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Financial budgeting: One chance to succeed

Planning a hedge fund launch is a serious business. People need to decide whether they are truly ready, both financially and mentally, and be confident in their investment strategy. This may sound trite but all too often start-ups rush to get a hedge fund in place without clearly thinking everything through. 

"It is a significant undertaking and should not be treated lightly. From a financial perspective the first thing to do is to create a budget broken down into three categories: budgeting for fund expenses, budgeting for manager expenses and finally budgeting for personal expenses," says Jeffrey I Rosenthal (pictured), CPA, Partner- in-Charge of the Financial Services Group at Anchin Block & Anchin LLP, a full-service accounting, tax and advisory firm. 

Fund expenses

With respect to budgeting for the fund, one needs to factor in the anticipated management fee and professional fees; audit, tax, legal and administration expenses. "The expenses are not radically different for a USD10m fund versus a USD100m fund but they will significantly impact the rate of return of a smaller fund," says Rosenthal. 

Manager expenses

"One of our roles is to educate the manager, not only from the fund perspective but also from the manager perspective. The Fund Manager also has to absorb a fair amount of expenses. The 1% or 2% management fee needs to cover business overheads: office rent, employee salaries, IT costs, insurance and so on," adds Rosenthal.

The management fee is what the manager will survive on so factoring in all these costs at the pre-launch phase is vital as it will help determine how much Day One capital they will need to launch with. 

"It is therefore important to forecast what you anticipate the management fee income is going to be based on the assets raised, and calculate what the overhead expenses will be. Most start-ups are not likely to raise significant capital in the first year that the management company will be running a profit. So it's important the manager knows what the overheads will be, deduct them from the expected management fee and have a clear idea of what the deficit is likely to be," asserts Rosenthal. 

Personal expenses

Given that a start-up manager will be putting a significant amount of his personal wealth into the fund, he needs to also make sure there is enough personal income to cover living expenses. 

The majority of people who start up hedge funds know how to trade but don't focus on all the associated costs of running a hedge fund business. The reality is they are going to be paid last, after their employees, so they need to know what will be left in the honey pot.

Start-ups would like to launch with USD100m or more and be confident that the amounts remaining after expenses will leave them with plenty of `burn capital' to grow the business. But raising capital remains a challenge. Rosenthal relates how, when he meets start-up managers they will often reveal that they are going to raise USD50m or more. "At that point I always ask: `What happens if you only end up raising USD20m?' 

"Start-ups have to anticipate what the threshold needs to be before launching the fund. Adopt the mindset that you're only going to raise half the target capital. You have one shot to do this so plan it out properly," concludes Rosenthal.

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