Hedge Fund Formation

This video covers the basics of how to move from being a trader or portfolio manager to running a hedge fund business.  If you are doing research on hedge fund formation you are in the right place.  We explore how to start a hedge fund, what service providers you need to work with, the hedge fund formation process and how much it costs to get started.  These are important considerations that you should take into account before you start a hedge fund.

Video Transcript/SummaryThe strategies and tips provided within this video module include:

  1. A recent study found that over 50% of hedge fund failures were due to business and operational reasons, not poor performance.
  2. To help prepare for this before you start your hedge fund I highly recommend that you complete a business template and complete a full business plan for your hedge fund including: marketing, operations, hiring practices, mission, goals and your growth strategy.
  3. A business plan will prepare you for hedge fund due diligence questionnaires as well as putting you on the path to efficiently start a hedge fund.  
  4. Putting in place formal hiring contracts can help you get through the hiring process more easily.  Be sure to take advantage of less expensive or even free resources for the legal documents you need, such as Legal Zoom.  
  5. If you are about to start a hedge fund, I recommend seeking the services of an attorney with experience in fund formation.
  6. Be sure to use some tool to organize your plan for starting a hedge fund.  
  7. Keep in mind the five best practices for starting a hedge fund that are provided in the video.

Transcript of Hedge Fund Formation:

Hello, this is Richard Wilson and today we’ll be talking about hedge fund startups, investment fund startups and emerging managers. Specifically we’re going to talk about common mistakes made by them but then also some marketing and sales best practices which should help you if you are an emerging manger.

A statistic came out in 2005 showing that over 50% of hedge fund failures were due to business and operational reasons and not due to poor performance. I think most people outside the industry and most investors don’t realize that, and having the sound business is not only something that investors are starting to scrutinize more but it’s also something that if you’re running a fund obviously it should be one of your top concerns since it’s the number one reason for funds failing in the past.

To help mitigate some of the risks of running your business as an investment fund there are a few things you can do. One, what I highly recommend is that you download a business plan template and complete a full business plan for your hedge fund. This should include your marketing, operations, hiring practices, your commission, your goals and your gross strategy as your firm expands. If you meet with institutional consultants as your fund grows, they’ll ask the types of questions that should be included in this business plan. So really complete a really solid business plan. It’s going to help you complete due diligence questionnaires and help you complete due diligence phone calls down the road.

Next, we definitely recommend putting some formal hiring and contract templates in place for your firm. You should meet with an attorney or there are some websites that provide kind of a template based legal contracts if you’re looking for something simple such as an employer contract or a confidentiality contract. Legalzoom.com has a whole bunch of free resources that we have used in the past and it can lower your overall legal cost. If you do have something such as a fund formation that you’re looking at doing, so if they’re more complicated or if you want a hedge fund attorney to review something that you’re gotten from a website, such as this, you could go to our service provider directory.

The biggest one we have is on hedgefundblogger.com. If you go to Service Provider Directory, go down to Hedge Fund Attorney. Here are two attorneys that you could meet with or speak to over the phone, Bilal Malik and Brent Gillett. I’ve met with both in person and referred over 50 funds to them in the past and I’ve never gotten any negative feedback at all from professionals that worked with them. So I highly suggest meeting with an attorney if you’re forming a fund, if you just formed a fund, if you haven’t yet, you should get their advice. It could save you much more money than you spend in a long run.

Next, to mitigate your business risk further in a running a fund, I suggest using some sort of business process analysis tool or mind-mapping tool. If you’re not familiar with this, it’s very simple. Here’s an example of one. Here’s our website that we’re launching, fund marketing tools. And you see, you can organize one idea and then you have child ideas that come off of that. So for your hedge fund business, you could manage the different parts of your business and make it visual for either the management team of every one in your firm exactly what you’re spending your time on, what different resources your firm must constantly be building, what types of expertise your building, perhaps what types of processes you’re working on or getting them in place. This can be a really good visual tool for your firm to use.

