What about margin interest expense or short borrow fees? Those are trading business expenses that are generally not deductible on an investor's returns. In my understanding you can file trader tax status regardless of whether the funds are in an incubator LP, an S Corp or a personal account, so maybe the incubator topic is independent of the tax topic...
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Starting a fund / raising capital
- Thread starter doublet83
- Start date
Just one thing to add to Heech's comments on personal account performance. If you use ANY proprietary (or hypothetical) performance capsules you must include ALL proprietary accounts within the last 5 years. So if a manager was trading 5 different accounts and choosing to present only the good one, it should be very evident in the disclosure document.
Forming the entity and trading the entity account is the only real way to generate a stand alone performance capsule. That said, any good due diligence team is going to uncover the fact that it really is just a prop account under an entity title. But that will only be relevant during the early stages when coincidentally clients are really just investing in the manager anyway. The benefit is that nobody will care once you've got >$3-5MM in client AUM, and even though the early entity account was really just a prop account, it will still count toward that 3 year hurdle that many offices seem to have.
{edit} What I was really trying to say was that it is all in how you present yourself. Everyone you meet with is expecting you to be emphasizing the good and skirting the bad. As a start-up manager you must come to grips with one thing. They already know they are taking a big risk with you. You don't need to make them feel like there is no risk. Be straight up with them and make them realize that the risks are well known and accounted for. This will result in most of them taking a smaller position to start, but they will still be taking a position. Then you are set to exceed expectation, after which they will increase their investment.
Forming the entity and trading the entity account is the only real way to generate a stand alone performance capsule. That said, any good due diligence team is going to uncover the fact that it really is just a prop account under an entity title. But that will only be relevant during the early stages when coincidentally clients are really just investing in the manager anyway. The benefit is that nobody will care once you've got >$3-5MM in client AUM, and even though the early entity account was really just a prop account, it will still count toward that 3 year hurdle that many offices seem to have.
{edit} What I was really trying to say was that it is all in how you present yourself. Everyone you meet with is expecting you to be emphasizing the good and skirting the bad. As a start-up manager you must come to grips with one thing. They already know they are taking a big risk with you. You don't need to make them feel like there is no risk. Be straight up with them and make them realize that the risks are well known and accounted for. This will result in most of them taking a smaller position to start, but they will still be taking a position. Then you are set to exceed expectation, after which they will increase their investment.
Quote from doublet83:
Thanks for the color here. Given me some more things to think about.
In addition to the initial set up costs and work needed to set up the structure, it appears that if I trade under a LLC - S corp, my taxes will also be higher, thanks to some self employment taxes and payroll taxes, which I cannot really offset given that I have few business expenses.
I'm not sure what the point of an incubator hedge fund is. I feel like I either trade with all my money in my PA, or I trade with all my money under an LLC.
http://www.greencompany.com/HedgeFunds/HedgeFundIncubatorFunds.shtml
It should be noted that an "incubator" fund isn't anything special. In reality it is just a product that was invented to sell accounting and legal services to a niche demographic.
The idea behind the incubator fund is that you form the legal entity, but remain exempt from registration because you aren't soliciting new capital, holding yourself out publicly, or charging fees. Because you aren't doing any of this, you don't need the expensive parts, eg annual audits, offering memorandum, partnership agreements, subscription documents, administration, etc. The interesting thing about this product is that you are essentially eliminating anything you would really need a lawyer for. Setting up a an LP/LLC or LLC/LLC is a very simple task. So they are pretty much charging you $3-5K for almost nothing.
The only purpose of this "fund" is to hide the fact that it is really just a prop account. But like I said before, any good DD team is gonna ask what percentage of AUM is internal capital. When you say 100%, the true picture becomes crystal clear. Sure, the incubated performance comes in handing a few years later, but it could really be done DIY style for about $500.
For that matter, if the trader is in commodities, I still don't see why he couldn't simply form a couple LLCs and start as an exempt CTA until the track record was good enough. Not really difficult to switch to a pooled fund later, once the program is more proven.
