Creating A Family Investment Fund: A Guide For Beginners

Starting a small family investment fund can be a great way to pool resources and knowledge to make intelligent investment decisions. The first step is to get your club together. This could include family, friends, and co-workers. It's important to define goals and ensure everyone is on the same page regarding their level of interest, financial contributions, and investment strategies. Once you've established your group, you'll need to incorporate your investment club, open a brokerage account, and start researching potential investments. It's also crucial to establish clear rules and policies, appoint roles, and create an educational agenda to ensure everyone is informed about investing. When investing as a group, remember to celebrate victories and learn from losses together. Keep in mind that there are legal and regulatory considerations when starting an investment fund, especially if you plan to manage money for others. Be sure to consult with legal and financial professionals to ensure compliance with applicable laws and to make informed investment decisions.

Define the business strategy

To define the business strategy for your small family investment fund, you should consider the following steps:

Outline your business strategy and differentiate your financial plan

Firstly, you must conduct significant research into a defined market or individual sector. Some funds focus on energy development, while others may focus on early-stage biotech companies. This step is crucial as investors will want to know more about your fund's goals and investment strategy.

Determine the purpose of each investment

Consider whether the aim of the investment is to grow capital for mergers and acquisitions, or to raise capital to allow existing owners to sell their positions in the firm.

Consider a geographic focus

Will your fund focus on a specific region within the United States, a particular industry in a certain country, or will it emphasize a specific strategy in similar emerging markets?

Adopt a business focus

You must also decide whether your fund will aim to improve your portfolio companies' operational or strategic focus, or whether it will center on cleaning up their balance sheets.

Determine the type of investors

Will your investors be institutional investors such as insurance firms, sovereign wealth funds, and pension programs, or will they be accredited investors who meet a specified annual income threshold or maintain a certain net worth?

Comply with regulations

Ensure that you comply with all relevant regulations, such as obtaining approval from your employer and adhering to FINRA rules. Additionally, consider the SEC's family office exemption, which allows you to include only family members in your fund without advertising it.

Structure your fund

Determine the legal structure of your fund, such as a limited partnership or a limited liability company (LLC). Consult with a lawyer to understand the implications of each structure and choose the one that best suits your needs.

Establish roles and responsibilities

Clearly define the roles and titles of the fund's leaders, such as partner or portfolio manager. Establish a management team, including positions like CEO, CFO, and chief compliance officer.

Develop an investment strategy

Decide on the types of investments your fund will focus on, such as stocks, mutual funds, or investment properties.

Set up operations

Establish in-house operations, including office space, technology requirements, and hiring staff. Consider compensation packages, profit-sharing programs, and retirement plans for your employees.

Create a business plan

Prepare a business plan that outlines cash flow expectations, establishes timelines, and includes a marketing plan to target future investors.

Build an external team

Assemble a team of external consultants, including independent accountants, attorneys, and industry consultants who can provide valuable insights into the industries of the companies in your portfolio.

Explore disaster recovery strategies

It is important to plan for potential disasters such as cyberattacks or market downturns. Develop strategies to mitigate these risks and protect your fund's assets.

These steps will help you define a comprehensive business strategy for your small family investment fund.

Write a business plan

The business plan should include cash flow expectations and establish a timeline for the fund, including the period to raise capital and exit from portfolio investments. Most funds have a life of 10 years, but this is ultimately at the manager's discretion. A sound business plan should also include a strategy on how the fund will grow over time, a marketing plan to target future investors, and an executive summary that ties all of these sections and goals together.

It is also important to establish a firm and fund name, as well as decide on the roles and titles of the firm's leaders. The management team should include a CEO, CFO, chief information security officer, and chief compliance officer.

The business plan should also outline the fund's investment strategy. This includes whether the fund will have a geographic focus, such as a specific region of the United States or country, or if it will focus on a specific industry or strategy in emerging markets. It is critical to determine the purpose of each investment. For example, is the aim to grow capital for mergers and acquisitions, or to raise capital to allow existing owners to sell their positions in the firm?

Additionally, the business plan should address how the fund will be structured and how fees will be determined. For example, private equity managers typically receive an annual management fee of 2% of committed capital from investors.

Establish the investment vehicle

Establishing the investment vehicle is a critical step in setting up a small family investment fund. Here are the key considerations and steps to achieve this:

Understanding Investment Vehicles

Investment vehicles refer to the methods or instruments used by investors to grow their money. These can range from low-risk options like certificates of deposit (CDs) and bonds to higher-risk alternatives such as stocks, options, and futures. Other examples include annuities, collectibles, mutual funds, and exchange-traded funds (ETFs). Pooled investment vehicles, such as mutual funds, pension funds, and hedge funds, allow multiple investors to combine their capital to gain advantages they might not have as individual investors.

Choosing the Right Vehicle for Your Family Fund

When selecting an investment vehicle for your family fund, it's important to consider the investment goals, risk tolerance, and financial objectives of your family members. Here are some common types of investment vehicles to consider:

• Public Investment Funds: These are conventional mutual funds traded on the capital market, accessible to any investor, and offering various types such as equity, bond, commodity, mixed, or short-term funds.
• Private Investment Funds: Private investment funds operate similarly to public funds but require a larger amount of capital to participate and have a limited number of investors. They typically invest in illiquid assets or those not traded on the stock exchange.
• Hedge Funds: Hedge funds aim to profit regardless of market trends and are known for making risky investments to pursue higher-than-average returns.
• Real Estate Funds: These funds invest in commercial or residential properties to generate rental income and capital appreciation.

