Establishing an Emerging Manager Fund

1. Emerging Manager Program Establishing an Emerging Manager Fund 1

2. Table of Contents

3. Overview Emerging managers are often categorized as managers with a recently formed team or track record and can come in different forms including: • Spin-out organizations – a group or team leaves its current organization to establish a new firm • New partnership – individuals who have worked together in different roles or have an existing relationship and believe that their synergies can create a cohesive team and successful investment partnership • Pledge fund – relationship sponsored or backed by larger institution • Publicly trading holding company – company that has a history of raising capital through an IPO and subsequent secondary offerings, recycled processed from realized investments and institutional co-investors that aims to diversify its products through a fund offering • Deal-by-deal – company that raises capital on a deal-by-deal basis from institutional investors and private equity groups to develop the team’s track record and gauge appropriate timing to raise the first institutional fund • New product category – existing private equity firm that is looking to expand its platform by investing in a new strategy and hiring a dedicated team

4. Firm Formation

5. Keys to Establishing a Firm • Team • Key senior members of the investment team should be substantially in place (or at a minimum, indentified and committed to join) at the time of launch • It is not uncommon for first-time funds to have some open boxes in the org chart during the early stages of marketing. Less senior members, COO or fund administration can join subsequent to launch • Shared economics of the investment team to illustrate the opportunity for growth and incentivize all employees • Office • Important to define how a single or multi-office structure suits the anticipated investment strategy and business model • Investment in office space to substantiate the idea behind the business and provide physical support of its validity • Logistics • Create a firm brand name and logo that represents the newly formed entity

6. Business Organization Checklist: • Office space • Employee compensation and benefits • Accounting and administration • Information technology infrastructure • Printing and distribution of marketing materials • Legal organization and fund formation • Registration with government regulators • Travel expenses The above overhead costs must be budgeted in the management fee (typically 2% of fund size) as additional sources of capital will likely not be obtained until later in the fund’s life

7. Back Office Best Practices • Investors should require that their managers follow “best practices” • Accounting • Administration/Operations • Reporting • Back-up Systems • Investors should assess the quality of a manager's back office as part of its due diligence • The number of professionals and their reporting hierarchy, information and accounting systems, and model of delivery (in-house vs. outsource) may vary • Regardless of a manager's size or scope, an investor should consider a number of common characteristics of well-controlled back offices, including: • Documented policies and procedures are maintained around all back office functions • The back office professionals are appropriately qualified & experienced • A reputable software package is utilized to administer and account for the manager's fund(s) and deal pipeline. • Use of a reputable custodial bank to maintain cash and securities accounts, to the extent applicable

8. Back Office Best Practices (continued) • An established investment valuation and monitoring function, in which all valuations are reviewed and approved by the investment committee • Managers should seek to value their investments at fair value in accordance with the fund legal documents and appropriate accounting guidance (in the U.S., Accounting Standards Codification 820 Fair Value Measurements, formerly FAS 157) • Timely and accurate reporting to investors that provides transparency to the investor • Quarterly reports that provide detailed financial and qualitative information regarding the portfolio • Annual reports should be audited by a nationally recognized accounting firm with real estate or private equity experience • Larger managers should have an independent reporting hierarchy for their back office, with periodic reviews/internal audits. • If an outsourced model is utilized for any back office functions, a reputable and experienced vendor should be used and a secure process for transferring information to and from the manager should be established and documented. • The vendor should engage an accounting firm to examine its internal controls at least annually and report on the operating effectiveness of its internal control environment

9. Back Office Check List • Accounting • Financial statements – appropriate content & format • Who audits firm financials? • How often are audits conducted? • Administrative/Operations • Company budget (business side, not investment side) • Are G&A costs reasonable? • Are overhead costs reasonable? • Back office organization chart • Outsourcing back-offices services • Legal services • Accounting services • Financials • Reporting • Technology maintenance • Reporting • Sample performance report • Experience in reporting to institutional clients? • Back-up systems • Electronic back-up of reports, data, & other files • Off-site storage of electronic back-up • Hard copy document storage

10. Capital Formation Plan

11. Strategy Development • Managers Should Develop and Communicate a Clearly Defined Strategy to Access Capital Needs • How Do You Make Money? • Why Do You Make Money on Your Strategy? • When do You Make Money? • Why are You Best Suited to Execute Your Strategy? • What is the End Goal for Your Strategy and Your Business? • How Many Quarters and Years to Get There? • Have you Built Out a Timeline and Cost Projections?

