By David Proskin, Managing Director, Integrated Solutions
So, you’ve made the decision to embark on one of the most exciting, challenging and fear-inducing adventures of your career, launching a fund. Whether you are a seasoned veteran or a newly minted CFA with an “edge”, this is not a decision to be made without careful consideration. It is critical that before putting pencil to paper you understand what your motivations are for spinning out of the mothership. Is it the desire for autonomy? A spark of entrepreneurial spirit? ego? A drive to build a lasting legacy? Or perhaps a noble objective to make the world a better place (unlikely as it may sound)? The answer to those questions will shape how the launch process will unfold.
Obviously, you may be smart, have gone to the best business schools and in many instances have led a sheltered and charmed life within the comfort of your legacy firms. You know how to analyze a company, build portfolios, and manage risk, but may have never faced the prospect of running a business beyond that. It is paramount for you to have and be able to articulate what you believe to be your “edge” in a clear, convincing and concise manner. In other words: Why are you better than everyone else? Generally, this is no time for modesty but a healthy dose of humility and the ability to communicate confidently but not arrogantly goes a long way here.
Another key consideration will be who your investors will be. This determination should be thought of chronologically as well as in terms of financial milestones. For example, will your Day 1 capital come from personal funds and contributions from friends and family, or do you have somewhat of an institutional following with one or more key investors. It will be important to understand how what you are doing aligns with the objectives of those investors in terms of liquidity needs and investment time horizons. This will be the time to evaluate economic terms, your flexibility in negotiating terms with strategic investors and so forth.
It will also be a good time to begin thinking about how much this adventure will cost and whether resources are available to put together a credible team to support the operation. A well-thought-out budget is a good place to start. Since strong performance is never guaranteed, it is sensible to build budgets based on recurring revenues, such as management fees. For example, let’s assume the fund will launch at $10 million, I know, it will, of course be way more, but humor me. Assuming that all investors are fee-paying and the management fee is 1.5%, your top-line budget would be $150,000. It is also a good time to think about what fees will be absorbed by the Fund versus those covered by the Management Company. Prospective investors will expect clarity on this. While certain portfolio-related costs-like research, travel or subscriptions-can be charged to the Fund, others such as compliance, shadow accounting, office rent, etc. are much less straightforward and often fall under the Management Company’s responsibilities.
Assuming the venture still appears viable, consideration needs to be given to the composition of your team. Will you be a one-man band, flying solo, or what will the support system around you look like? This will include, assessing key-person risk, how the obligation to protect investor assets will be discharged or put differently, and what would happen should you be unavailable for an extended period of time? Establishing a clear contingency plan and defining roles within your team will be essential to instilling confidence in investors and ensuring operational continuity.
Whether you’re launching solo or with partners, the time to plan for contingencies, compensation and structure is now, while the Management Company is in its embryonic stage and everything is “kumbaya”. Partners are getting along, all are generally at similar life stages (perhaps, or not) so this is the time to analyze the “what-if” scenarios. It is also wise to begin thinking about ownership structures with a long-term view, especially regarding future income tax (and estate) planning while the Management Company is small and has little or no significant value.
As you move forward with launching your fund, now is the time to assess what partners will need in terms of compensation-both cash and equity, along with benefits and certain obligations relating to compliance with federal, state and local tax compliance (e.g., income and payroll taxes, etc.) Engaging a payroll processor or Professional Employer Organization (PEO) could be appropriate to streamline these responsibilities.
These are just some of the foundational considerations even before the first entities get formed. Clearly, this is not a journey that is being undertaken without research and talking to colleagues about the roads they have travelled, and lessons learned about what is a best practice.
A good legal advisor is generally considered to be the first hire. Law firms come in various shapes and sizes and the one selected should be experienced in the structure and strategy that will be employed. This is NOT a decision to make solely based on costs. You get what you pay for, and mistakes can be exceedingly more costly than the quoted fee.
Next, engage a tax advisor or preparer. Along with the lawyers they will be positioned to guide and determine tax efficient structures and domiciles based on the underlying fund strategy. Typically, there are synergies to be obtained by using the same firm for tax preparation and the Fund’s financial statement audit, which is typically required by the Fund’s Offering Memorandum.
Another key service provider that will need to be engaged will be the Fund Administrator. Post 2008 financial crisis & the Madoff scandal, the role of the 3rd party administrator took on much more significance and their presence went from being a “nice to have” to being essential. The Fund Administrator will maintain the “official” books and records of the Fund(s), process investor transactions (i.e. subscriptions/redemptions, Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements) in addition to performing critical independent reconciliation and reporting functions. Essentially the Command Center for all non-research and trading matters.
Depending on your investment strategy, you’ll need to identify the Prime Broker (or multiple Prime Brokers) to facilitate trading, manage collateral and cash flows for the Fund.
Though it may seem counterintuitive, it is suggested that a technology provider be engaged to guide and advise concerning connectivity, data security and data protection protocols —critical components of your operational infrastructure.
At this stage, it makes sense to consider a chronological timeline of the evolution of the organization which will include various milestones in terms of asset growth as well as infrastructure requirements at various levels. For example, given limited resources, are funds best allocated to portfolio research, construction and risk and how other internal controls will be addressed, typically via in-house or out-sourced resources? One might reasonably describe this as the “business plan”.
Ultimately, the responsibility for the managing of the fund resides with the Fund Manager, you, and that responsibility CANNOT be delegated to any third party. Selecting reputable, experienced service providers is critical to support your strategy and protect your reputation. Again, you only get to do this once, and the reputational damage to you personally and the firm can be catastrophic if not managed properly.
Mistakes will happen despite everyone’s best efforts to avoid them, and the key will be in how those mistakes are communicated and managed. Transparent, proactive communication builds credibility and trust with stakeholders. Mistakes with financial implications take on a different level of significance and how investors are treated speak a great deal about the character of the Fund Manager and the type of organization he or she manages. Mitigating the risks associated with financial and disclosure errors may be dealt with via insurance in the form of Errors and Omissions (E&O) coverage. For a start-up this can be a material consideration as coverage is typically quite expensive and a cost benefit analysis versus identified risks for a given investment strategy will be a key component in determining whether insurance is a cost-effective risk mitigation strategy or not.
How We Can Help
At Integrated Solutions, our team brings decades of combined experience to help you navigate these complex challenges with confidence and clarity. We maintain broad and deep relationships with the key service providers and partners needed to ensure a successful launch, and we would be happy to discuss any questions or concerns you may have as you navigate these exciting days. Please reach out to us to schedule a call at your convenience.
