Launching An Investment Fund: A Comprehensive Guide

Launching an investment fund is a complex and challenging endeavour that requires careful planning and execution. Whether starting a private equity fund or a hedge fund, there are several crucial steps that must be taken to ensure a successful launch. From defining a clear and differentiated business strategy to assembling a capable team, the process is demanding and often expensive. Raising capital is consistently cited as one of the most difficult aspects of establishing a fund, as investors typically seek out experienced managers with a proven track record of success.

Define the business strategy

The first step in launching an investment fund is to outline your business strategy and differentiate your financial plan from competitors and benchmarks. This requires significant research into a defined market or individual sector. Some funds, for example, focus on energy development, while others may focus on early-stage biotech companies.

As you articulate your investment strategy, consider the following:

• Will your fund have a geographic focus? For example, will it focus on one region of a country, or will it have an international scope?
• Will your fund aim to improve portfolio companies' operational or strategic focus, or will it centre on cleaning up their balance sheets?
• What is the purpose of each investment? For instance, is the aim to grow capital for mergers and acquisitions, or to enable existing owners to sell their positions in the firm?

Before launching, it is important to become an expert in the field. This is a complicated process with many nuanced steps and risks that fund managers need to understand. It is also important to choose a name for your fund that best describes your investment style and strategy.

You will also need to determine the legal structure of your fund. In the US, for example, a fund typically assumes the structure of a limited partnership or a limited liability firm. As the founder of the fund, you will be a general partner, meaning that you will have the right to decide on the investments that compose the fund.

Finally, you will need to determine provisions related to management fees, carried interest, and any hurdle rate for performance. Typically, private equity managers receive an annual management fee of 2% of committed capital from investors. Carried interest is often set at 20% above an expected return level.

Develop a business plan

Developing a business plan is a crucial step in launching an investment fund. It involves outlining specific strategies, goals, and timelines to ensure the fund's success. Here is a detailed breakdown of the process:

Strategy and Goals

The first step in developing a business plan is to define your investment strategy clearly. This includes deciding on the sectors or industries you want to target, such as energy development or early-stage biotech companies. You should also consider whether your fund will have a geographic focus, such as a specific region within a country. Additionally, contemplate the purpose of each investment. For instance, is it for mergers and acquisitions or to enable existing owners to sell their positions? Articulating your investment strategy will help attract investors by providing clarity and confidence in your fund's direction.

Timeline and Expectations

Creating a timeline is an essential aspect of your business plan. Investment funds typically have a lifespan of ten years, but this can be adjusted at the manager's discretion. Your timeline should include key milestones, such as the period for raising capital and exiting portfolio investments. It should also outline the fund's growth strategy over time, including any plans for expansion or diversification.

Marketing and Target Audience

A well-thought-out marketing strategy is vital for a successful investment fund. Identify your target audience and develop a plan to reach them effectively. This could include creating marketing materials, such as a website or pitch deck, that showcases your fund's unique features and benefits. Consider hiring a professional marketing team to help craft your message and highlight your fund's strengths and potential.

Operations and Team

Establishing the operations of your fund is crucial. This includes deciding on the business structure, such as a limited partnership or a limited liability firm, and determining the roles and titles of key personnel. Outline the management team's responsibilities, including positions like CEO, CFO, and Chief Compliance Officer. Additionally, address operational aspects like office space, technology requirements, and hiring staff, including compensation and benefits packages.

Regulatory and Compliance

Complying with regulatory requirements is essential for any investment fund. Depending on your location and the nature of your fund, you may need to register with relevant authorities, such as the Securities and Exchange Commission (SEC) or similar bodies in your country. Consult with legal professionals to ensure you understand and adhere to all applicable laws and regulations to avoid any legal pitfalls.

In summary, developing a comprehensive business plan for your investment fund requires a clear strategy, well-defined goals, a realistic timeline, effective marketing, a solid operational foundation, and compliance with regulatory frameworks. This plan will serve as a roadmap to guide your fund's launch and ongoing operations, helping to secure investor confidence and set your fund up for success.

Establish the investment vehicle

Establishing the investment vehicle is a critical step in launching an investment fund, and it involves several key steps. Firstly, it is essential to determine the fund's legal structure. In the United States, investment funds typically assume the structure of a limited partnership or a limited liability company. As the founder of the fund, you will be a general partner, which means you will have the right to decide on the investments that comprise the fund.

