- September 7, 2016
- Posted by: Vincent Sarullo
- Category: Direct Lending, Fund Administration, Fund of Funds, Hedge Funds, Private Equity / Venture Capital, Real Estate, SMA, Tax Liens
Do you think you can be a hedge fund manager? Do you want to work for yourself and do you think that you have a great strategy to offer investors?
If you truly enjoy doing this type of work, that goes a long way towards having the best shot at creating a sustainable business and attracting investors.
Believe it or not, most allocators and seeders will ask a hedge fund manager this question to see if your heart is truly in the business.
A hedge fund manager who is motivated by money alone will not survive the tough times and may make riskier investment decisions in order to generate performance fees and then ultimately self-destruct.
Time and time again, I hear investors say that throughout their due diligence process, they are trying to get past the numbers and get to “know” the manager. Personality is a major factor in making the decision to invest.
Your investors not only hope to see how a manager will react in various market conditions, they also want to see if you really are a person they want to work with on an ongoing basis. They plan to work with you for many years and they’ve put a lot of time and resources into the decision to invest. They want these costs to pan out over an extended period.
Investors are more than just money dropped into your account to invest, they are people who you should have a REAL relationship with.
During the three stages of the fund, the management fee arrangement can change. During the investment period, fund managers usually receive their management fee based on the fund’s total committed capital, at a rate of 1% to 2% of the committed capital.
The underlying philosophy is that the manager is getting paid to find acquisitions that could potentially use up all the committed capital and maximize the potential returns for investors. The manager must do a lot of work to find and close these investments.
Either at the end of the investment period or soon after, the management fee earned by the manager often changes, going from being based on what the total commitments were to being based on the fund’s total invested capital. Given the chance to deploy the investors; capital, the fund managers now earn their management fee based on what is in the portfolio and their responsibility to work with and sell those companies.
Do not feel too bad for the fund manager who has not deployed all of the available capital in the fund and who potentially faces a significant reduction in management fees. The timing of this change in fee typically coincides with when the first portfolio company is getting ready for sale and the fund manager will be earning their carried interest on the profits of that sale. The manager can expect the trade-off of the management fee (at 2%) in exchange for the carried interest on profits (around 20%).