The following post is courtesy of Diane Harrison who is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002 specializing in alternative assets.
There’s no denying that one of the biggest challenges small managers face is raising capital. To become large enough to turn a profit and expand is a common migraine that keeps emerging managers up at night. Forget fretting over last quarter’s performance: most of these managers obsess over not being able to add enough LPs to their fund before they run out of cash.
A July article on the CAIA website AllAboutAlpha, Hedge Fund Gigantism is Not Necessary, offers solace for these smaller fund managers, loosely defined as those at or under $500M. A joint survey by the Alternative Investment Management Association and GPP, the financial services firm formerly known as Global Prime Partners, states that this segment of the industry numbers 2,052 participants, accounting for 6% of the total industry AUM. A notable glimmer of hope from this study for these smaller players was the fact that the average break-even point for small funds is achievable for many, at around $86M. And for some, with certain strategies such as a quantitative focus, that figure can drop under $50M.
WHERE WILL THE CASH COME FROM?
So the good news is small managers need less to make it. But they still need to secure enough funding north of $50M to consider their business viable for the long term. Beyond the obvious―putting in their own money, garnering as much as possible from family and close friends with belief in the process― where is the rest going to come from?
Not to sound overly pessimistic, but perhaps beginning with where not to look for money is a good starting point. Small managers cannot plan to rely on institutional investors falling in love with their strategy and jumping on board, even if they have prior experience as a portfolio manager managing hundreds of millions of their dollars.
Also, these managers shouldn’t waste time talking with third-party marketers, who gush over the smart approach and claim they can raise that initial $100M lickety split. They can’t and they won’t. The ones with real institutional contacts will not present managers who don’t fit the mandates of established contacts. The sketchy marketers don’t have credible contacts willing to invest with a small manager that can’t be found through other means directly. For skeptics who feel the need to verify this, just ask these third-party marketers to work on a straight commission basis, or for a referral fee per each investor landed. The phone line will suddenly be filled not with effusive words of praise, but with a hum of dead air as they suddenly have nothing to say.
VIABLE SOURCES TO MINE FOR INVESTMENT
But take heart, intrepid small managers. There are several means of accessing actual prospects for emerging manager funds, with some give and take required to land the deal. Be prepared to work the relationship actively, remain flexible on terms of investment where possible, and be straightforward and committed to communicating effectively with each of these investment unicorns.
Talk to seeders. Although seeders, unlike family and friends, will expect a formal relationship to provide capital to a fledging business, most likely including a piece of equity staked to the deal, there are two compelling reasons to explore this type of arrangement if you are a struggling manager but believe there is a real chance to grow into a self-sustaining business. One, the ability to secure a significant early investment from a professional seeder provides a measure of comfort to the audience small managers need to pursue, namely high net worth individuals and family offices. And two, with a reasonable cushion of investment to provide the fledging fund start up ‘run room,’ managers can adopt competitively lower fee management structures which are in keeping with the industry’s trending direction of fees. Eurekahedge shows the average fee rate for fund launches declining steadily over the past 10 years from 1.68% (2007) to 1.27% in 2017.
Find an ‘personal’ angel. Consider asking a wealthy personal connection who qualifies as an accredited individual to be an angel investor. Unlike a seeder, the capital this type of angel investor provides may be flexible and set up with more favorable terms than a seeder or traditional angel investor requires. This funding may also be delivered in stages as an ongoing injection of money to support and carry the company through its difficult early stages. These investors are persuaded more by particular interest in a fund’s approach or the experience of the manager rather than the hard data of performance and pedigree metrics that traditional seeders and angels follow. Managers may also be able to strike a deal with a personal connection angel for a straight percentage of return for their investment with no equity stake in the business.
Actively mine your referral network. ‘Mining’ means making the connections you have work for you. While there’s nothing wrong with scouring your own contacts for interested investors, there is a far greater pool of prospects that might be potential LPs unknown to a small manager, but one derivation of contacts away. For example, these first-level connections probably have their own circle of friends and colleagues who potentially want to learn about investment options within the alternative asset sector to complement their portfolios.
They might also sit on the boards of companies or foundations, and have relationships with other board members who have similar investment goals. These second-level individuals could be introduced to small managers through their common connection, as none of these prospects would have been on the radar for the small manager through their own resources. However, the manager needs to initiate the asking for such introductions to start this network wheel rolling.
Develop a very clear 1-minute explanation of your value. Describing what investment value you add and why an investor should care cannot be overstated if you are a small alternatives manager. To be able to do so verbally, in a natural and understandable way, is a crucial tool in the asset-gathering process. More importantly, understand that this is not the same as having a good presentation deck. The explanation should not come off as a sales pitch, but as a thoughtful reply to the natural question managers get asked repeatedly, “What is your fund about?”
It seems obvious, but many managers nervously devolve into an overly detailed and foggy explanation of the process involved in their strategy when asked this question. Taking the time to formulate and absorb an answer that can be delivered conversationally and using nontechnical words will boost the likelihood of getting follow up interest from someone new to the subject.
Consider taking on offshore investors. While this structural format may not be an option for all small managers due to their fund’s legal set up, those managers who build the ability to accept offshore monies into their business open themselves to investment options beyond the US base most small funds target. It bears exploring with legal service providers as to how this may be accomplished efficiently and cost-effectively, as the funds that may be available to small managers through offshore accounts might be easier to attract than those within the crowded and competitive US field.
Returning to the fact that small funds can achieve a break-even point under $100M, with certain strategies dropping under $50M, it seems that employing some of these actions might make the difference between the ‘has’ and the ‘has beens’ of small managers.