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Nov 2, 2016

When I arrived down at the marina the other day, there was a new boater on my dock. He had the latest model tournament boat, top fishing gear and the best available private captain and crew. As I stopped to greet my new neighbor, he told me that he decided to become a professional tournament fisherman. I wished him luck. For sure, he was the best outfitted boat at the marina and certainly appeared ready to take on the challenge.

A month later, I saw that same neighbor down at the dock and asked him how he was doing in the fishing tournaments. He told me that he had to sell the boat and fishing gear and let the crew go. He had to WIN a tournament in the first month to afford continuing with his fishing operation. He left the marina that day still shaking his head and wondering what went wrong.

If you have considered, or are considering, launching a fund, then the fictional anecdote you have just read can provide insight into some valuable considerations that can increase the likelihood of your success.

First, remember that when you launch a hedge, private equity, or venture capital fund, you are also starting a small business. Unlike the boater in our story, start with a realistic budget that provides a long enough runway to allow the operations to become self-sustaining. Individual circumstances and capital outlay required to cover the early years of operation may differ dramatically between launches, but expenses such as legal, filing fees, IT infrastructure, IT support, research, travel, rent, utilities, marketing, printing, accounting, tax preparation and potentially salaries/benefits for employees should be considered. Additionally, an investment manager will need to consider whether they will reimburse some or all of the fund level operating expenses during the formative year(s) of the launch. While this has great appeal to your potential investors and helps your overall performance, as an investment manager, these items represent a further drain on the operating budget.

To make an operating budget go further, managers can either increase revenue or reduce expenses. Let’s start with increasing revenue, since this is always a positive. To an investment manager, this means raising capital. Given we are concentrating on new launches, there is an inherent optimism in the prospects of raising capital and successfully launching a fund. My advice for investment managers, which would have served our friendly fisherman well, would be to temper the expectations of the launch. If after talking to prospects a manager expects $40 million at launch based on those conversations, then I propose the manager budgets for half that amount. Raising capital is a challenging prospect in today’s environment. Inevitably, some prospects will not invest when the time comes and others may be significantly delayed in funding their verbal commitment. Obviously, these events reduce the revenue earned and may adversely impact how long a venture can be sustained.

Fortunately, there is another side of the equation available to managers looking to extend the budget and create a longer window of opportunity. Very simply put, reduce expenses. Just as our boater would have doubled his time to succeed by purchasing a used boat that cost half as much, investment managers can make similar choices.

One of the major decisions facing an investment manager during launch is determining what functions to perform internally and those that should be outsourced. Performing functions in-house for the fund (such as fund administration, tax preparation, etc.) tend to require additional IT infrastructure and support costs as well as potential increased staffing and related expenses. Keeping these functions in house is more prevalent in the private equity and venture capital markets than the hedge fund markets. On the investment manager side, hiring a CFO, trader, administrator, etc. to support the operations can significantly increase the internal budget in the early years. While hiring a full complement of staff at all levels may make sense for the $200 million dollar launch, the $20 million dollar launch with friends and family money may find an outsourced model preferable. When evaluating staffing decisions, a manager must determine if there is sufficient work to support the hire and if there are outside influences that would prevail in requiring the internal hire. Depending on the circumstances, by outsourcing the traditional internal functions (trader, CFO, compliance, IT support, accounts receivable/payable, etc.), the manager may be able to “staff” their company with experts across many fields for the same cost as a single senior level hire.

One should not lose sight of the fact that while we have been discussing the budgets of the investment manager, the expense budget of the fund is important as well. Every vendor decision that is made at the fund level will directly impact performance and expense ratios. In turn, this could negatively influence capital raising if the effect is significant enough. Investment managers need to impartially and critically review themselves to identify the best vendor solutions for their individual needs.

The good news for managers is that in any given area of service, vendor choices range from the big guns to the boutique shops and cover every tier, sector and specialty in between. With so many choices available, the challenge of each manager is to identify the vendor that best compliments the fund’s complexity, strategy, investor base and management team as well as the budget. In today’s landscape, there is most certainly a service provider that is the right fit, with the right personality and right cost for virtually every manager in the industry.

Launching a fund should be exciting and requires founders to take a leap of faith, expend a whole lot of effort and be blessed with a little bit of fortune to succeed. Remembering that you are also launching a small business; establishing a realistic budget will maximize the opportunity you have for success.

Ken Poudrier is founder of Pillar Fund Services, which provides outsourced CFO/COO, fund administration and consulting services for the alternative investment community.

Asset Management Intelligence - Q4 2016

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