12. Optimize Capital Raise Based on Strategy • Raising a first time fund: blind pool of capital • The typical private equity fund is structured as a pool of capital with a 5-year investment period and 10-year fund life and allows the manager to make investments with full autonomy and discretion over how capital is deployed • Managers must develop a narrow focus of investments that will be targeted based on strategy, stage and/or geography that can also be supported by a track record • Assess the opportunity that has been set by historical investment pace and deal flow • The management team’s historical investment pace as illustrated through number of transactions completed each year and capital deployment rate will help dictate what an appropriate and reasonable fund size will be for its first institutional fund • Identify the best pools of capital to approach early-on in the fundraise process • Generating interest from existing investors and targeting certain new relationships will create a focused road map to increase the chances of early success from key potential investors

13. Targeted Investors • Deal-by-deal investors • The ability to leverage relationships and develop a strong network of industry contacts can help generate momentum with prospective investors and support early on in a manager’s life cycle • It is important to generate interest in new managers by capitalizing on existing relationships and developing new relationships by offering co-investment opportunities or presenting deals on a one-off basis to prospective investors • Historical or Anchor investors • Once a manager’s ability to generate deal flow, execute transactions and create value has been demonstrated, it is important to secure commitments from existing investors to and get them into a first close • Given the high level of competition in the fundraising market, many emerging fund managers are offering favorable economics to investors willing to support a first-time fund and become an anchor investor

14. Institutional Marketing

15. Marketing Process Pre-marketing Materials Marketing Campaign Due Diligence Closing Process • Flipbook • Used in meetings with prospective investors to describe the fund in a more concise, live presentation format • PPM • Provides information to buyers regarding: Fund strategy, investment track record, management of the partnership, case studies, terms of the offering, risk factors and legal and tax matters • Due Diligence Questionnaire • Proactively address key questions from prospective investors • Other key steps: • Develop roadshow strategy and target lists • Define role of advisory board • Initiate a “whisper campaign” • Dialogue with strategic existing or anchor investors to generate momentum to get to a first close • Distribute PPMs • Generate interest among new investors and set up introductory meetings and calls • Other key steps: • Finalize LPA Documents • Closely track and monitor LP feedback • Strategically plan close timings • Responsiveness • GPs to respond to prospective investors’ due diligence requests in a timely and efficient manner • Attention to detail • Customize information provided by the GP to be responsive to prospective investors’ specific questions • Sample customized due diligence requests include: • - Customized questionnaire • - Qualitative explanation of investment strategy • - Operating company financial performance • - Value creation analysis • - Overview of competitive landscape / benchmarking • - Cash flow analysis • - Reference information • - Market data • - Details on changes to terms and conditions since the GP’s prior fund • Partnership terms and negotiations with LPs • Frequent dialogue between managers and investors • LP and GP legal counsel to review comments on the Limited Partnership Agreement and discuss appropriate/reasonable responses • Timing • Ensure that dialogue is consistent between GPs and investors, as well as their respective counsel, to ensure that closing deadlines are met

16. Limited Partners in the Emerging Manager Space The following parties have demonstrated or expressed an active interest in the emerging manager space through prior commitments or reserved allocations