The idea behind the incubator fund is that you form the legal entity, but remain exempt from registration because you aren't soliciting new capital, holding yourself out publicly, or charging fees. Because you aren't doing any of this, you don't need the expensive parts, eg annual audits, offering memorandum, partnership agreements, subscription documents, administration, etc. The interesting thing about this product is that you are essentially eliminating anything you would really need a lawyer for. Setting up a an LP/LLC or LLC/LLC is a very simple task. So they are pretty much charging you $3-5K for almost nothing.
The only purpose of this "fund" is to hide the fact that it is really just a prop account. But like I said before, any good DD team is gonna ask what percentage of AUM is internal capital. When you say 100%, the true picture becomes crystal clear. Sure, the incubated performance comes in handing a few years later, but it could really be done DIY style for about $500.
For that matter, if the trader is in commodities, I still don't see why he couldn't simply form a couple LLCs and start as an exempt CTA until the track record was good enough. Not really difficult to switch to a pooled fund later, once the program is more proven.
Epic,
Given your last reply, would you suggest that route? Going DIY to set up a simple LP to get the clock ticking?
FWIW, I have an RIA, and would like to establish a HF in addition to my existing practice. I have been trading my strategy for less than a year in my own accounts, and less than 6 months for clients. I am just starting to have clients who want to invest in the strategy open up side-car accounts to potentially track their performance separately, come back-audit time. I am where many others seem to be. I feel confident that I can pull in a quick 2mil, but after that, it would get increasingly harder, institutional money is not even a dream yet.
It seems to me that a 5mil threshold is my target minimum to launch a full fledged hedge fund.
Thus, I am left wondering whether to establish a prop account disguised as a LP to incubate, get the clock running, and get performance numbers established, while continuing to "sell" the strategy within my RIA into SMAs and hope to covert them to the HF later.
Sorry if I was all over the place.
Given your last reply, would you suggest that route? Going DIY to set up a simple LP to get the clock ticking?
FWIW, I have an RIA, and would like to establish a HF in addition to my existing practice. I have been trading my strategy for less than a year in my own accounts, and less than 6 months for clients. I am just starting to have clients who want to invest in the strategy open up side-car accounts to potentially track their performance separately, come back-audit time. I am where many others seem to be. I feel confident that I can pull in a quick 2mil, but after that, it would get increasingly harder, institutional money is not even a dream yet.
It seems to me that a 5mil threshold is my target minimum to launch a full fledged hedge fund.
Thus, I am left wondering whether to establish a prop account disguised as a LP to incubate, get the clock running, and get performance numbers established, while continuing to "sell" the strategy within my RIA into SMAs and hope to covert them to the HF later.
Sorry if I was all over the place.
Quote from moneyguy:
Epic,
Given your last reply, would you suggest that route? Going DIY to set up a simple LP to get the clock ticking?
FWIW, I have an RIA, and would like to establish a HF in addition to my existing practice. I have been trading my strategy for less than a year in my own accounts, and less than 6 months for clients. I am just starting to have clients who want to invest in the strategy open up side-car accounts to potentially track their performance separately, come back-audit time. I am where many others seem to be. I feel confident that I can pull in a quick 2mil, but after that, it would get increasingly harder, institutional money is not even a dream yet.
It seems to me that a 5mil threshold is my target minimum to launch a full fledged hedge fund.
Thus, I am left wondering whether to establish a prop account disguised as a LP to incubate, get the clock running, and get performance numbers established, while continuing to "sell" the strategy within my RIA into SMAs and hope to covert them to the HF later.
Sorry if I was all over the place.
This is just my opinion, and others like Heech are proving that it can be done, but I don't see running a pooled fund with less than $20MM as a viable option. It can be done if performance is >30% annual, but a solid business plan should be based on something a bit more easily attained. Something like 10% CAGR is more reasonable. So, at $10MM AUM and a 2/20 you'd have gross revenue of about $400K.
$400K is just enough to keep things running with a solid personal income, but not worth the headaches unless you are going to try to grow it. Growing at a more rapid rate means hiring out aspects of the business, which means higher costs.