If you want to create one of these for yourself it is free to use. The website bubbl.us and it can very easily — I can show you real quick here. Once you log in and create your own account, you choose start a new sheet and after you start a new one, it’s very simple. You start with one central idea and then you just grow it from there and you can expand and describe your whole business here very quickly. So here in the middle we’re going to put, say Wilson Capital Management. Okay. Now, this might be a business plan for yourself, just a visualization for yourself in managing your fund. Next here, you could put Marketing and Sales. And down here you could put Employee and Team Management. Over here you could put Portfolio Management.

And you could see within each of these areas that there might be 5 or 6 tasks that you’re having to complete, either every day or over the next quarter for Marketing and Sales, you might decide just for planning purposes that you want to break this up. And you might allocate equal amounts of time to these three different types of marketing. Make marketing the high net worth individuals, marketing to family and friends and then perhaps marketing to local and financial advisers. Usually I like to make it with their different level. I like to make them some sort of different colors, it makes it easier to read.

But you can see here you can manage your whole business and within just 20-30 minutes of using this website you can have everything very visually laid out. It makes it easy to train somebody new and makes it easy to see what challenges or tasks you have in front of you and it makes sure that you keep a 10,000-foot view of your business so that you don’t forget that on top of managing the portfolio and trying to raise capital, you’re also running the business and there needs to be formal business processes in place so that you can manage those and improve those over time.

Okay, so now onto some marketing and sales best practices. Most hedge funds do start with marketing to friends and family. They look at co-workers, they look at people that have known them for 10-20 years and they know they’re trading abilities, they know their portfolio management abilities. This is the way that most people initially raise capital. By Friends this can mean past co-workers or peers in the industry that you know. Many times traders will help fund other traders who go out and start their own funds. Another form of raising capital is financial advisers, going after financial advisers that have high net worth individuals as clients can be an effective way especially locally if you can meet face to face to raise capital.

And then the next step beyond that would be meeting with wealth management firms. And we create a little bubble here for that, but meeting with larger wealth management firms that have many clients with high net worth status that could possibly invest in your fund. And as your fund grows in size then you can kind of move down the totem pole or move up the totem pole I guess to a more sophisticated less retail investors up through wealth management, to family offices, institutional consultants, pension funds, endowments and foundations.

One thing to remember and a common mistake that I see a lot of hedge fund startups making, is they describe their strategy as well-diversified, uncorrelated with the general markets. They have a very in depth experienced team. The problem with that is that professionals like myself and especially investors will probably get twice the number of hedge fund marketing materials than I do. I see the same thing over and over again and everybody looks the same. So the trick is to come up with a unique selling proposition and not just a selling proposition. And to make it truly unique, you need to figure out exactly why you did start your fund, what skills you guys have on your team that combines and create something unique or what unique insight or strategic information advantage your firm has over all of your competitors because if it doesn’t look unique, then it probably won’t get read at all.

I recently gave a speech in Florida on hedge fund marketing best practices and this was at a Mark Seven’s conference in Boca Raton and during that conference or during that speech, I went over the 5 best practices that hedge funds can use to market their fund. One of them here is the materials that focus on the 4 factors of hedge fund marketing. So what I suggest here is that the 4 most important things on marketing are pedigree, building your team to a high quality, highly experienced team unique to your business process and the product you’re offering, getting your presentation quality up, so having a professional logo, having professional marketing materials, having an investment process that is described in a way that presents a unique selling proposition and not just a selling proposition.

And then the last thing obviously is managing portfolio risk and having that track record of managing risks within your portfolio over the long-term. So I really think that those are the 4 things that investors really look for most: Pedigree, Presentation Quality, Process and a Unique Selling Proposition for you to buy that investment process and then Portfolio Risk Management.

So that pretty much wraps up our talk today on hedge fund startups and if you’re looking for more information on starting a hedge fund or a running a small investment fund, please see hedgefundstartupguru.com.

Hedge fund formation and starting a hedge fund can be an intimidating and difficult process.  I hope that this video helps you navigate through the steps you need to take to start a hedge fund.  

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About Richard Wilson