3c1 vs. 3c7 Structure Questions
I've come across an interesting piece of reading (from 2007, so it's probably a little dated) that has again got my startup HF bug going and I was hoping someone with startup HF experience could help answer some of my questions, or take a shit on my dreams.
http://www.hedgefundlaunch.com/how-to-start-a-hedge-fund-part-1/
HFL: Should I utilize a 3c1 or 3c7 structure for my funds?
Kuchta: This really depends on the investor base that you are initially going after. 3c1 accreditation standards are more lenient for investors ($1 million of net worth or a previous 2 years compensation of $200,000 for each year). In this situation you will be able to attract more “mass affluent” type investors for smaller amounts of capital per investor, but will be bound by a 99 investor limit in the fund. These slots do tend to go quick when you are taking smaller amounts, but this is generally a more friendly class of investor for attracting assets when you are a new manager.
3c7 standards are stricter, requiring $5 million of net worth to invest. The number of slots available in the fund, however, is increased to 499. Due to the net worth requirement, this generally entails a more sophisticated and demanding group of investors who may have more stringent investment requirements and may not be amenable to investing in a start up.
It has generally been feasible for a start up manager to initially employ a 3c1 structure, and if the 99 slots become fully utilized, the manager can subsequently launch a 3c7 vehicle for qualified purchasers.
1) It is obviously much easier to raise money for a 3c1 fund than a 3c7 fund. Does anyone have any experience with fundraising for a startup HF? I'm assuming the cost per unit of capital is much lower than raising institutional money and requires way less credentials. A 5 year track record in an incubator hedge fund, a solid pitch book, and a half decent stock broker working for you should be enough get 99 rich people to fork over ~$100,000 per investor.
2) You've filled up the 99 spots at $100,000 a piece and now have $9.9 million AUM. Is there any way to be profitable with so little AUM, even if your fund raiser is the firm's only employee? Are legal/accounting expenses less for 3c1 funds as opposed to 3c7 funds? If the answer to these questions is no, then I would assume the only purpose of a 3c1 fund is to later convert it into a 3c7? I've heard of several well known HF guys that have started with less than $1 million AUM, so $9.9 million seems doable.
Another big perk of working with rich people, instead of institutional investors is that you don't need to be based in a major finance hub. Florida sounds perfect. Plenty of rich old people with money to invest, no state income/capital gains tax, and a much cheaper cost of living compared to NYC.
What makes you think nearly 100 people will write you a 6 figure check? You make it sound easy, but certainly, it is not. If these people are worth less than $5MM, $100K is meaningful to them and they aren't likely to give it to a kid in a 'garage'. That wouldn't be easy to do. $10MM in AUM isn't nearly enough to pay for anything. You need data through Bloomberg or some other expensive source. You need to pay for fund accounting and legal expenses. With that low of an AUM, a lot of that will be coming out of your pocket.
Say you charge 2/20 on $10MM and you get a 10% return. That's about 4% in fees, so $400K in revs. If you get no returns, cut that in half. You're going to have to front fund setup costs, which could run into six figures, if you deal with reputable firms. Then, rent, health insurance, salaries, etc. It starts adding up quick. If you're working with a 'stockbroker' (third party marketer), he'll want a huge cut of the fees, but nobody you would want would likely even work wih you, because it's not an easy sale. Forget about having a broker at a place like Merrill Lynch sell your fund, they're not even allowed to do so.
I can't think of any reason that anyone would set up a 3-c-1 instead of a 3-c-7 fund right now. Realistically, every potential investor should be a qualified purchaser anyway. Plus, it's self-reported, it's not like you have to verify it with their financial statements.
Thank you for your response Dick Fuld. A few points I'd like to make.
1) I'm not planning on doing this now, this is more of a 10-15 yr plan. I figure I'd need AT LEAST $500,000 of my own money in this to get the ball rolling and yes I would be willing to eat fund start-up costs. Not to mention some industry experience, an MBA and/or CFA, and a little bit of gray hair would help get rid of the kid in a garage persona.
2) I would only want an in-house fundraiser. Clients need to know about referral fees and sales commissions. Discretionary bonuses do not need to be disclosed. The last thing I'm trying to do is make a tough sale more difficult.
3) I really don't think getting rich people to invest $100,000 per person is an impossible task when armed with a track record in an incubator fund, a solid pitch book, and a decent sales person on your team. Institutional money would be impossible at this stage but not all millionaires are sophisticated investors. I think raising money comes down to being as simple as how much a capable in-house fundraiser is going to cost? I was thinking something like $100,000 base salary and a discretionary bonus based on how much he raises. I'm hoping that sounds better in Florida than it does in NYC.
4) I don't need any other employees but my fundraiser. I'm a one man research team with a long history of raping the S&P 500.
You do make a pretty good point about 3c7's though, that is if legal and accounting expenses are the same. I can still target wealthy people, rather than institutions with a 3c7 and have up to 500 investors.
Recusandae perspiciatis inventore enim veniam. Nihil magnam deleniti ea cumque cupiditate ratione. Explicabo blanditiis est nemo eius velit dolorem.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...