Raising Capital for a Hedge Fund: 10 steps, the RULES, Types of INVESTORS, Seed Capital

Now we're going to focus on the number one issue facing startup raising capital. First of all, you need to know the rules. First. Principle they teach you in law school is that ignorance of the law is no excuse. You can't tell the judge, I'm sorry, I didn't know about it. Your Honor, the rules, especially around advertising, can be complicated and differ based on the jurisdiction. There's also some performance disclosures that you need to be very careful about, such as stating net performance, not gross. You also have to be careful about cherry picking your performance or using hypothetical. You need to be careful with track record portability right from a previous employer. And also testimonials are also highly restrictive. There are some significant hurdles that you need to overcome to successfully raise capital. The industry has become a lot more institutionalized. This is because there are more institutional investors entering the hedge fund scene. And also as a result of Madoff and the banking crisis. Investors are insisting upon a sufficient level of staffing, especially in compliance and accounting. It's crucial to have a really strong COO and or a CFO in place to raise capital. Other roles can be outsourced, but be important to whom? The vendors must be qualified and experienced. Institutional investors especially don't want to invest in funds that have a hint of potential regulatory or accounting issues, regardless of the PM's track record. The LPs also don't want the PM to be spending time on that side of the business. They want the firm to be fully staffed with sufficient resources that the pm, the analyst, can spend their time on the portfolio making them money. Another hurdle to raising capital is the level of aum. This is a bit of a chicken or egg scenario. While there are some exceptions, in general, institutional investors don't like their investors to more than 10 to 20% of a firm's AUM. They also don't like to invest in amounts smaller than 25 million, which means that for most institutional investors, the fund needs to have 250 and 500 million. Next, you need a strategy or a plan for marketing, for branding, for advertising. They overlap, but there are differences. The key is to have a plan for each one of them. Timing is really important in all of this. Be sure to put all of your information together before you meet with prospective investors. First impressions are crucial and people will talk. That's what they do. It's a small community, believe it or not. So what are the key aspects of your marketing presentation? First, there are four documents to prepare. The tear sheet, which is really just a quick summary term sheet the deck is crucial and really should be prepared by a professional. Remember, there's a lot of competition out there and this is an area that many managers tend to skimp on. The elevator pitch really important so you can get your story out and get investors excited about it quickly on an elevator ride to the 10th floor. Then there's the DDQ, which is merely just a formal Q and A that can answer a lot of the technical questions about your fund. You don't want to waste your precious minutes during a meeting with an investor reviewing technical issues that can easily be read in a document, right? Send those before you want to spend your valuable time influencing and bonding, right? Remember that sales is mostly about striking rapport. Also, be sure that all members of the team and outside advisors have a consistent message about the fund. Nothing worse than an investor hearing conflicting messages about your fund. This is one that a lot of founders don't think about but can really give you an edge. Be a thought leader. This is legal. You can do this. In other words, get the word out there that you're an expert in your space. You should find ways to provide insights in the topics that you'll be investing in. This will build trust and credibility with your potential investors and differentiate you. You'll need a content strategy. What will your content be? Product specific, Industry specific? And what form will it Text? Audio? Video? How will you disseminate or distribute it? There are many dissemination vehicles to choose from. Blogs, books, articles, websites, social media, podcasts, interviews, speaking engagements. Next on our list is the firm's website. This serves as a digital hub between the business and the outside world. The idea is to draw people in to tell your story. This is where you're going to connect with various potential leads. So it's important to have the right messaging now. It's also cruel to identify potential sources of capital not talking about investors themselves but but the connections to investors. The most lucrative and important sources by far are the cap insure teams of the prime brokers. These teams are quite valuable because it's their role to match the prime brokerage clients with potential investors and they are incentivized to do so. The larger the hedge fund is, the more money they have under management, the more fees the prime broker will eventually realize. Merging manager conferences sponsored by various vendors including cap intro teams of the prime brokers. Another great source of meeting vendors Fairly recent occurrence has been the introduction of outside consultants performing due diligence on behalf of investors looking to invest in funding. Theoretically, these firms have more expertise than the investors themselves. They will report back to the investor their findings and even give the investor a grade. You guys thought you're done with grades? Not all types of investors are the same and therefore it's important to have a set of criteria for the fund's ideal investor, or avatar if you will. You can direct your marketing efforts at these avatars and ignore the rest. This is a much more efficient and wise use of your resources, especially time, which is the most limited. Think about what the criteria are for the ideal investor. Who is your avatar? Some possibilities are an investor that has the ability to fund a margin market market managers under certain aum Remember you're going to start small, a large enough pool to add to their investment, right? You want them to be able to add and grow with you over time. Reputation for not taking up too much of the manager's time, right? Keep your time for managing the portfolio. Not be too risk averse stickiness of their capital. In other words, you want them to have a long term investment horizon. Can they add value perhaps to the research process? Can they add value by introducing other potential investors? So here's a list of 10 classes of investors, right? These are types of investors. As I mentioned, it's important to recognize that not all investors have the same profile. The classes themselves have different profiles and then the individual investors within the classes have different profiles. Be sure to know what you're looking for so you can target your marketing to your ideal lp, your avatar. Also, don't be afraid to turn the tables on your potential investor and ask them for references on them as an lp. Due diligence can and should work both ways. I didn't figure that out till we were well into our partnerships. Like wait, we can actually do due diligence on our investors right before we take them in? They will literally be a partner of yours. So you want to be sure that you want them as a partner. Really important. In order to successfully grow your fund, it's important you have at least one anchor partner. Someone has to step up first. There are generally two types of anchor partner relationships. Seed partners and founders. Class interests. Seed investors will invest a certain amount initially and in return will get an equity interest in the fund. They may also provide some type of advisory services to help the fund grow. A founder's class of investor will invest early in the fund's life and in return will receive preferred terms such as reduced fees or liquidity options. Generally a good idea to get one of those at least.