Sure, you might hit 40% ROR your first year, and that would be great. But you can't write a business plan around that expectation. At $20MM AUM, the management fees alone are enough to keep things running smoothly, as well as providing a good fundraising budget. But with less than $10MM, you are really vulnerable. Literally, one bad quarter might put you under.
Otoh, running it as SMAs would be cheaper and simpler. Compliance, accounting, and administration are all easier and far less costly. Setup is a breeze. As far as track record, if the program is the same, the performance carries over when you decide to create the pooled fund. You'd setup the Advisor's master account (usually an LLC) at the broker, and then a linked account for the LP that would be the only client of the Advisor. It could be an LLC too, but that is for you to decide.
Anyway, you'd run the program in the LP account, and any testing in your own personal account. Never conduct testing in the LP account as any managed account performance must be reported, but prop trading in personal accounts doesn't. You could just run it like this at minimal cost until you were ready to bring on clients.
As soon as you bring on clients, you need to full setup. In your case, you are already holding yourself out to the public as an adviser, so typical exemptions don't apply to you. If they aren't family, you're probably gonna need to register.
Yea, I would be the first to tell you I'm a bit of an exception. (Doublet83 kinda falls in the same category though, based on what I've seen.) We're trading this prop for our own money regardless, and any operational expenses are just a small percentage of the strategy's overall performance for our own investment.
To think of it as strictly a business for someone starting from (almost) scratch, I think Epic's comments are largely correct. You really do need to get a substantial amount of capital in hand at launch to make a good go at this.
To think of it as strictly a business for someone starting from (almost) scratch, I think Epic's comments are largely correct. You really do need to get a substantial amount of capital in hand at launch to make a good go at this.
Quote from heech:
Yea, I would be the first to tell you I'm a bit of an exception. (Doublet83 kinda falls in the same category though, based on what I've seen.) We're trading this prop for our own money regardless, and any operational expenses are just a small percentage of the strategy's overall performance for our own investment.
To think of it as strictly a business for someone starting from (almost) scratch, I think Epic's comments are largely correct. You really do need to get a substantial amount of capital in hand at launch to make a good go at this.
Yeah, the biggest costs for the pooled structure are audits and admin. Both of which are mostly unnecessary under an SMA structure.
Fun fact: if using an RIA as advisor+GP of the LP is that the RIA becomes subject to "custodian" requirements. Surprise annual audits etc... This is a relatively new reg and can be avoided by setting up a separate GP / managin member entity (which will be subject to custody regs, of course)
The cost of maintaining another entity isn't huge but better to know this before the RIA "advisor" entity is tainted. This was recently pointed out to me by a compliance consultant (I'm considering the same SMA plus pooled fund dual structure) so I thought I'd add to the stream of thought in case this weren't common knowledge.
The cost of maintaining another entity isn't huge but better to know this before the RIA "advisor" entity is tainted. This was recently pointed out to me by a compliance consultant (I'm considering the same SMA plus pooled fund dual structure) so I thought I'd add to the stream of thought in case this weren't common knowledge.
Quote from sf631:
Fun fact: if using an RIA as advisor+GP of the LP is that the RIA becomes subject to "custodian" requirements. Surprise annual audits etc... This is a relatively new reg and can be avoided by setting up a separate GP / managin member entity (which will be subject to custody regs, of course)
The cost of maintaining another entity isn't huge but better to know this before the RIA "advisor" entity is tainted. This was recently pointed out to me by a compliance consultant (I'm considering the same SMA plus pooled fund dual structure) so I thought I'd add to the stream of thought in case this weren't common knowledge.
Yea, I guess maybe I didn't make that clear. I wasn't suggesting that his current RIA be the SMA Advisor. Typically the two are separate entities. That's why I said, setup the Advisor (LLC) and also a second entity (LP or LLC). Both are separate from the current RIA. But that doesn't change the fact that his current business pretty much disqualifies him from most regulatory exemptions. Even though his new Advisor would have less than 15 clients, he cannot realistically say that it is not holding itself out to the public. there will always be a question of how clients were introduced to the Advisor.