Anyone has experience starting a hedge fund?

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!    

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Comments (44)

  • Analyst 1 in HF - Macro
Sep 24, 2021 - 3:08pm

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.

Sep 25, 2021 - 1:07pm

Thanks for the advice and insights! 

Do you think it would make sense for a large investor in the fund to also be our seed investor? For example, we would manage $5mm for one individual and that same investor would also pay $xx, in exchange for 10% of our company for us to start the fund? We would then use that fund to pay for the cost to form and run the fund. 

I think we can make it work with $4-10mm. We'd have to be very lean at least in the first year. Depending on market conditions, we hope the performance fee will be high enough to pay for the future cost of keeping the fund afloat. I've seen other people (I don't personally know) start a fund at $4mm.   

Sep 25, 2021 - 2:54pm

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

Sep 24, 2021 - 3:53pm

For what it's worth I have a friend (or had a friend as I'm not sure if he is still there) in prime brokerage at Wells Fargo. He said the smallest fund they would trade with (this was in like 2018/2019) would maybe be around $5-10mm. I spoke to one of his colleagues there I believe who said she could have their lawyers set up the formal GP/LP structure for like $10,000. However, I do have another friend who actually started a hedge fund and they just wanted to get more brand name service providers so he mentioned they have spent much more to set theirs up as far as I know. Best wishes and good luck :)

Sep 25, 2021 - 1:10pm

Thanks for the insight! I'd love to spend only $10K for a lawyer to set up the GP/LP. Is it possible for you to DM me the information of the lawyers? I really appreciate it!

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Sep 25, 2021 - 1:15pm

$10k is seriously tough, I don't think that's really a good idea.

  • 1
Sep 26, 2021 - 2:19pm

Arena8

Thanks for the insight! I'd love to spend only $10K for a lawyer to set up the GP/LP. Is it possible for you to DM me the information of the lawyers? I really appreciate it!

You are welcome. I don't know the lawyers nor do I remember the person at WF who set it up but she was some lady in the prime brokerage division I think that covered family offices. Are you able to contact someone at WF and ask about seeing if their in-house team can set up the legal entities for you? 

  • Analyst 2 in HF - EquityHedge
Sep 27, 2021 - 3:39pm

do not work for clowns on an unpaid basis lmao

Sep 26, 2021 - 12:12pm

Trying to start a fund as well. From what I've heard you'll need 200k just to structure it and the legal process is not easy. Also get an advisor like a retired legendary manager and give small amount of equity for them to help build your network and introduce u to people. Talk to a LOT of people.

path less traveled

  • 1
Sep 27, 2021 - 2:06pm

Im nowhere near anything. Still a student but I got a year to get a quant fund off the ground so here i go

path less traveled

  • 1
Most Helpful
Sep 26, 2021 - 2:04pm

"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.

  • Analyst 2 in ER
Sep 27, 2021 - 5:40pm

I can literally buy QQQ and get the same returns without the concentration risk, liquidity concerns, or any fees lol

People invest with hedge funds because they employ leverage and invest in esoteric shit - and you want to......use no leverage be a LO tech names? Legitimate question for you - what incentive do investors have to give you their money? What makes you better/unique than all the other tech funds, or better yet, an ETF? Do you have any competitive advantage that you can reasonably provide clients with consistent value?

Sep 28, 2021 - 9:33am

I'm not defending OP because I tend to agree with you (see my above response) but I've actually come to find out that well off people sometimes really don't know jack shit about the market.

There is tons of capital coming out of successful executives, small business owners that got a lucky break and scaled very quickly, etc. Shit... I have peers that are 25 to 27 and are asking me for advice on how I set up a brokerage / etc. I try to help obviously but am baffled every time I see an example of a lack of financial literacy... it's shocking to me that I have peers who are mid to late 20s, making 6 figures and they don't even have a brokerage. On the other hand here I am dumping every last cent of mine into TQQQ ride or die baby.

Sep 28, 2021 - 2:27pm

The key things I've heard on this topic are:

1)  It's HARD and you probably shouldn't do it.

