My partner and I have been investing in public tech equities on behalf of a high net worth individual who's very well connected. Since this is our first time managing other people's money, I turned down investments from referrals we received last year.
We're currently up about 40% YTD. All of the companies in our portfolio are doing really well. We expect our primary pick to continue to be the primary driver of portfolio growth.
Now that we're comfortable with all of the aspects of running a portfolio, we're looking to start a small ($4 - $10 million) formal fund. We believe we have a good strategy to scale up to a much bigger size in the future..
The only issue is, we are only stock pickers (primarily tech), and don't have a hedge fund background. I was wondering if anyone here has experience with starting a long only fund or a hedge fund. Below are some of the questions I have:
How long does it typically take to start a small fund and how much does it cost on average to get everything set up? Do you get a sponsor to seed your fund or do you pay for all of the cost of starting/running the fund from the management fees you collect upfront? If you're charging 2/20, do you charge 1/4 (quarterly) of the 2% management fee upfront when investors subscribe to your fund? I'd love to connect to and hear from people who have gone through this process. Any tips and advice is greatly appreciated!
Disclaimer: I'm not a PM or a founder and not in your geographic region, but I might be able to offer some helpful advice.
Currently an analyst at what most would consider to be a "start-up" fund (~$100mm AUM, started in the last 5 years, seed investment 1-2 years ago and took off from there).
I joined post-seed investment while they were scaling up, so I got to (and still get to) see some of the kinks getting worked out.
AFAIK, each seed investor deal is different. We do a revenue share with ours, but they don't have any equity in the business. In return, they provide us with infrastructure, some overhead costs, sales staff, etc. They have an incentive to see us succeed obviously b/c revenue share agreement (which tapers off over 10 years). We started off doing SMAs and then started a legit offshore fund when we got the seed investment and now primarily raise for that fund.
Our infrastructure costs are pretty low: office space, auditor, etc. Not sure the total dollar amount or how much (if any) our sponsor covers or timing of fee payments sorry. I do know that you most likely won't be able to charge 2/20 (especially for startup LO or L/S) to early investors and you'll probably have to be flexible and do something like 1/20 or 1.5/15 or something tailored to each client.
Edit: Also just saw that you only plan to start with $4-10mm, that seems really low to me. For reference, I know our seed funding check was ~$25mm and I suspect you'll need something at least this high for the fund economics to work.
Haven't started a fund myself and am relatively junior, but I work at a boutique placement agent with startup hedge fund clients that fit this MO with direct experience working with them to build it into an institutional business. First off, the smaller end of startup hedge funds I know all have at least $20mm in AUM. Starting below this only makes things harder, as its basically impossible to cover operating costs with just management/performance fees with sub $100mm in AUM. You're basically untouchable to any institutions below $200mm AUM, as these investors typically like to write $15-20mm checks with rules that they cannot make up more than 10% of the fund.
You're first 5 years after launch, fundraising should solely be focused on high net worth individuals and family offices. You'll need to put up a minimum of 3 years of quality returns with minimal drawdowns at the most before you get any real interest from those who can cut meaningful checks. I doubt you and your partner would be able to take in any real income until you crack $75-100mm AUM without some pretty outrageous returns, and even then it wouldn't be anything crazy.
If you really want to do this, you need a good 4-5 years of personal finance runway to live, with the assumption you'll receive no income until the fund hits a baseline level of critical mass with regards to AUM & returns. The hardest part about all this is that the PM will have to allocate an inordinate amount of time to fundraising rather than portfolio management, which is notoriously difficult. There needs to be someone running this business that has real experience running a hedge fund, as the little things from an operational perspective need to be perfect from an investors perspective before even considering the return profile. These people are not cheap to say the least.
If you do all of this perfectly, you MIGHT have a small chance of making this into a serious institutional quality fund. It will take an excessive amount of luck, be the biggest shitshow of your life, and has a good chance of ending in failure. If you haven't considered every single one of those points (including the other 99% I didn't even get to), then this probably won't go very well.
Best of luck with your endeavor if you decide to go for it, but you need to be completely prepared in your personal life if it's going to have even the slightest chance of working out. There's is little to no wiggle room at all for startup funds to make mistakes. You and you're partner need to be all in on the business with 200% of your focus and time. Nothing less. That's my two cents
🚨TOP OF MARKET ALERT🚨
Charging 2/20 to be long-only tech...is highway robbery...and even with those crazy fees, uneconomic at that scale...good luck
"We've been up 40% investing in Tech this year and our current top pick will probably continue to drive fund growth"
Dude right now you're a glorified WSB "investor" that's picked a couple good tech stocks at the top of a market bull run during a time that's contributed quite perfectly for the growth of tech. Everyone and their mother is up 40%. Why would anyone pay 2/20 to be part of LO tech with founders who have admitted they have 0 HF background...?
Really not trying to be an asshole and wish you the best but candidly think you owe yourself a long look in the mirror before you start dumping the $300k+ that'll be required just to get the legal entities / structure set up.
What is the capacity on your strategy? I would be surprised if you couldn't run hundreds of millions through it, given your description. $4-10m is a tiny, tiny fund, 2% on that doesn't even pay the salary of one analyst. Why wouldn't you take your track record to a multi manager, who could pretty quickly give you carry on hundreds of millions if not multiple billions of GMV, as well as a salary, analysts, and all the data / resources you need to start a real effort?
If the answer is they wouldn't give you a shot or your track record doesn't pass their thorough due diligence process, I would think long & hard about that. If you don't think you can get a PM role there, when they have years of experience identifying new talent and taking gambles on early PMs, then what makes you think you can consistently generate returns in a highly competitive arena, trading against the people they do pick? If they would want you to take a more junior / analyst role first (as they often do), I would also think long & hard about whether you would maybe benefit from the learnings of being in such a position before taking a shot at running money.
Running a small fund only makes sense when you have a highly capacity constrained strategy, or you have a very, very high paying other job that demands a lot of your time, and feel you can still outperform at this as a side hustle (but you would be making so much money in your other job that this would be a hobby / you don't care at all about the money you do or do not make here). If you choose to ignore my thoughts and go down the usually gruesome / downright silly path of starting a tiny hedge fund:
- You can start a literal hedge fund for less than $50k in legal costs, and file for SEC registration exemptions for being less than a certain AUM (the number is $20-25M if I remember correctly), which gets you out of paying most of the operating costs. You could also run a separately managed account for clients, which is typically what people do when managing small amounts of money, and that is usually free to set up and can take less than a week, and still enables you to charge fees to the client(s).
- Taking proper institutional money will probably run you $1-2M/year in expenses, as passing operational due diligence will require paying dozens of service providers absurd fees, or hiring a large team in house to do all those back office / compliance jobs for you. HNW typically won't have this requirement, but most don't write checks more than $5-10M (and compare you to bad benchmarks, are fast to withdraw their money, etc.), so you will have to sell many people before you have a reasonable sized fund.
- Management fees are typically paid monthly, and carry is typically collected annually. Top funds have the leverage to negotiate otherwise, but a tiny startup fund would be very lucky to get these kind of terms at 2/20.