A few weeks ago, many start-up hedge funds gathered at the offices of Grant Thornton for the Emerging Manager Forum hosted by Informa. They came to talk about their unique situations – their value proposition, the challenges of raising capital in 2018, discuss setup questions, and gain insights to help them start their businesses on the right foot. They weren’t disappointed. While many lively discussions focused on attracting capital, there was also considerable interest in gaining an edge during investor due diligence – the critical part of the capital raising process in which operations can play a key role.
I was fortunate enough to moderate a panel with several up-and-coming emerging managers, focusing on the challenges and opportunities funds face during initial setup. We talked about due diligence, lessons learned during fundraising, and what you can do with the help of technology to ensure your fund starts off on the right foot. Here are some takeaways from that discussion, and the rest of the Forum:
It will probably take longer than you think to launch
One recurring theme we’ve heard at the Forum and elsewhere is that it takes some time to get up and running these days: on average, at least 6-9 months. It takes significant time to set up legal entities, line up auditors and prime brokers, and hire the right personnel — all before you start setting up your fund. We’ve also heard that fundraising is taking longer in a post-2008 environment, with many investors taking additional time to run due diligence on potential investments.
Take care of must-haves before you start marketing
When starting to market your fund, there are certain expectations investors have for what you should have in place before you enter the due diligence phase. While the requirements may differ slightly between the more stringent institutions and the more liberal family offices, most will expect to see:
- Legal and tax infrastructure completed in all jurisdictions the fund will be operating in.
- Connections to 3-4 prime brokers. This step is particularly important in fundraising, as primes can often serve as great source of capital introductions.
- A well-thought-out system for taking care of daily trading, accounting, reconciliations and other operations. You don’t have to have systems in place, but you should have an idea about what you will do and who you’ll be hiring to help you. We often hear from clients that this question is coming up fairly early in the due diligence process, and answers such as ‘I haven’t thought about it yet’ can result in lost contracts.
Technology can make a difference, so hire the right partners
While taking care of your investment technology may not be a Day 1 task, many investors, especially institutional entities, prefer to see an established infrastructure before committing. Having a well-thought-out plan, or, better yet, a retained technology platform in place before beginning fundraising will help your fund company stand out from the pack. During due diligence calls, potential investors want to see that you have at least thought about how you will manage risk and flow of information from the front to the middle and back office, and how data integrity is maintained. For instance, we see our start-up clients run paper portfolios through Eze Eclipse to make sure they have a practical example of generating profit using an investment management operations system.
Moreover, due diligence teams are often asking which service provider funds are retaining or getting ready to retain. Institutional due diligence teams expect to hear names with a long track record in the industry, as well as a record of doing their jobs well. It’s also advisable to work with a firm that will help you during the due diligence process, ensuring that all of the key components of the system are set up in a manner that’s comprehensive, minimizes conflicts of interest, and ensures that information across the operation is set up to be captured correctly. And, it goes without saying, you need to make sure that your service provider and you are on the same page when it comes to your operations, as your service provider will be getting an independent due diligence call as well.
Look beyond Day 1
As you search for the right technology platform and partner to get your fund off the ground, consider your growth trajectory. Many founders focus aggressively on fundraising, with technology getting a cursory review to see whether it can meet the immediate needs of the fund without breaking the bank. However, it’s worth noting that it’s often costly to switch systems and providers you don’t like down the line, since many of your existing processes will be deeply engrained within your technology infrastructure.
A better approach is to look for a system that can grow with you, backed by a provider that takes a partnership approach to service. Ask yourself:
- What’s my ultimate size goal?
- What strategies do I want to run, and how much flexibility do I want to be able to introduce new asset classes, geographies, or styles?
- How big do I envision my firm getting? How much mobility should my system have across offices and jurisdictions?
- Do I want to be going after larger investors, and will I be adjusting my fee structure to be able to accommodate them?
- If I have any issues, who can I call? How quickly will my service provider address those issues?
- If I have new ideas, is my service provider open to helping me expand my technology to accommodate them?
These are only a few of the considerations that often come up for start-ups about investment technology. The good news is the market appears to be realizing the important role technology can play in helping during fundraising, and beyond. Technology doesn’t have to be yet another cost to fear; done right, it’s a source of opportunity.
For more of the considerations you should make when starting a hedge fund, check out our comprehensive guide: