When launching a fund, consider both alpha and operations
In the current environment, launching a fund requires more preplanning than ever before. Along with successfully raising capital and focusing efforts toward ensuring that you have that big check ready to go when you need it, there are various other key factors that play a crucial role in making sure that your launch will be successful and you will have adequate operation support.
As a fund manager, your time is valuable; your first and foremost goal should be to focus on generating that alpha. However, you cannot ignore the operational needs of running your business. Keeping that perfect balance between focusing on the portfolio and running the operational side of the business is one of the toughest tasks that every emerging manager must face. Clarifying your long- and short-term vision with clear goal-setting and proper planning is one part of it. In addition, you must have a supporting cast of service providers who also understand your vision and business and are willing and able to provide you with the support that you will require in achieving your success.
Read on for some of the key areas to consider when planning to launch a new fund.
Articulating your story
- Differentiate yourself from the pack: Highlight your background, trading strategy, and successes. In most cases returns aren’t portable, but you can discuss your accomplishments.
- Have a well-documented and thought-out business plan, including adequacy of working capital and development of your institutional-grade back office.
- Formalize your investment strategy, growth strategy, and expense management plan, as well as your risk management plan.
Determine the best fund structure based on your investment strategy and investor composition.
- Stand-alone domestic fund
- This structure is relatively simple to manage and set up. Typically funds have this structure when there are few or no offshore or tax-exempt investors.
- This structure is most common as it is efficient from a trading perspective. The portfolio is only at the master level. It’s more expensive to set up and manage compared to the stand-alone fund.
- Onshore and offshore investing are parallel to each other. Unlike the master-feeder structure, there are two portfolios to be managed in this structure at each fund level. This structure requires rebalancing of portfolios to maintain similar performance returns.
- This structure, considered to be in between master-feeder structure and side-by-side structure, is more cost-effective than a master-feeder structure, but some offshore investors do not feel comfortable investing in a U.S. entity, even if it is done indirectly.
- Understand common tax adjustments that could affect the fund, such as wash sales and straddles.
- Be aware of tax issues of trading in certain countries that have capital gains or other withholding tax.
- Understand state and local tax implications.
- Structure your fund in a way that is tax-efficient for both you and your investors.
- Select a tax service provider who understands your business and possesses proper expertise in your focus area or strategy.
- Understand whether your trading strategy will qualify your fund to be an investor or trader fund. Or does it make sense to make a mark-to-market election, also known as a 475(f) election, assuming you are a trader fund?
- Plan to provide timely tax reporting to your investors.
- Understand the pros and cons of setting up your management company as a limited partnership or limited liability company.
- Understand the benefits of setting up a trust and gifting a portion of the carry to the trust on Day 1.
Alignment of fees
- Your fee structure needs to be in alignment with other funds with similar strategy.
- Consider charging lower fees to the founders’ class to attract that initial capital, or charge in layers where fee percentage decreases as net asset value (NAV) increases.
- Consider hurdles tied to relevant benchmarks.
- The fund administrator will be maintaining your official books and records of your fund.
- Be sure to select a fund administrator that understands your investment strategy.
- Reporting technology capabilities are an important factor to consider when deciding on a fund administrator.
- You and your investors will be dealing with your fund administrator daily, so it’s crucial that your administrator understands the importance of client service and can meet your deliverable demands.
- Auditors and tax compliance
- Select a firm at the early stages of your launch and utilize their expertise of the industry to help guide you every step of the launch process.
- Make sure the firm and teams you are working with have knowledge and experience working with similar funds and a good industry reputation.
- Provide timely tax reporting to your investors. Your investors will need to receive tax reporting information from the fund so they can file their returns or extensions.
- Have timely completion of your audit(s). Remember that advisors who are registered with the SEC as registered investment advisors have 120 days from the end of its fiscal period to distribute their annual audited financial statements to their investors (180 days if the fund qualifies as a fund of funds). Advisors who are registered with the Commodity Futures Trading Commission (CFTC) have 90 days from the end of its fiscal period to distribute their statements.
- Legal counsel
- Legal counsel will help you structure your fund to best fit your investor pool and investment strategy.
- Make sure you pick counsel that understands the risk and disclosure requirements to protect you, your firm, and your investors.
- Counsel will also help you align the key terms of the fund with the needs and desires of your investors, draft your fund legal documentations, and assist in making sure that you are compliant with federal, state, and local rules and regulations.
- Prime broker/custodian
- It is crucial that your prime broker has specialization in your strategy, security types, regions, and ISDA agreements.
- Understand which prime brokers provide you with the best ISDA agreements if you are trading derivatives.
- Partner with a prime broker that best suits your needs, based on your size and cost structure.
- Understand their capital introduction, financing, stock borrow, and stock lending capabilities.
- Technology firm
- Partner with a firm that can help build out and support your technology needs and infrastructure.
- Make sure that you implement cybersecurity practices and policies to prevent and detect any potential threats and ensure safekeeping of confidential information. Data confidentiality is extremely important and a top priority of regulators and investors.
- Other service providers to consider
- Outsourced CFO firms and other managed services
- Compliance firms
- Insurance companies
- Professional employer organization
Launching a fund takes more than just knowing how to gain investment alpha. Planning around gaining operational alpha is just as important. Being able to identify compatible partners and having a strong supporting cast around you that works together as a team when you launch is crucial to your success. As investors’ due diligence processes have become more rigorous than ever before, regardless of the size and stage of your fund, when it comes to your business operations, there is a certain level of sophistication that is expected. Be sure that you position yourself properly to attract capital.
Raza Ashfaq, CPA, Senior Manager
Gary Berger, CPA, Partner, Financial Services Leader – Northeast
Joshua L. Blumenthal, CPA, Partner
William Pidgeon, CPA, Partner, Financial Services Industry Co-leader
John Stomper, CPA, Partner
Marc J. Wolf, CPA, Partner, Financial Services Industry Co-leader
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
InsightHealthcare Investment Report: A watershed moment for healthcare servicesClaudine Cohen, Caroline ZnaniecRead about COVID-19 and telehealth’s impact on valuations; M&A and add-ons; deal activity in various subsectors; and more.
InsightLooming CMBS litigation: Are you prepared?James H. Aronoff, Charles CampbellCMBS market participants should be ready for any possible upcoming litigation – especially in the current environment. Learn more.
InsightQ&A with Jim Aronoff and Charlie Campbell: What’s on the horizon for financial institutions?In this Q&A, CohnReznick’s Jim Aronoff talks about why he decided to join the firm and what’s on the horizon for financial institutions. Learn more.
InsightCurrent trends in the alternative investment industry (plus 5 top tips for emerging managers)Get insights on trends in fees, strategies, launch size, and more, plus 5 factors that separate successful and unsuccessful emerging managers.