and infrastructure support, along with a nice salary and corporate expense account, often receive a rude awak- ening when introduced to the complexities and costs of running an individual business. Exhibit 4 displays the necessary steps for getting started as a new manager. The catalyst to getting started usually begins with an opportunistic setting for raising assets and/or bringing together key members of a team. The team is the crit- ical component for setting up a fund. Typically, the key member of the team begins with an experienced man- ager who has an investment idea and performance track record. But soon afterward, other members will need to be brought in to help run the organization. An integral component includes raising assets. Without new assets, revenues will not grow and there will be no ability to achieve economies of scale. From the very beginning, emerging managers must focus on raising assets. The impetus for launching a fund often originates once a manager convinces a seed investor to allocate some discretionary money to the new fund. Seed inves- tors typically receive incentives (such as equity participa- tion in the management company) as compensation for being early backers. They are characteristically successful entrepreneurs or institutional investors who meet invest- ment managers through an affiliated network of friends and acquaintances. They not only have hopes for gen- erating strong returns in their underlying investments, they also expect to receive an additional return from a fund harvest a few years into the future. Managers typically add their own personal savings into their company along with assets from family and friends. Investors prefer emerging managers who show
conviction in their own strategy and inject risk capital. Seed capital investors feel more comfortable knowing that an investment manager has life savings in a joint project. This provides high motivation for the manager to succeed. The investment pledges from family and friends usually enter the f irm with modest effort and little formal contracting. This creates both a blessing and a curse. Although pledges from family/friend/angels in early stages are always welcome news for emerging man- agers, it often creates unrealistic expectations regarding future fundraising challenges from non-affiliated inves- tors. To the extent that emerging managers set up their funds with overly optimistic fund raising expectations, it can lead to numerous operational inefficiencies (e.g., overspending on superf luous items) and a drain on scarce working capital resources. Regardless, once emerging managers have a siz- able asset commitment, they will typically launch their firm. They may start with as little as $1 million or $2 million, but savvy managers will often wait until they have gathered at least $5 million or $10 million in AUM. Although emerging managers may be anxious to com- mence operations, they need to think about the con- sequences of starting too early with unsustainable cash “burn rate.” There are many up-front costs and ongoing costs of operations (see Exhibit 5). Starting operations with too little in AUM may significantly lower the odds of success, although the manager needs to also consider the patience of prospective investors to maintain interest given market conditions and other investment options. Once managers are comfortable with budgeted cost outlays and assurances from seed investors to execute their pledge, they can proceed with the actual setup of operations. Lawyers will initiate fund documents. This includes, but is not limited to private placement memo- randum, corporate registration documents, manager’s operating agreement, along with various equity partner relationships and corporate terms. Managers that choose to create an exchange-traded fund or mutual fund will require extensive legal work and SEC interface. This undertaking incurs appreciably higher fees over a six- to-nine-month process.
E X H I B I T 4 Steps for Getting Started as a New Manager
THE COST OF DOING BUSINESS
The complicated array of infrastructure setup and ongoing costs can overwhelm a new manager. Running a professional stock or bond fund on a day-to-day basis
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