Launching a hedge fund can be challenging. Many aspiring managers believe that if they establish a reasonably successful investing track record, the next step is to hang up a shingle, and they will come.
The first step when embarking on the hedge fund path is similar to what needs to be done at the outset of any business venture: creating a sound business plan. The major considerations when devising the plan include:
- Fund Structure – Standalone, side by side, Master-Feeder or Mini-Master. What structure you end up with will be affected by your projected capital base and the domicile of your major investors.
- Investment Strategy – You may not want to give away too much of the “secret sauce” in your fund docs, but you also do not want to run the risk of confusing your potential investors with too much esoteric detail.
- Fee Structure – Fee structure is mainly a function of “what the market will bear.” Most want a 2 and 20 fee structure, but for an emerging manager, it’s more important to gather initial capital than to maximize your fees. Long-term greed trumps short-term greed every time.
- Raising Capital – Your marketing strategy goes hand in hand. You need a professional-looking marketing deck and a “tear sheet” to send to prospective investors. While your initial capital will likely come from “friends and family,” you should treat the initial seed investors as if they do not know you and provide them with a professional marketing package. This establishes a good working process for when you approach outside investors.
- Managing Company Structure – Always be open to giving up a piece of the management company to a major seed investor. 50% of something is better than 100% of nothing.
After creating a sound business plan, the next step is selecting the team to assist you in implementing the plan. Most emerging fund managers will not have the luxury of being able to afford an internal team for all functions that a new hedge fund requires, including:
- Attorney – We all want to engage the “best and the brightest” of hedge fund lawyers; it’s important to “right-size” with all your service providers. Even if you can afford to pay a top-notch firm, do not be the smallest fish swimming in the pond. Consider, weather a smaller, less well-known firm with equally competent staff suits your needs better.
- Audit and Tax – Unless you are required to be SEC-registered, you should consider whether engaging an independent auditor is necessary. This is a decision in the early years of a hedge fund, and cost vs. benefit must be weighed. If an audit is to be done, does the fund document allow for an initial stub period of less than a full year to be rolled into the next year for a more cost-effective audit? Who will prepare the tax return if there is no auditor for an initial period? Does the Fund Administrator have this capability?
- Selecting a Fund Administrator – Appointing a reliable third-party fund administrator to prepare monthly NAVs, communicate with investors, provide AML/KYC services, etc., is one of your most important decisions. Your fund admin is a liaison between you and your investors, responding to questions regarding capital accounts, subscriptions and redemptions, lock-ups, and more. It is vitally important, even more so than with the selection of the fund attorney, to choose an administrator who will not let you “get lost in the shuffle.” When you have a question for your admin, do you want to speak to a low-level staff person, or would you rather be able to speak to a senior manager, or a Partner at the firm you engage?
- Fund Officers – Can you afford someone to fill the CEO, COO and CFO roles, or are you all three? What about compliance issues? Do you have the time, or are you trained to perform these functions? Outsourcing with the right firm is paramount.
- Directors – Consider appointing directors for the management company or an advisory board. Investors like to see a team of experienced professionals available to solve problems and take advantage of opportunities that will arise.
Critical Fund Documentation
No one looks forward to the meticulous review required for fund-related documents. Grassi Fund Services assist managers who commit to our services during this time-consuming process. While attorneys, bankers, and prime brokers will prepare these documents, you are ultimately responsible for what is included. Review includes, but is not limited to:
- The offering binder includes PPM, subscription documents and LP agreement
- Prime Broker and/or Custody agreements
- Compliance Manual
- DDQ
- Marketing Materials
- Form ADV review if SEC-registered
- Review of valuation and other critical fund policies
- Compliance and regulatory issues – The securities industry is heavily regulated. In addition to the form ADV for SEC-registered funds, there are Forms 13-F and PF, which may be required filings. Managers must know the various compliance-related documents and filings if the fund is registered in a foreign jurisdiction like the BVI or the Cayman Islands.
General business office needs:
- Insurance requirements, including errors and omissions, health, umbrella liability, etc.
- Leases for office and equipment, as well as data providers
- Banking relationship for fund and management company.
- Disaster recovery plan
- Cyber Security – To protect investor information, will you provide a secure portal for investors to access? Does the cost for such services make sense for an emerging manager?
Emerging managers must “right-size” their selection of service providers. Everyone would like to be associated with the best providers, but managers should carefully weigh the cost of hiring the biggest, most expensive providers versus the benefits when marketing the fund. Is a full-service, national brand necessary for the fund’s success, or does a focused, smaller provider offer the fund manager more freedom to succeed in job one for any fund manager, earning above-average returns for the fund’s investors?
Grassi’s Fund Services provides comprehensive assistance to fund managers, leveraging our extensive experience with various fund structures. The team, led by principals and partners, offers personalized support throughout the fund formation process. This includes complimentary guidance and access to established banking relationships, ultimately contributing to the success of its clients.
