Setting Up An Investment Management Firm: A Comprehensive Guide

Setting up an investment management firm can be a complex and time-consuming process, but with the right help and tools, it can be very rewarding for entrepreneurs. There are many steps and factors to consider when starting your own investment management firm.

Firstly, it is important to understand the industry and conduct market research and feasibility studies. This includes knowing your competition and choosing a business structure, such as a sole proprietorship, partnership, limited liability company (LLC), or corporation. You will also need to secure startup funding, choose a location, and register your business with the government and the Internal Revenue Service (IRS).

Other key steps include choosing a business name, developing a business plan, obtaining the necessary licenses and permits, and purchasing the required equipment and software. It is also essential to establish a firm and fund name, decide on leadership roles, and set up in-house operations such as office space and technology requirements.

One of the toughest steps is often raising capital, where fund managers may be expected to contribute a percentage of the fund's capital. Marketing and branding your firm effectively are also crucial for attracting investors and clients.

Overall, starting an investment management firm requires careful planning, legal and regulatory compliance, and a strong understanding of the industry and your target market.

Choose a business structure: corporation, partnership, or limited liability company (LLC)

When setting up an investment management firm, you will need to choose a business structure. There are several options available, each with its own advantages and disadvantages. Here is an overview of the most common business structures for an investment management firm:

Corporation

A corporation is a legal entity that is separate from its owners. It has its own tax ID and can have shareholders. One of the main advantages of a corporation is that it offers limited liability to its owners, meaning they are not personally responsible for the company's debts and liabilities. This can provide greater protection for the owners' personal assets. However, corporations are subject to double taxation, where both the corporation and the shareholders pay taxes on profits. Forming a corporation also requires more paperwork and can be more complex than other business structures.

Partnership

A partnership is an agreement between two or more people who want to start a business together. In a partnership, the partners share in the profits and losses of the business. One advantage of a partnership is that it is relatively easy to set up and can provide flexibility in management. However, a significant disadvantage is that partners are jointly liable for the company's debts and obligations. This means that each partner can be held personally responsible for the company's debts, which can put their personal assets at risk. Partnerships can also be more challenging to dissolve if disagreements arise between partners.

Limited Liability Company (LLC)

An LLC is a business structure that provides limited liability to its owners, known as members. This means that the members are generally not personally liable for the company's debts and liabilities, offering protection for their personal assets. LLCs also offer flexibility in management and pass-through taxation, avoiding double taxation. However, LLCs may not be available in all states, and members may be subject to self-employment taxes. Additionally, LLCs may have more complex tax reporting requirements than other business structures.

When choosing a business structure for your investment management firm, it is important to consider the specific needs and circumstances of your business. Factors such as the number of owners, the level of personal liability protection desired, tax implications, and management structure can influence your decision. It is always recommended to consult with a legal professional to determine the most suitable business structure for your investment management firm.

Develop a business plan

Developing a business plan is a critical step in starting your own investment management firm. It ensures that you fully understand your market and your business strategy, and provides a roadmap for your company's future. Here are some key components to include in your business plan:

Executive Summary

Begin with a concise and clear summary of your entire business plan, allowing readers to quickly grasp the key details of your investment firm. This section should provide an overview of your company, including its history, the type of investment company you operate (e.g., mutual fund, hedge fund, closed-end fund, or exchange-traded fund), and the services you offer.

Industry and Customer Analysis

Conduct market research and document key information about the investment industry. Analyse the size of the industry and the trends that are shaping it. Identify your target customers and their demographics, such as age, location, gender, education, and income. Understanding your ideal customers will help you tailor your products and services to their needs.

Competitive Analysis

Identify your direct and indirect competitors and assess their strengths and weaknesses. By understanding your competition, you can develop strategies to differentiate yourself and build a competitive advantage. Look for unique value propositions that set you apart.

Marketing Plan

Your marketing plan should address the 4Ps: Product, Price, Promotions, and Place. Determine the products and services you will offer and their prices. Decide on promotional methods to attract customers, such as pay-per-click advertising, public relations, search engine optimization, and social media marketing. Consider the location of your business and how it can help increase sales.

Operations Plan

Outline the day-to-day operations of your firm, including the key processes and staffing requirements. Create a projected growth timeline, highlighting the milestones you aim to achieve over the next few years.

Management Team

Provide an overview of your management team's background and qualifications. Highlight their expertise and experience in the industry, demonstrating their ability to lead and grow the company.

Financial Plan

Address the financial aspects of your business, including startup costs, revenue sources, projected sales, and expenses for the next five years. Determine if you need external funding to launch your business and explore options such as personal savings, loans, or angel investors.

Secure startup funding

Starting an investment management firm requires a significant amount of capital, and there are several ways to secure funding for your startup. Here are some strategies to help you get started:

Understand the Financing Landscape

The current market offers numerous funding options for startups, with about 10 times as many providers lending to high-growth startups compared to 15 years ago. This increase in lenders is due to several factors, including a decrease in public companies, higher yields sought by lenders, the proliferation of software-as-a-service (SaaS) businesses, and the solid performance of lenders attracting new market entrants. This landscape provides a wide range of debt options for startup funding.

Explore Debt Structures

The debt options available depend on the growth stage of your business. Initially, options may be limited to cash-secured loans or personal guarantees. As your business grows, more debt structures become available, such as asset-based lines of credit and bullet loans, which offer lower interest rates or increased flexibility, respectively. Banks typically offer asset-oriented options, while hedge funds provide enterprise value-oriented debt structures. Business development companies and specialty private funds offer flexibility across the spectrum. Lenders evaluate your startup's revenue model, customer base composition, and documentation when considering loan applications.