Structuring Your Family Investment Vehicle

When establishing the legal structure of your family investment vehicle, consider the following:

• Limited Partnership (LP): In the US, funds often assume the structure of a limited partnership. As the founder, you will be a general partner with the right to decide the fund's investments. Investors will be limited partners, only accountable for losses tied to their individual investments.
• Limited Liability Company (LLC): An LLC structure may also be considered, providing limited liability protection to all members. It is important to consult with legal and tax professionals to determine the most suitable structure for your family fund.
• Family Investment Partnerships (FIPs): FIPs are specifically designed to help families address their collective and individual investment goals. They can be tailored to meet short- and long-term investment and liquidity needs, allowing for flexibility in portfolio customization.

Compliance and Documentation

Regardless of the chosen structure, ensure that you have the necessary documentation in place. This includes a private placement memorandum, operating agreements, and any other required contracts or legal documents. Consult with legal professionals to ensure compliance with regulations and to protect the interests of all involved parties.

In summary, establishing the investment vehicle for your small family investment fund involves understanding the various options, choosing the right vehicle for your family's goals, structuring the vehicle appropriately, and ensuring compliance with legal and regulatory requirements.

Determine a fee structure

When determining a fee structure for your small family investment fund, there are several key considerations to keep in mind. Here are some detailed instructions and guidelines to help you establish a comprehensive fee structure:

Management Fees:

Private equity managers typically charge an annual management fee, which is calculated as a percentage of the committed capital from investors. For example, a standard rate is 2% of the total capital raised from investors. So, if you raise $10 million, you would collect $200,000 in management fees annually. However, less experienced fund managers may receive a smaller management fee to attract new capital. It's important to consider your level of experience and the current market rates when determining your management fee.

Carried Interest:

Carried interest, also known as "carry", is the share of profits that the fund manager receives. It is typically set at 20% above an expected return level. For instance, if the hurdle rate (minimum required return) for the fund is 5%, you and your investors would split the returns at a rate of 20% for the fund manager and 80% for the investors. This structure incentivizes the fund manager to generate strong returns.

Hurdle Rate:

The hurdle rate is the minimum required return that must be achieved before the fund manager can start collecting carried interest. It is important to set a realistic and achievable hurdle rate that aligns with the investment goals and expectations of your family investment fund.

Performance Fees:

In addition to management fees and carried interest, some fund managers charge performance fees. These fees are typically calculated as a percentage of the profits generated by the fund. Performance fees are intended to reward fund managers for exceptional performance and align their interests with those of the investors. However, it's important to carefully consider the fee structure to ensure it is fair and reasonable for all parties involved.

Compliance, Risk, and Valuation Guidelines:

When establishing your fee structure, it is crucial to implement compliance, risk, and valuation guidelines for your fund. These guidelines will help ensure that your fee structure complies with relevant regulations and that you are properly managing risk. Additionally, valuation guidelines will help you accurately assess the value of your investments and determine the appropriate fees.

Comparison with Industry Standards:

Before finalizing your fee structure, research and compare it with the standard fees charged by other investment funds in the industry. This will help you ensure that your fees are competitive and in line with market rates. Consider factors such as the size of your fund, the level of risk involved, and the expertise you bring to the table.

Remember, the fee structure you choose will impact your ability to attract investors and maintain their trust. A well-designed fee structure should balance the interests of the fund manager and the investors, providing fair compensation for the fund manager while also maximizing returns for the investors. It is recommended to consult with a financial professional or advisor to ensure your fee structure is appropriate for your specific circumstances.

Market the fund

Marketing the fund is the final step before launching your small family investment fund. This step is critical to raising capital and convincing others to invest in your fund. Here are some strategies to market the fund effectively:

• Prepare to invest in your own fund: Fund managers with successful track records are expected to contribute 2% to 3% of the fund's total capital commitments. New managers with less capital can likely commit 1% to 2% for their first fund. This demonstrates confidence in your fund and shows potential investors that you are willing to take on the same risks.
• Develop a comprehensive marketing strategy: Your marketing strategy should articulate your fund's unique value proposition, target audience, and channels you will use to reach potential investors. Consider hiring a marketing professional or consultant to help develop and execute your marketing plan.
• Leverage your network: Utilise your personal and professional networks to spread the word about your fund. Attend industry events, conferences, and networking opportunities to connect with potential investors and showcase your expertise.
• Create compelling marketing materials: Develop professional and informative brochures, pitch decks, and other marketing collateral that highlights your fund's investment strategy, track record (if available), and potential benefits for investors. Ensure all materials are compliant with relevant regulations.
• Utilise digital channels: Build a website that showcases your fund's strategy, team, and contact information. Use social media platforms, such as LinkedIn, to connect with potential investors and share updates and insights about your fund. Consider creating a newsletter or blog to share thought leadership content and establish yourself as a knowledgeable investor.
• Reach out to potential investors directly: Identify individuals or institutions that fit the profile of your target investor and approach them directly. This may involve cold calling, emailing, or attending industry events to connect with potential investors. Be prepared to pitch your fund and highlight why it is a worthwhile investment opportunity.
• Build relationships with intermediaries: Cultivate relationships with financial advisors, wealth managers, and other intermediaries who can connect you with potential investors. These individuals can vouch for your fund and facilitate introductions to accredited investors.

Remember, marketing a small family investment fund is about building trust and relationships with potential investors. Be transparent, compliant with regulations, and confident in your fund's strategy and potential.

Frequently asked questions