Business Valuation

The valuation is fair if you like the guys. The option agreement is kind of bogus though - being retroactive it needs to have a very short expiration. 1-2 months. And make sure there's no wording where they basically own 30% of everything you do in the future.

On second look:
Their valuation of 1/3 AUM is actually very high. I don't understand why they are doing this.
 
garachen said:
The valuation is fair if you like the guys. The option agreement is kind of bogus though - being retroactive it needs to have a very short expiration. 1-2 months. And make sure there's no wording where they basically own 30% of everything you do in the future.

On second look:
Their valuation of 1/3 AUM is actually very high. I don't understand why they are doing this.
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You mean that if the "exercise the option" at a late stage, what you are saying is that they get a bargain if the valuation is much higher at that point of time, did I understand you correctly?

On your second comment: Valuation is based on expected returns as a result from the AUM, not AUM itself.
 
AlphaMale said:
You mean that if the "exercise the option" at a late stage, what you are saying is that they get a bargain if the valuation is much higher at that point of time, did I understand you correctly?

On your second comment: Valuation is based on expected returns as a result from the AUM, not AUM itself.
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It sounds like the valuation is struck now. In February and they can from now start using your profits to pay for their share in the future. So if you make really good money and its a long option they'd get their share for free. Without paying you anything. That part is what's strange.

But usually hedge funds are valued between 10-20% AUM. And that's for established funds. So I think your value is more than fair.

The really important stuff is the dissolution agreements. Those need to be super clear and with as few loopholes as possible that would provide legal fodder for when you guys go your separate ways.

Best of luck. Exciting times.
 
I got another piece of advice from a veteran hedge fund manager and he suggested to have another option clause to give me the opportunity to buy these guys out in case progress is not satisfactory (I guess this has also to be defined, both in terms of AUM contribution and/or time?).

When exercising this option, this should then be with the same valuation as when they joined as partners (as a matter of principle, if valuation is fixed for them, the same should apply for me, or?).

Finally, since my trading is 100% automated and very easy to snatch, is there any way I can keep it secret from the partners? Theoretically, if things would turn sour, they could easily snatch the software and set up their own shop...any ideas around that?

In any case, I guess I need a good lawyer who can help cover all necessary bits and pieces...

Thanks in advance!
 
That's the put and call rights I was referring to. You can probably lock up the intellectual capital in the contract - might be hard to determine if they have stolen it but if you do you can sue.
 
Well, if there's one thing I've learned is that IP protection clauses are merely a tool for litigation, if the IP dissipates irreparable damage is already done - can I some how contractually control *physical* access to the source code? I mean, if I become partner of GETCO or Citadel, I would never get access to their computer systems, would I?
 
I work with a couple private equity firms, working for an investor in the fund, who do these exact sort of deals (buying equity interest in money managers), and it can be a good deal for both parties involved given certain circumstances. There typically are only two good reasons why a money manager would sell out a stake to an outside investor:
1) you want a liquidity event: either to get some future value now and not have too much of your net worth tied up in the fund, or to save on taxes as these earnings would be taxed at long term capital gains rates instead of short term rates (not sure if this would apply without knowing when you set up your LLC).
or
2) you want to grow the business and the potential partner brings a lot of added benefits to the table.

It sounds like you want to grow and develop this plan into a bigger business over the long run, so you better be sure these "investors" offer something of substantial value in terms of growing the business (relationships with potential future investors or experience raising money for funds) and not some skill you could simply hire someone to do later on (accounting, tax work, "business guidance") on a contract basis.

One last thing to clarify, how much of the AUM is your money compared to investor money? If your funds make up a large portion of the AUM, you are essentially giving away rights to profits on your own money for no good reason.

The valuation of 4X EBITDA might be a little low, but its not below market. Typically I see deals get done between 4X-7X EBITDA, but it depends on a lot of variables. Just know that PE funds that I meet with sell a 4.5X EBITDA investment in an investment manager as a great purchase price, so as the other person on the end of that transaction I'm not sure how that makes you feel. One last note in your valuation, is there no hurdle rate or high water mark before your charge incentive fees? Typically a fund will have a benchmark or preferred return that must be met before incentive fees are charged, I'm not sure if you just used a rough example in your calculation but it was listed under "fact". Either way that could change your cash flow projection.
 
Thanks for your feedback. To answer your two bullets above: 1) I don't live in the US and the main place of business is outside of the US so tax is not a major issue, 2) This is a correct understanding.

The idea of bringing these two partners onboard I'd say are two-fold, namely 1) Grow AUM and 2) Bring in industry expertise and create a more "credible" management team rather than running a one-man show.

In terms of my own AUM, it's very small, not even 5% of overall AUM.

We apply a 2/20 fee structure, with a one-year high-water mark, no hurdle rate.

The tricky question is of course whether this is a good thing to do? Alas, you can only tell in retrospect. I can certainly continue to grow the business by myself by mainly targeting family offices, FOHFs, HNWIs etc., but when climbing the ladder, having a proper management team becomes increasingly important.

Having said that, I would probably like to see the partnership setup attached with some sort of milestone scheme or deadline, to which the partnership can be made conditional - is that reasonable? If yes, what could that look like? Finally, what should an appropriate dissolution clause look like? A marriage is supposed to last forever, however, few do...
 
garachen said:
It sounds like the valuation is struck now. In February and they can from now start using your profits to pay for their share in the future. So if you make really good money and its a long option they'd get their share for free. Without paying you anything. That part is what's strange.

But usually hedge funds are valued between 10-20% AUM. And that's for established funds. So I think your value is more than fair.

The really important stuff is the dissolution agreements. Those need to be super clear and with as few loopholes as possible that would provide legal fodder for when you guys go your separate ways.

Best of luck. Exciting times.
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Yes, but how to mitigate the "long option" conundrum? By stating that their deferred payments can only be done 1) by their own cash infusion, and/or 2) through profits generated on capital _they_ have raised, i.e. not from "my share" of the capital base?
 
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