and prioritize when developing an investment strategy for your initial fund?
JW: My decision to leave my prior firm was driven by my passion to chase lower middle market manufacturing deals, which I was no longer able to do as that firm got larger. So, we had that strategy set from the beginning. Ultimately, we think we can earn outsized returns on those deals for our investors and, very importantly, we enjoy working alongside the families with those types of companies.
Q: With emerging manager programs on the rise, what do you foresee for the future regarding LPs' willingness to invest with emerging managers?
JW: Sky Island is the first firm I started, so I do not have a personal history to know how the LP landscape with emerging managers has changed recently other than what we heard from several placement agents and LPs we interacted with. Right now, I think there are more LPs that say they are willing to invest with emerging managers than are actually out there. I think several LPs are just trying to establish relationships with managers for future funds if they are successful with their first funds. Of those LPs that do invest in emerging managers, a good portion of those groups seems to be looking for very favorable economics, including general partner stakes or free co-invest.
However, I know there are investors that believe in emerging managers delivering strong returns even with standard economics, including several we are fortunate to be partnered with, so they are definitely out there today. I think, as more and more quality managers leave their existing firms to start new ones and demonstrate strong returns, more LPs will support emerging managers going forward.
Q: Recognizing the complexities in raising a first-time fund, what are some teachable moments you have encountered along the way?
JW: We raised a fund during COVID-19, so that presented even more challenges than normal. I think by now a lot of investors are taking meetings back in person again and/or have figured out their investment process using Zoom, so hopefully that is less of an issue going forward.
A few big takeaways for me: First, the LP community generally does not move at the same pace as the deal community, so new managers will need to have some patience. Also, most LPs have very specific commitment goals for a given year, so it is important not only for the LPs to want to invest in your fund, but for the timing to work out as well.
Q: What is the best piece of advice you were given when raising your first fund?
JW: Several people warned that raising a first fund can be difficult, so I should be mentally prepared for a long fundraise. This was advice before COVID-19 hit. I always try to abide by the saying, “You are never quite as high or low as you think,” which helps me not get overconfident when things are going well or wallow when things are not. There were definitely some ups and downs in the fundraising process, but, like most things in life, persistence paid off for us.
Jack Waterstreet is the managing partner of Sky Island Capital. He is responsible for overseeing all facets of the firm's investment activities and sits on the investment committee. Prior to founding Sky Island, Waterstreet was a partner and the chief investment officer at Insight Equity, an operationally focused middle market private equity firm with approximately $1.4 billion under management. At Insight Equity, Waterstreet sat on the investment committee and was responsible for sourcing, executing and managing investments.
Prior to Insight Equity, Waterstreet was an associate at Brockway Moran & Partners, a middle market private equity firm with approximately $1.3 billion under management. While at Brockway Moran, he evaluated and executed numerous investment opportunities and worked extensively with portfolio company senior management teams. Prior to Brockway Moran, Waterstreet was an analyst with Harris Williams & Co., where he provided sell-side merger and acquisition advisory services.
Waterstreet currently serves on the board of Material Sciences, Polished Metals, Valley Forge Flag, USA Industries and SkyMark Refuelers. He was previously a board member of several Insight Equity portfolio companies.