How to Start a Hedge Fund: Part 3

August 9, 2007 |

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This is the third installment in a four part Q&A on “How to Start a Hedge Fund” with Jeffrey F. Kuchta, CFA, Managing Member of Hedge Fund Launch LLC

HFL: Why is it important to have an independent auditor?

Kuchta: For internal operating reasons it is important to have at least an annual audit in order to review the fund and Management Company’s periodic operating position.  It is also commonplace to have less formal audits on a quarterly basis.  As with an administrator, a good auditor will be triangulating by comparing information from a number of different sources in order to confirm and attest to your operation’s financial position and also to opine on the methodologies for which items have been reported.

In the same way that you should be interested in reviewing your fund’s financial position, your investors will be equally interested in understanding how their capital is being deployed, where income is being generated, what sort of  expenses they are occurring, and how sound the operation is.  Again, an independent audit is another source of comfort for investors to rely upon in determining that their manager is above board and is a trusted steward of their assets.

HFL: My personal accountant for years has been Dewey, Cheatem, and Howe CPA and they have always done a fantastic job.  Should I retain them to be my hedge fund auditor?

Kuchta: While local or regional CPA’s may have a wealth of experience in handling retail and small business accounting issues, hedge fund and management company accounting and audits are complex beasts and require firms with the infrastructure, experience, networks, and integrity required to get the job done in a timely and accurate fashion.

As with any service provider, you get what you pay for.  Some managers may opt to start out with a less expensive auditing firm with the intention that they will change auditors as they grow.  Unfortunately, many of these managers find that they are having difficulty growing because potential investors are skeptical about the audits performed by the unknown CPA.  Furthermore, many managers find themselves in a position of having to employ a more reputable auditor to go back and re-do previous audits.  In the end they spend much more money than they would have in the first place if they went with the more reputable auditor.

HFL: How should I go about marketing my fund?

Kuchta:  Assuming you have already secured your seed capital, there are a number of viable options for new and emerging managers to go about marketing.  The first is to subscribe to the commercial hedge fund databases.  Some of them allow managers to report their information for free while others may charge the manager a fee to report.  You will certainly want to post your information on the free databases, and generally the cost of the pay databases is not so prohibitive to keep you from submitting your information to at least one or two of them.  Make sure your information is accurate and timely.  Believe it or not, a large number of investors rely on the databases to generate investment ideas.

Assuming that you have opted to employ a reputable prime broker, make sure to check with your relationship manager about the capital introduction services offered.  Most reputable prime brokers have capital introduction services that are at no additional cost to their hedge fund clients.  A good cap intro program will set up investor conferences and roundtables for you to participate in, and will schedule meetings for you with their relationships in many of the major cities throughout the world.  Good cap intro units also provide at least an annual, but generally quarterly, database of all of their managers to their investor relationships.

A topic that is covered quite frequently at Hedge Fund Launch is third party marketing, so I will not delve too deep into this subject in this forum.  In general though, do your homework on potential third party marketers.  Determine how much money they have raised for other managers, and how those managers stack up against you.  A good third party marketer will be well known, and a few reference calls will generally tell you if this person is worth their salt or not.  It is often desirable from the manager’s point of view to only pay a marketer if he has raised you capital.  Don’t be surprised, however, if a reputable third party marketer requires some sort of monthly retainer.  If they do require a retainer, make sure that they are spending it on travel and other expenses that directly benefit you in the capital raising effort.  Outside of a retainer, the industry average fee charged by marketing agents is 20% of the fees attributable to any capital raised by the marketer.  If the marketer requires a higher percentage, make sure they are able to justify it.

In the last part of this series, we will discuss additional marketing tactics as well as some other miscellaneous topics of interest.

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