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
Structure and Timeline
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
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
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
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
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