17. Manager Due Diligence

18. Strategy and Process • TRS thoroughly vets each general partner’s investment strategy and process to identify those groups with sustainable franchises generating superior returns Criteria “Best of breed” examples • Control / minority positions • Specialized industry / geographic focus • Deal sourcing • Targeted fund size • Fund type (i.e., buyout, mezzanine, special situations, secondaries) • Due diligence process • Value-added post-investment • Exit strategy • Transparency in reporting • Controlling ownership to effect operational change or negative controls in minority stakes • Differentiated strategy vis-à-vis competitors • Demonstrable access to truly proprietary deal flow • Appropriate based on team size and investment pace • Differentiated risk / return profile; consistent with LP focus areas • Rigorous, thorough, well-documented • Quantifiable operational improvements (CEOs corroborate) • Clear path(s) to realization • Deliver regular, in-depth reports / updates to LPs on portfolio company and fund level performance

19. Individual Responsible For: Sourcing Negotiating Structuring Recruiting Monitoring Exiting Investment Investment Investment CEO / Management Investment Investment Team • TRS utilizes numerous criteria in evaluating GP teams to identify top performing managers Criteria “Best of breed” examples • Deal attribution • Depth of team • Cohesiveness of team • Complementary skill sets • Time commitment • Alignment of interests - GP investment - Carried interest splits / vesting • Current team responsible for historical track record • Strong second tier / next generation of professionals • Minimal team turnover / significant years together • Mix of finance / operating / legal experience • Minimal non-fund-related responsibilities • Team compensation tied to performance of fund - Sizeable team commitment (cash vs. management fee deferral) - Appropriate distribution of carry and vesting schedule

20. Historical Track Record • TRS utilizes numerous criteria in evaluating GP teams to identify top performing managers Criteria “Best of breed” examples • Realized investment performance - Multiple of invested capital - Gross and net IRRs • Realized versus unrealized components • Unrealized portfolio performance - Trendline analysis - Debt covenant analysis - Valuation write-downs • Consistency of returns • Focus on investments generating poor returns • Consider absolute and relative performance - Varies by strategy (e.g., LBOs: 2.5x+ cost ) - 25% (gross); compare net returns to benchmarks • High portion realized; manageable unrealized portfolio • Positive momentum in unrealized portfolio companies - Demonstrable value creation (sales, EBITDA, debt) - Assess near-term maturities and relevant covenants - GP actions to recover / maximize value • Returns not largely driven by one or two “home runs” • Investment rationale consistent with historical strategy; ability to articulate “lessons learned”

21. Sample Background Check This memorandum summarizes the results of our background investigation of Firm ABC and its principals Partner A, Partner B and Partner C, pursuant to your request and at your direction to assist you in your due-diligence process. This investigation, commenced on September 18, 2009, included searching for any criminal or civil litigation naming the company or individuals as a party; searching for any actions taken against them by regulators or licensing authorities; reviewing professional licensing history; and reviewing news articles and the Web for any adverse or risk-relevant information. To that end, we conducted online searches in news and public-records databases, supplemented by targeted online searches of relevant court indices. LITIGATION SEARCHES We found no record of any criminal cases (felonies or misdemeanors), judgments, liens, bankruptcies, U.S. Tax Court cases or any other litigation naming Firm ABC as a party. We searched multiple databases, which, when taken together, cover federal litigation nationwide—civil, criminal and bankruptcies—and select state-level litigation as available online. 2007: Firm ABC Advisors Sued the Dominican Republic According to news articles from March 2007, Firm ABC was involved in a breach of contract lawsuit against the Dominican Republic for alleged failure to make payments for energy produced (Attachment 2). We searched for but did not find court records for this lawsuit naming Firm ABC as a party; however, news articles suggested that the suit was filed by the Parent, Firm ABC’s ultimate parent company. REGULATORY AGENCIES No Sanctions We found no record of any securities-related or other regulatory enforcement proceedings taken against Firm ABC on the federal or state levels. We searched for any actions by the Securities and Exchange Commission, Federal Trade Commission, Department of Justice, Financial Industry Regulatory Authority, stock exchanges and other authorities, including the California attorney general. Not on Government Watch Lists We searched for but found no record of Firm ABC appearing on any government watch lists, including the Office of Foreign Assets Control, Commodity Futures Trading Commission, World Bank Debarred Firms list and the United Nations Sanction list. No Licenses or Registrations We did not find any licenses or registrations for Firm ABC. We searched with the SEC for investment advisors, FINRA for brokerage firms and NFA for commodities trading.

