Tackling the issues
Let us assume for sake of argument that you are an Asian based start-up looking to raise money in the West.
The first decision to make is the route you want to take: the seeder/feeder/dribbler route or simply going it alone.
The seeder route means finding a friendly provider of capital for the fund, who in return will expect a percentage of the management company, low or no fees on money invested and possibly all sorts of other incentives such as capacity rights, transparency and some interesting buyback provisions. With no "normal terms" for such deals, very much depends on the respective bargaining strengths of the two sides; anecdotal evidence shows that a US$20m investment in the fund for 30% of the management company is in the ball park.
A dribbler is a seeder who agrees to top up his stake as
the fund grows, for example, should the fund get to US$20
million, he adds another US$5 million, should it grow to US$40
million, he adds another US$10 million. For obvious reasons,
there is a reluctance for any one investor to be a large proportion
of the fund-both from the manager and the investor point of
The advantage of the seeder route is that the business has enough money to be self-financing from day one and the partners can make drawings to live on. The disadvantage is having a significant minority shareholder whose interests are not necessarily perfectly aligned with those of the partners. As an illustration, the managers may want to increase the size of the fund to maximise potential returns for themselves, whereas the seeder may want to stop the fund getting too big to dilute performance.
If you are going to go down the seeder route, decide early and stick with it. It is extremely painful, costly and time wasting to create a regulated structure and then having to scrap and re-engineer it to bring in the seeder into the entity.
For start-ups that can afford the financial pain and suffering of putting money into the business rather then taking it out, going it alone is often ultimately the preferred option with a higher upside.
Perhaps the most important factor in the seeder option versus going it alone is the financial standing of partners in the start-up. If you can afford to live without a salary for a year or so, you go it alone. In general, most seeder financed start-ups are run by ex-fund managers while ex-prop traders tend to go it alone.
Start-ups always think that in the go it alone scenario, cashflow turns positive quicker then it does in reality. Even in the best case scenario, more often it is closer to two years then one. (Remember management fees are paid monthly but in most cases performance fees are only paid at the end of the year.)
Understanding the critical path analysis of forming a hedge
fund is vital to the process of raising money. An outline
goes like this:
- finding your partners and sorting out style and location
and equity stakes - two months,
- deciding which prime broker, administrator, lawyer
and accountant to use - two months,
- creating company structure and submitting regulatory
documents - one month,
- getting regulatory approval - two to four months.
The quickest we have seen the process completed is six months, but putting a year into your timeline could be a more realistic move.Show me the Money
Start-ups have to think very carefully at what point to approach the allocators. Allocator is a generic name for the variety of possible investor types who might "allocate" money to hedge funds, fund of funds, family offices etc. Going in too early with just a few back of the envelope ideas can be counter-productive. Allocators have long memories and it is difficult to recover from a bad first impression.
There is also the question of seeking to raise money before your start-up has gained regulatory approval. The dilemma: until you talk to allocators, you do not necessarily know whether your fund is likely or not to succeed. There is of course a subtle distinction between pre-marketing and actual marketing. Also what you can do (or say or send) in the country where you choose to be regulated and what you can do in countries outside your regulated arena are a matter of interpretation. Suffice to say that it is worth getting good legal advice on exactly what you can and can not do and at what stage in the regulatory process.
Our research shows there are 200 plus potential allocators to an Asian hedge fund in London, the same in Geneva and probably more in mid-town and Connecticut. These are the three big centres of hedge fund allocation money, but then places such as Chicago, Milan or Montreal should not be ignored. Whether to concentrate on the big three centres or do the rounds at the satellites as well is always a dilemma for a time pressed manager. In many respects, the big three are often well traveled and/or over marketed, whereas a manager could get a better reception if the allocator feels he has gone out of his way to make the meeting.
Simplistically, it might be true to say that allocators in London and Geneva historically have more experience and appetite for Asian funds, unlike many of their counterparts in the U.S. who do not have the legal or tax structure to buy plain vanilla Asian hedge funds. An investment may require the fund to invest in a master feeder structure and that costs money. Also there is a trend for the big U.S. allocators to set up offices in London to cover Asian and European focused hedge funds. Nevertheless, demand in the U.S. is growing.
Allocators are a combination of fund of funds, family offices and financial institutions and private banks. Defining the split of the pool is impossible but a semi-educated guess breaks this down to a third each.
To the start-up manager, coming from the long-only investment banking culture, the hedge fund world is very much a parallel universe. In the long-only game, 90% of the money is controlled by say ten big high profile institutions such as Fidelity or Capital. In the hedge fund world, it is very much a flat tail situation where there are no dominant players.
While some names (certain global banks with extensive wealth management activities) stick out, even then they do not allocate as one entity and can have as many as 30 different hedge fund buyers under one umbrella, each with its own objectives and tactics.
