Raising capital for a startup fund is about who you know ... and in many cases, who your parents are.
Meet the Global Center for Investment Fund Studies
Successful hedge funds share several key attributes: strong, consistent performance, a management team with impressive professional and academic backgrounds, and a compelling fund strategy. However, the most predictive factor for a startup fund's success is whether or not it has a sufficient critical mass of initial capital at launch. This initial capital usually comes from friends, family, professional relationships that meet the fund’s investment qualifications, or from a major seeder.
Fund managers with relationship-based access to initial capital are far more successful at attracting post-launch capital through outside fundraising. Initial capital commitments and seeder relationships are typically based, at least in part, on personal or family relationships. As such, these investments do not always reflect objective fund manager capability.
Initial Capital Is Vital
An initial base of capital gives confidence to subsequent investors and spreads out costs to make the fund viable. Without initial capital, even the most competent and talented fund managers will have difficulty gaining traction. The reality for many talented fund managers, even for many that are adept at capital raising, is that without an initial base of capital it is very difficult to even get the chance to launch.
Emerging fund managers can rarely access the services of a placement agent or other legally authorized capital raising intermediaries. It is generally illegal for a fund to pay transaction-based compensation for the introduction of capital from anyone but a FINRA registered broker-dealer or outside registered investment advisor. Emerging funds are typically too small to justify the cost of the regulatory burden placed on the broker.
The inability to pay non-broker-dealers, or “finders” to assist with initial capital raising efforts is one of the key obstacles to raising capital for small fund managers. There is no lobbying organization dedicated to representing finders and efforts to address this need of small issuers have as of yet been unsuccessful. See the article by The Street, addressing this issue.
But it is not just talented managers that are harmed by the unequal access to capital. Subsequent Investors can be misled by misconstruing the management team's competence and abilities based on initial investments made by close friends and family. This is particularly problematic if certain relationship-based investments are inadequately disclosed.
Available Avenues Exist, But are Inadequate
The problem of how to assist emerging fund managers with capital raising is an issue that I have been working on for many years. Without general access for broker-dealers, and with the prohibition on paying fees to unregistered finders, there are limited options.
The following are some of the currently available paths for emerging fund managers to find initial capital
- Service Provider Capital Introductions. Service providers, such as introducing brokers and fund administrators often offer capital introduction services as an added benefit to clients, and are not paid directly for their services. This can be helpful for a fund that has a strong track record and an established base of capital, but fund managers should understand that these introductions are only as strong as the fund manager's attractiveness, which is based in large part on existing assets under management.
- Fund Performance Directories. There is a growing number of online directories (or portals) meant to pair qualified investors with well-performing funds. Most often, these are available through companies that include data about fund performance and rely on a network of qualified investors to look for investment opportunities on the portals. While it is helpful for fund managers to post on these directories as a general marketing strategy, in our experience, these for-profit based online directories are inherently limited and have been of limited helpfulness for emerging funds.
- Attending Industry Events. Attending industry events can be a helpful way to network with other investment funds and make connections with potential capital sources. Managers should be selective in which events to attend, as many of the events that are intended as specific capital raising events can prove costly and ineffective for emerging funds, particularly funds with a small capital base. Smaller fund managers tend to be more successful by indirect networking, rather than seeking direct fund investment.
- Joining Forces With Other Fund Managers. I often recommend that a hedge fund management team consist of individuals with complementing skills, backgrounds and contacts. What one or two trading-focused hedge fund managers cannot achieve alone can often be accomplished by four or five managers with diverse skills and networks. We encourage managers to be realistic about the number of partners needed to raise the needed initial capital.
GCIFS- Advancing Merit-Based Capital Raising Through Research, Publication, and Education
To focus on the issue of providing capital raising opportunities to emerging fund managers, our firm founded the Global Center for Investment Fund Studies ("GCIFS"), a nonprofit research center in 2017. Our focus in establishing GCIFS is to promote merit-based capital raising for emerging managers globally, through research, publication, and education. GCIFS has established an ever increasing network of directors, advisors, research fellows and analysts in several countries throughout the world.
In October, 2017, GCIFS partnered with approximately thirty student analysts, to do an initial literature review of capital raising trends and available resources in the alternative management space for New York, Los Angeles, London, Hong Kong, Singapore, and Dubai, in preparation for several forthcoming capital raising studies.
Current GCIFS Studies:
The GCIFS is currently working on two major studies:
- a New-York-City-based study of predictive factors for capital raising success among emerging hedge funds; and
- a worldwide study of cryptocurrency funds and investor trends, as well as various component research projects on regulatory and market factors.
The research results will be publicly available and used to promote transparency and education of emerging fund managers and qualified investors. Students and fund managers benefit from networking opportunities and shared purpose.
1. Study of Predictive Capital Raising Factors--New York City, Summer 2018
In 2018, GCIFS was joined by a team of New-York based student analysts directed by academic and industry advisors to conduct an empirical research study.The study examined predictive factors for capital raising success among first-time fund managers.
The study scored, gathered and analyzed predictive capital raising factors among emerging fund managers through interview-based studies with participating emerging managers in New York City. This study primarily focused on small, open-end funds pursuing long-short equity and options trading strategies (the largest category of emerging hedge funds globally).
We gained a deeper insight into factors that investors deem to be most important for raising capital, and factors that are actually predictive of capital raising. GCIFS is currently in the process of designing, testing the methodology, analyzing our existing available information, and compiling the data gathered from this study to better assist our emerging fund managers.
2. Cryptocurrency Investment Study--Underway
GCIFS is conducting a major cryptocurrency fund study involving law students, business students, and other blockchain-focused students across the world in examining trends involving cryptocurrency fund strategies and performance.
This study, which is already underway, focuses on the evolution of cryptocurrency funds from 2016 through 2018, and the evolving attributes of managers and investors.
We are also working on various component research articles focused on various regulatory and market issues involving cryptocurrency funds in the US, EU, the Middle East and Asia.
We encourage students, professors, funds, and industry participants with a focus on hedge funds to contact us to get involved with either of these projects.
Please contact us at email@example.com to learn about the GCIFS and our initiatives.