22. Increased Focus on Terms in Fund Formation • ILPA released its latest private equity principles in January 2011, detailing what it considers to be “best practices” regarding alignment of interest, governance and transparency • These principles should be viewed as guidelines vs. a checklist • Certain “hot button” items are noted below • Fees • Management fees should be based on reasonable operating expenses and salaries and step down significantly post-investment period (certain LPs requesting cash flow budgets) • Transaction, monitoring, advisory, and other fees should accrue to the benefit of the fund (i.e., 100% offset against management fee) • “Fund as a whole” vs. “deal-by-deal” carry is strongly preferred. When deal-by-deal model is used, require carry escrow accounts with significant reserves (>30% of carry distributions) • GP cash commitments are preferred to fee waiver schemes • Governance and disclosure • Management fees should be based on reasonable operating expenses and salaries and step down significantly post-investment period (certain LPs requesting cash flow budgets) • The investment period is automatically suspended when a key man event is triggered • No fault rights upon two-thirds in interest vote of LPs for suspension or termination of commitment period (75% for removal of the GP or dissolution of the Fund)

23. Terms Review TRS provides considerable input with respect to terms early in the offering process, advising an appropriate fund structure to fundamentally align the general partner’s interests with those of the limited partners • ILPA friendly • Alignment of GP / LP interests • Preferred return • Fee splits • Catch-up • Distribution “waterfall” • Deal-by-beal • Back-ended • GP investment • Meaningful portion of liquid net worth • Source of funds (cash vs. fee deferral) • Capitalize management fees and organizational expenses • Commitment period • Reinvestment / recycling provisions • Clawback / escrow accounts • Fund size relative to investment activity • Investment mandate / restrictions • Diversification • Conflict of interest resolution • Termination provisions • Key man provisions • “No fault” divorce • Investor reporting • Accounting and administration • Outstanding and pending litigation

24. Standard Fund Terms • Below are favorable and fair fund terms for a typical commingled fund • Hurdle Rate/preferred return: 8%-10% • Carried Interest: 20% over 8% (sometimes tiered after 1st hurdle) • 2% management fee • Catch-up: None • Back end promote shared fairly amongst management team • Investment period: 3 yrs • Fund Life: 10 yrs • ILPA friendly • Strong Advisory Board collaboration and participation

25. Emerging Manager Marketplace: Making it to the Finish Line • Who is closing and why • A mixture of 1st, 2nd and 3rd time funds • Those with successful closings tend to have all or mostly all of the following characteristics: • Clarity of strategy • Direct and exceptional operating experience • Strong and attributable track record • Institutional quality fund and institutional relationships • Exceptional performance in niche plays like senior and student housing • Well poised to take advantage of today’s opportunities • Terms of successful closings • These funds have quickly gotten to LP friendly terms, generally comprising: • 8% hurdle with no catch up • 9-10% hurdle with a catch up, but often only after a second hurdle of 13-14% gross IRR • Back ended promote across the management team • ILPA friendly • Strong advisory board rights