Your investors, on the other hand, will be limited partners. They will not have the same decision-making rights as you regarding the companies included in the fund. Limited partners are only accountable for losses tied to their specific investments, whereas general partners handle any additional losses and liabilities to the broader market.

At this stage, it is crucial to engage a lawyer who will draft important documents such as a private placement memorandum, operating agreements, and any other necessary contracts. These documents will outline the terms and conditions of the fund, define the roles and responsibilities of the partners, and ensure compliance with relevant regulations.

Additionally, establishing the investment vehicle also involves determining the fund's fee structure. This includes provisions related to management fees, carried interest, and hurdle rates for performance. Typically, fund managers receive an annual management fee, which is a percentage of the committed capital from investors. Carried interest, on the other hand, refers to the fund manager's share of profits above a certain return level. These fees are essential to cover expenses, compensate the fund manager, and provide incentives for strong performance.

In conclusion, establishing the investment vehicle is a complex process that requires careful consideration of legal structures, roles, and fee structures. It is a critical step in launching an investment fund and forms the foundation for the fund's operations and compliance with relevant regulations.

Determine a fee structure

When determining a fee structure for your investment fund, there are a few key considerations to keep in mind. Firstly, it is important to understand the standard fees within the industry. For example, private equity fund managers typically receive an annual management fee of 2% of committed capital from investors. So, for every $10 million raised from investors, the manager can expect to collect $200,000 in management fees annually. However, less experienced managers may receive a smaller management fee to attract new capital.

Another common component of fee structures is carried interest. Carried interest is often set at 20% above an expected return level. For example, if the hurdle rate for your fund is 5%, you and your investors would split returns at a rate of 20-80.

When determining your fee structure, it is important to consider the level of experience you and your team bring to the table. If you are a first-time fund manager, you may need to be prepared to accept a lower management fee in order to attract investors. However, it is also important to ensure that the fee structure covers your expenses, provides a living wage, and allows you to participate in the fund's success.

Additionally, when launching an investment fund, it is crucial to offer discounted "founder" fee terms to anchor investors and early investors. This is often done through "side letter agreements". It is worth noting that raising "full fee" capital is a mark of success, as it indicates that your fund is in high demand and investors are willing to pay the standard fees.

Finally, it is important to be mindful of the competition when determining your fee structure. With the intense competition for investor dollars between traditional and alternative investments, your fund offering should stand out. This can be achieved by presenting a compelling investment proposition, understanding your fund's value proposition and target market, and having a coherent offering in terms of investment strategy, structure, and operations.

Raise capital

Raising capital is often the most challenging step in launching an investment fund. Fund managers will be expected to contribute 1% to 3% of the fund's capital. Here are some strategies to raise capital for your investment fund:

Fund it yourself:

Dipping into your personal savings is the easiest way to raise capital for a startup. It demonstrates your confidence in your business idea and can make investors or lenders more likely to commit funding. However, funding a business yourself carries financial risks.

Business loan:

Small business loans are a common way for entrepreneurs to access capital. However, loan approval is not guaranteed and often requires an excellent credit score and a minimum time in business.

Crowdfunding:

Crowdfunding platforms like Kickstarter, GoFundMe, and Indiegogo have helped startups raise capital and gain exposure.

Angel investment:

Angel investors are wealthy, accredited individuals who typically fund businesses alone or join other angel investors. They usually expect a solid business plan and pitch with key financial information.

Personal contacts:

Friends and family can be a source of funding, but mixing business and personal relationships can add stress to the capital-raising process. According to Fundable, 38% of startup founders raise money through their personal connections, investing more than $60 billion per year.

Venture capitalists:

Venture capitalists tend to invest in more mature companies than angel investors and operate out of a firm. They invest in a lower ratio of businesses that apply for funding but typically invest larger amounts.

Private equity:

Private equity firms invest in private companies or startups with long-term growth potential. They buy shares in companies on behalf of institutional and accredited investors.

Institutional investors:

Institutional investors such as insurance firms, sovereign wealth funds, financial institutions, pension programs, and university endowments can provide capital for investment funds.

High-net-worth individuals:

Targeting high-net-worth individuals who meet specific annual income thresholds or maintain a certain net worth can be a strategy to raise capital for your investment fund.

Seed capital and strategic investors:

Seed capital from strategic investors can provide initial funding for your investment fund.

Prime brokers and investment banks:

Prime brokers and investment banks can be a source of capital for hedge funds.

Frequently asked questions