Self-Funding or Bootstrapping

Self-funding, also known as bootstrapping, allows you to leverage your personal financial resources or turn to family and friends for capital. This approach gives you complete control over your business but also means you shoulder all the risk. Be cautious not to spend beyond your means, especially when tapping into retirement accounts early, as this can incur penalties and impact your retirement plans.

Venture Capital Investments

Venture capital (VC) firms offer funding in exchange for an ownership share and an active role in your company. VC firms typically seek high-growth companies, investing capital for equity rather than debt. They take on higher risks for the potential of higher returns and usually have a longer investment horizon. When approaching VC firms, be prepared to give up a degree of control and ownership. Almost all VC firms will seek a seat on the board of directors.

Small Business Loans

If you want to retain full control of your investment management firm but lack sufficient funds, consider applying for a small business loan from banks or credit unions. To increase your chances of securing a loan, prepare a comprehensive business plan, expense sheet, and financial projections for the next five years. These documents will help you determine the required funding amount and assure lenders of the viability of your venture. Compare offers from different lenders to secure the most favourable loan terms.

Crowdfunding

Crowdfunding is another funding option where you raise money from a large number of individuals, known as crowdfunders. Unlike investors, crowdfunders do not receive ownership shares in your business and are not expecting financial returns. Instead, they usually receive gifts, such as the product or service you plan to offer or special perks like meeting the business owner. Crowdfunding carries a low risk for business owners, as you retain full control, and there is typically no obligation to repay crowdfunders if your plan fails. However, be sure to read the fine print and understand your legal and financial obligations when using crowdfunding platforms.

Angel Investors

Angel investors are wealthy individuals who invest their money in startups, often based on emotional or rational reasons. They may be motivated by the cause your startup promotes or the potential for high returns. Most angel investors will not risk more than 10% of their portfolio, so it's important to understand their expectations for ownership and involvement in your company.

Incubators and Accelerators

Incubators and accelerators are programs designed to support the growth of startups. They can provide mentorship, resources, and guidance during the early stages of your business. In exchange, they typically take a percentage of ownership, usually ranging from 5% to 10%.

Government-Backed Loans

If you face challenges in obtaining traditional business loans, explore government-backed loan programs, such as those offered by the Small Business Administration (SBA) in the United States. These programs provide guarantees to lenders, reducing their risk and making them more willing to lend to startups.

Choose a location and register your firm

When deciding on a location for your investment management firm, it is important to consider the tax environment. Ideally, you want to find a state with low taxes so you can keep more of your profits. It is also important to find a city with a strong economy that is welcoming to businesses.

In terms of the physical location, you will need to rent or purchase office space, furniture, and technology. You will also need to hire staff, so it is important to consider the profit-sharing programs, bonus structures, compensation protocols, health insurance plans, and retirement plans that you will offer.

Once you have chosen a location, you will need to register your firm with the relevant authorities. In the United States, this involves registering with the Securities and Exchange Commission and obtaining a securities license from the state in which you plan to do business. You may also need a broker-dealer license, depending on the products you plan to offer. Additionally, you will need to obtain any applicable permits or licenses from the local municipality.

Some states have basic requirements for the minimum amount of capital you must have to start a securities company, but most do not. You may also need to file with your state's department of corporations or secretary of state.

It is important to consult an attorney to determine the best legal structure for your firm and to ensure that you comply with all applicable laws and regulations.

Hire professionals for legal, regulatory, and compliance work

Setting up an investment management firm requires extensive legal, regulatory, and compliance work. It is crucial to hire professionals to ensure that your business complies with all the necessary laws and regulations. Here are some key considerations:

• Legal Counsel: Engage a lawyer or a law firm with expertise in investment management and financial services regulations. They will guide you through the complex legal and regulatory landscape, ensuring your business meets all the necessary requirements.
• Regulatory Compliance: The financial industry is heavily regulated, and your firm must comply with various rules and standards. Familiarize yourself with the regulations enforced by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Other regulatory bodies, such as the Federal Reserve, the U.S. Treasury Department, and the Federal Deposit Insurance Corporation (FDIC), may also have oversight over your firm. Ensure you understand the specific requirements applicable to your business.
• Compliance Officers: Hire experienced compliance officers who will establish and maintain your firm's compliance program. They will ensure your firm adheres to relevant laws, regulations, and internal policies. Compliance officers also monitor and identify potential risks, develop policies and procedures, and conduct employee training.
• Risk Assessment and Management: Your compliance team should conduct regular risk assessments to identify potential compliance risks and develop strategies to mitigate them. This includes implementing internal controls, conducting compliance audits, and establishing a robust compliance monitoring program.
• Registration and Licensing: Work closely with your legal and compliance teams to ensure your firm obtains all the necessary licenses and registrations. This includes investment advisor licenses, such as the Series 65 license in the U.S., and registration with relevant state and federal regulatory bodies.
• Contractual Obligations: If you are leaving an existing firm to start your own, be mindful of any contractual obligations, non-compete clauses, and non-solicitation agreements. Understand the scope and length of any restrictive covenants to avoid legal issues when starting your new firm.
• Data Protection and Cybersecurity: With the increasing use of technology in the financial industry, data protection and cybersecurity become crucial. Ensure you have robust data protection policies and procedures in place and that your firm complies with relevant data privacy laws and regulations.
• Insurance and Risk Management: Work with insurance professionals to assess the risks your firm may face and obtain appropriate insurance coverage. This includes professional liability insurance, cybersecurity insurance, and other relevant policies to protect your firm and its assets.

Hiring professionals with expertise in legal, regulatory, and compliance matters is essential to ensure your investment management firm operates within the boundaries of the law and protects your clients' interests.

Frequently asked questions