26. Emerging Manager Marketplace: Why Many Can’t Get Traction • Common problems • Crowded space: Many managers have strategies that are indistinguishable from others and do not have a compelling story. Multifamily operators in particular have suffered in this respect - buying properties in similar markets at sub 6% cap rates without a distinguishable means to achieve superior returns • Confusing/unfocused strategy: Many managers simply want to buy everything and lack focus & a clear value added strategy • Allocators: Many managers are allocating capital to local managers. While a few have made this a compelling approach, most have not done so • Insufficient track record: Particularly challenging for managers who are raising their 1st fund. Furthermore, in some cases where a team may be spinning out of a larger organization, they may be restricted from disclosing details of the track record they built during their tenure at the prior entity. Their ability to execute deals independently is often very uncertain • Out of the market: Many potential managers are becoming full time fundraisers. Their pipeline is stale and their ability to execute on their strategy is unclear. This is particularly hazardous for 1st time managers who don’t yet have a track record • Poor alignment: The level of GP contribution may be relatively light for initial funds (relative to their personal net worth). More significantly, the promote is not shared well among the team and too often held primarily by a few top executives • Too early stage: Some managers may not have substantially built out their team or established their organization’s infrastructure, particularly in cases where they may be raising their first fund • Confusing structure: Managers that operate a platform that includes multiple business entities may need to convince potential LPs that their proposed fund will be an area of significant focus for the firm. If the fund’s fees are shared across the broader organization, they will also need to demonstrate this will be done appropriately • Fiduciary qualifications: In cases where managers may have limited to no experience in managing institutional funds or separate accounts, they may not have incorporated institutional reporting and compliance systems into their organization

27. Early Stage Managers: Challenges and Solutions Institutional Platform Raising Capital Track Record Challenge • “Anchor it” • Be an anchor investor in a fund’s first close to enhance its marketability and create momentum • “Build it” • Provide co-investment capital for one or more deals to demonstrate sourcing and execution ability • “Institutionalize it” • Provide full platform services, including underwriting and asset management capabilities Solution • Cogsville – Credible LP is considering acting as a small anchor investor • Admiral – USAA has provided a $50 million pre-close commitment; CFIG is considering anchoring the first third-party close • W3 – Hunt Realty has anchored the first close with a $90 million commitment. LPs are considering providing an additional commitment to provide the fund with momentum • Admiral – USAA plugs Admiral into its existing platform • Cogsville – Colony plugs Cogsville into its existing platform, Examples • GCA– A sizable LP is evaluating a real asset transaction with this manager • Leumas Realty – LP candidates are exploring multifamily acquisitions with a manager that is looking to spin out of an existing platform Solution • “Rent it” • JV with local operating partners who have an existing platform • “Front it” • Act as institutional platform for local expertise • “Seed it” • Provide sole capital for a first fund Examples • CityView – partnering with Lincoln • Admiral – partnering with USAA • Cogsville – partnering with Colony • Hawkeye did this for four managers in their flagship fund • CityView acts as the institutional face for Lincoln and GCA • Early stage managers often lack (a) an attributable track record of successful investments, (b) an institutional platform and/or (c) momentum in raising capital

28. Conclusion • Keys to success for a first-time fund: • Establishing a team of professionals with a strong, successful track record and identifiable synergies • Properly align management compensation across firm and LPs • Mitigating potential issues early-on by using LP-friendly terms • Creating thoughtful and differentiated strategy and marketing materials • Strategically planning a list of targets and the best way to approach potential investors

29. Appendix

30. DEAL SOURCING DEAL FLOW EVALUATION PRELIMINARY DUE DILIGENCE COMPREHENSIVE DUE DILIGENCE INVESTMENT EXECUTION INVESTMENT MONITORING Regular Update Meetings YES YES Compile Deal Flow Preliminary Due Diligence Comprehensive Due Diligence Annual Meetings YES Calling Program Circulate Investment Materials Preliminary Investment Memo Investment Memorandum Board Participation* Final Legal Negotiations Fund Relationships Subcommittee Review YES Proprietary Databases Subcommittee Review Subcommittee Review INVEST Platform Meets the Manager Network Vote: Comprehensive Due Diligence Investment Committee Vote: Invest Industry Databases and Public Information Unsolicited Deal Flow Vote: Preliminary Due Diligence NO NO NO NO PASS Appendix: Traditional Fund Investment Process