Potential allocators vary from a dedicated fund of fund group with say US$6 billion assets under management and a dedicated Asian specific fund of funds of say US$500 million with 20 odd holdings to a family office in Connecticut with a portfolio of alternatives of say US$250 million who is looking to add their first Asian hedge fund. Evidently, not all of the 200 plus names in each city have the same knowledge or appetite for Asian hedge funds.
A start-up will hear this over and over again:
- we do not invest in funds until they have a 12 month track
record (it can be up to 24 months and as low as six but 12
- we only invest when the size of the fund is US$40 million (again this is an average).
The rules, well, certainly are there to be broken. There are exceptions however-normally if an allocator has previous experience with the manager in a different entity, he might go in at beginning such as in the case of a break-off start-up. But realistically, there is genuine reluctance to put money into start-ups. An interesting irony here though: it is widely believed that new managers largely perform better then more established ones. But this is balanced by the risk that "if the fund is going to blow up, it will happen in the first six months while everything is new and untested"
The big allocators are the ones that tend to stick to the US$40 million size rule more rigorously. This is simply because if you are managing billions of dollars, position sizes of US$1-5 million (which is the allocation size the Asian start-up would like to receive) are cumbersome and difficult to monitor.
Most big allocators have or are developing some form of specialist seeding unit, but in most cases they will require equity stakes in the management company.
Consequently, at the onset, the start-up is probably wiser off concentrating on the mid-tier allocators, who are more likely to have the flexibility to come in early. Larger allocators can always be approached at a later stage.
One thing that start-ups might look at is the distinction between soft and hard marketing. Soft marketing is making sure that your monthly details are going out to your potential buying audience-gathering the right email lists, making sure that you are on the right "radar screeens", and perhaps a call to target buyers every couple of months to make sure that information is going to the right person.
The soft marketing stage, thus, is an ideal time for the manager to concentrate on the key thing-getting the performance numbers right. The juxtaposition between spending time on performance and raising money takes time to get right. A lot depends on what the strengths of the individual partners are and how they work together as a team. Marketing works best if one person is clearly responsible for it as a function.
After say six to nine months of soft marketing with good performance numbers, it is time to move to hard marketing. This will constitute flying round the world, pounding pavements with pitch book in hand. This is the nitty gritty of raising money.
Do not get in too early; because without good numbers, your case will not be as strong and all you will end up with is a look-forward-to-keeping-in-touch meeting.
Allocators are unlikely to tell a manager to "never darken my door again" even if that is what they think. Instead, the manager will be politely told to keep in touch or send monthly updates. Managers, often used to the more brusque and frank meetings of the long-only environment, will be left with the impression that an investment is imminent when it is not. The realisation that good and friendly meetings do not equate to funds raised can take months.
Forecasting how many initial meetings it takes to get an
investment is an interesting game. The spread bet is eight
to 15, but this disguises the reality. Allocators rarely make
decisions quickly or independently. A typical routine goes
- initial screening meeting,
- ok you fit the criteria,
- meet colleague or analyst,
- ok you are a possible investee,
- send in the due diligence teams.
For a successful investment, allow maybe five individual meetings and say a three to four month timescale. Another way of looking at it is a two-week roadshow once every three months for 12 months with say five meetings a day.
Raising money requires an increasing face to face familiarity with allocators. A manager told us that he started to get money in when he could go to Geneva, the west-end and mid-town and not need a map anymore. Another described it as airport and fast food torture where each US$13.2 million raised cost him exactly a kilogram in weight gain. (The aforesaid manager has now lost all that weight and is in the process on buying his second Aston Martin.)
If all goes according to plan, the classic evolution of an Asian start-up is:
- start with US$5 million of partners and friends money,
- between six and 18 months, struggle to get to the sweet
spot of US$30 million,
- then a stampede occurs
- within nine months, fund closes at US$200 million or whatever the appointed size and the manager will now be turning away money.
Some brutal advice on pavement pounding:
- The money is not going to come to you, you have to go and
- At your previous asset management or investment bank firm,
everything was done for you. At a start-up hedge fund, nothing
is and you are on your own.
- Keep your presentation short. The 20-pages and 20-minutes
rule applies, i.e. you should have got through your presentation,
which should have a maximum of 20 pages, in 20 minutes and
move on to questions and answers.
- Use the meeting for yours as well as the allocators' benefit.
The three questions that you should get an angle on during
the course of the meeting are:
- what is their appetite for Asian hedge funds,
- within their organisation, how are decisions about allocation
made and what do you have to do to get a positive decision
on an allocation,
- when are they next in Asia or when is the follow-up meeting.
- If the allocator asks for further data or background,
write it down and remember to send it. We continue to be amazed
by how often we hear the refined "we were quite impressed
by X but they said they will send us more information and
then we never heard from them again."
- Go to as many relevant conferences as possible and tell your potential target audience you will be there and available for meetings.