2)  Why is it hard?  Because you have to be really good at 3-4 different types of things.

3)  Being a good trader / investor is the entry fee (and this is hard in its own right)

4)  You have to be a good manager, good with people, good at designing and leading a team

5)  You have to be GREAT at sales, great at marketing yourself.

6)  You have to have a great track record (well this is hard, by default, given you are new)

7)  Ton of other things I can't think of at this moment  -- hundreds of things will come up that you never even thought of

  • 3
Oct 8, 2021 - 2:53pm

Texas Tea

The key things I've heard on this topic are:

1)  It's HARD and you probably shouldn't do it.

Unless you have a very big warchest to wade into it with in the first place.

2)  Why is it hard?  Because you have to be really good at 3-4 different types of things.

Or have the money to hire the people who can specialize on each of those 3-4 different things so you can focus on your own specialty. Or outsource, there's plenty of HF/PE backoffice and operations firms that only do outsourcing for smaller firms.

3)  Being a good trader / investor is the entry fee (and this is hard in its own right)

To that point, if you are a good trader/investor, it takes a lot of mental gymnastics to not run your own book or just continue with this current $5mm AUM and stay nimble and focused (and your own damned boss that answers to no one else).

4)  You have to be a good manager, good with people, good at designing and leading a team

I'd push back slightly and say that if you find the right COO, that's THEIR job(s). You are still ultimately responsible for the firm's entirety of course.

5)  You have to be GREAT at sales, great at marketing yourself.

Again, if you have a good COO who can find you the right sales person(s) or introductory org, that can take some of the pressure off you. Ultimately, you still have to make sure the firm itself is worth marketing at all (strategy, staff, returns, fees, legality/liability, etc).

6)  You have to have a great track record (well this is hard, by default, given you are new)

Agreed. You are looking at needing at least three to five years of disciplined strategy with returns to match and no hiccups light "fat fingering" a huge drawdown event. So long as you could make inflation + 1% or so consistently and stably, that will attract the real big money who are more concerned about keeping their money first, and hopefully making money secondly.

7)  Ton of other things I can't think of at this moment  -- hundreds of things will come up that you never even thought of

As I mentioned in a post in reply above, oh hell yes there are hundreds of things that will come up you never even thought of because you never knew they existed. "You registered your feeder fund in Cayman, but your GP is a DE company with an LP in Florida who's putting their assets in the off-shore feeder. Do you have your Blue Sky discolosures in place? Sure, you're private, but you can't dodge a 13F-HR or 13-D/G. Oh yeah, your LP has to file lack of conflict with the GP despite owning more than 10% of the total assets of the firm and thus are a significant investor. What about reconciling between IFRS and GAAP back and forth? Are you insured and bonded with a prime broker for liability purposes? Do you have an account with the DTCC?" Just an example off the top of my head.

Oct 11, 2021 - 4:16pm

Good stuff.  I think we agree that it's incredibly hard and there are 1,000 things to get right.  If you have the funds and ability to hire the right COO/legal/sales/back office it might be a little smoother, but that's really hard in its own!  (and you can't really afford to mess it up)

  • 2
Oct 5, 2021 - 7:01am

Sorry bud, we're all undergrads and interns here. The topics we are well versed in include whining, talking of prestige. Also did I mention hating on diversity hires ? Well, I guess that counts as whining.

On a serious note, good luck! I am a high school student and it's great to see someone wanting to do their own thing.

Oct 9, 2021 - 2:04am

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.

Oct 9, 2021 - 9:42am

"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."

This is also a test to see if you can check your ego at the door and be patient instead of those one-hit-wonderkinds out there who strike one good pick and think they're capable of running a huge book because of that one trade that one time three years ago. Also, to dodge the full-on SEC fund registration you could get your FINRA licenses and register as a financial advisor which makes your fees legit and you have some legal cover plus look even better to a fund to come in as an analyst and eventual PM before striking out on your own.

Whitewalker listed out a much measured and pragmatic approach to getting into the game if it is your ultimate end goal.

  • 4
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