(Originally published April, 2016)
When working with emerging managers, at some point during the engagement I’m inevitably told “I really can’t afford an attorney/accountant/compliance person/ [fill in the blank] yet. I’ll just have to wait until I get an allocation of capital and start to get some revenue, first.”
This is the Catch-22 for managers. They can’t afford the help to get properly set up to receive an allocation, yet they can’t get an allocation until they’re properly set up.
Below are the harsh realities that emerging managers need to accept:
- Allocators won’t give money to people they don’t trust
- Allocators won’t give money to you just because they like you
- The barrier to entry in the alternatives industry is high because of the ever evolving regulatory environment
- The regulatory environment has evolved because of the risks associated with trading AND running a trading business
I tell clients that, if they can’t afford to spend at least $50,000/year for two years, with no revenues coming in, they need to rethink their business strategy. Being an emerging manager is not for wimps because it’s not all about the trading. It’s equally about identifying and mitigating the associated business risks. Below are typical services that are minimally needed for a new manager:
- Trade Reconciliation
- Daily Net Asset Value
- Track Record
- Back Office Support
- Risk Management
- Capital Raising
Allocators look at all of these areas. At the end of the day, they give money to traders they trust. No allocator is looking at just one trader. Professionalism can help separate you from the crowd.
So what are your options if you believe you’re a brilliant trader yet don’t feel that you have the money that it takes to get properly organized to market to allocators?
CAPITAL SOURCING OPTIONS
- Start with doing what you do best – be a trader. If your trading is that good, you can cut a deal with an incubator that will roll you under their umbrella and provide you with all of their operational help. You can negotiate a percentage of the fee and the use of your track record for when you part ways. By paying close attention, it’s also a great way to learn what you’ll need as a manager and develop contacts for the future.
- Use family and friends money to build up your track record. Charge a minimal (or no) fee but be sure you:
- Have a formal document for investors to sign that has been drafted by an attorney.
- Stay within the guidelines of an unregistered CTA or RIA. Better yet, get registered.
- Work on your “best practices” (you can refer back to this column for help!) as you build out your track record.
- Nell Sloane, of Capital Trading Group, suggests taking advantage of the network of independent introducing brokerage firms (IBs) in this industry. Seek out seeders but look to structure your business by building a team. Much of the daily operational cost can be built into a fee model that is a win/win. Certain IBs and seeders provide a trader with many of the infrastructure services they need. What’s nice about this arrangement is that much of the daily operational cost can be built into the commissions, so the trader doesn’t have to lay out quite as much money. Of note, performance will be affected due to the raised commission rate, there may be a fee sharing requirement and some services such as legal will still have to be addressed, although much can be staggered in as the manager gets more experience under his/her belt.
- Get a firm to invest in your firm. This gives you the capital you need but you’re giving up equity in exchange for working and investable capital.
Before determining which direction you want to go, attend industry conferences so you can meet people and firms that can help you. At a conference, you’re on a fact finding mission; discover what types of deals can be made, even if you’re not ready to make them. The more you learn about infrastructure services you need – outright, bundled or as a combination of both – the more you’ll understand what it’ll take to get to the next step and what you’ll want your next step to be. Recommended conferences? CTAExpo/Emerging Manager. One day, inexpensive, all the right people for you to meet, all gathered together for you.
For any choice other than being a prop trader, you must be willing to pay to get the support services you need so you can demonstrate an organized and scalable infrastructure. As Nell emphasizes, “You have to remember – you’re dealing with other people’s money. You have to hold yourself out as a professional.”
Once you’ve decided on a business strategy, where do you start? If your goal is being an emerging manager with your own firm, John Euler, of EAM Compliance Advisors, stresses that a manager’s legal documents need to come first; they lay the foundation on which the manager’s business is built. With that in place, a proper accountant, administrator, and other 3rd party vendors are added as needed. John cautions prospective managers to step back and evaluate the process as a whole to decide if they’re ready and financially able to take that step, converting their trading into a highly regulated and expensive business. “The last thing anyone wants, “he says, “is a simple and honest mistake that costs a lot of money in legal fees because the right foundation wasn’t established before moving forward.”