What’s the number one issue facing startup funds?
You guessed it: Raising capital.
What follows are 10 steps you can take to help you do just that.
Step 1: Know the Rules of the Game
The first step in raising capital is knowing what the rules are.
The fundamental principle taught in law school is that ignorance of the law is no excuse for breaking it; the same principle applies to your funds.
But to play the game, you need to know the LATEST rules. ESG (environmental, social, and governance) investing, cryptocurrency, the new marketing rules — there’s always something novel to consider when it comes to compliance.
It takes a combination of constant policy and procedure adjustments, team education, and the right technological solutions to keep your firm audit ready.
For example, the SEC recently implemented a compliance date of November 4, 2022, for the new Marketing Rule to modernize and replace a patchwork of old rules and no-action letters that have been in place for over 60 years.
Shortly thereafter, the SEC announced that they intend to immediately begin investigations and enforcement of the new marketing rule.
Knowing the rules of the game ahead of time and being prepared is critical.
Step 2: Overcome Imminent Hurdles
You’ll likely face some significant hurdles in raising capital for your firm, and the amount you need to raise has only increased since the institutionalization of funds. There are many choices out there, and you need to stand out in all areas of your business.
A clearly defined and differentiated investment strategy, high-quality team, operational infrastructure, and cybersecurity are equally important with your risk-adjusted track record.
Ensuring that you have the right staff – whether that be in-house or outsourced – to deal with all of the challenges you face is an important hurdle to overcome.
It’s expensive to set up, manage, and maintain a hedge fund. There’s a critical mass you need to reach both in terms of covering your costs and attracting investors.
For the most part, institutional investors don’t want their investments to be more than 10 to 20% of a fund’s AUM. These investors likely won’t jump to invest in amounts smaller than $25mm, which means that for most institutional investors, the fund needs to be between $250mm and $500mm.
Step 3: Develop Your Strategy for Raising Capital
Like any major project, success is incumbent on a well-conceived, carefully executed plan. Establishing the steps in that plan and setting key performance indicators to measure your progress is one of the areas where an experienced team can help.
Specific strategies for marketing, branding, and advertising will all play a part in the ultimate success of emerging managers. While they will (and should) very much overlap, you’ll need a solid plan for each method of promotion.
Step 4: Nail Down Your Timing
Timing will play a significant role in your success.
Understanding the current market conditions, particularly for your strategy as well as making sure you are fully prepared to “go to market” takes careful planning. Allow yourself enough time to prepare and leverage industry experts to make sure you’re ready for prime-time.
Remember: The first impression you make in your pitch will be critical in determining whether you raise the capital you seek. The adage “you don’t get a second chance to make a first impression” is particularly true when you are fundraising.
Which leads us to the next step…
Step 5: Prepare Your Marketing Materials
You’ll need four key documents for your marketing presentation:
- Elevator pitch: The story you tell investors on your way to the 10th floor; learn to calmly deliver this story in a way that’s both informative and engaging to investors. Sometimes, you only have a brief window to convince someone to take that next step
- Tear sheet: A concise, well-written one-page summary sheet describing your firm, your fund, and your value proposition
- Deck: More comprehensive collateral that should be professionally prepared due to its high importance
- Due Diligence Questionnaire (DDQ): The formal question and answer document where you answer all questions investors might raise about your firm across all of the functional areas
Generating interest in your prospective investors through these materials is sometimes the only thing they’ll see. You need to pique their interest through your written material to even get a chance at a face-to-face meeting.
Step 6: Build Thought Leadership
Thought leadership is an oft overlooked but key aspect of fundraising. Get the word out that you are an expert in your space by finding ways to provide insight on the topics you’ll be investing in. By building a reputation of expertise, you’ll be able to build trust and credibility with potential investors and differentiate yourself from competitors.
Next, you’ll need a content strategy. Determine the nature of the content you intend to produce. Will it be product-specific or industry-specific? What formats will resonate best with your target audience: Written articles, podcasts, graphics, explainer videos, original research?
On which channels will you distribute that content? Will you share content via your website’s blog, books, social media, email newsletter, earned or paid media, or speaking engagements in a designated community?
Being a thought leader means you raise capital based on your knowledge and expertise. The fund’s website is the primary vehicle for extending information and content for potential investors and maintaining straightforward, linear content can help them feel more confident in working with you.
Step 7: Develop Your Website
Next on the list for raising capital: Developing the fund’s website.
Let’s face it, everyone and everything is digital these days. Your website is your welcome mat to the world. The idea behind creating a website is to draw people to it, highlighting the uniqueness of your firm in a visually appealing way. On your website, you’ll be able to connect with potential leads so it’s important to have the right messaging and a best-in-class user experience. This includes making sure that regardless of whether someone is using a phone, tablet, or computer, your message is easy to read and access.
Step 8: Identify Potential Sources of Capital
Identifying prospective sources of capital is critical because these sources serve as the connections to investors (not the investors themselves). The prime brokers’ cap intro teams are the most lucrative and essential sources.
These teams are valuable because they’re incentivized to match their prime brokerage clients with potential investors. The larger the hedge fund is, the more fees the prime broker will eventually realize.
In addition, there are several other sources of capital.
- High-net-worth individuals
- Endowments
- Fund of funds
- Insurance companies
- Sovereign wealth funds (countries)
- Pension funds (public and private)
- Corporations
- Single and multifamily offices
- Foundations
- Sub-advisory relationships
- Friends and family
- Business colleagues
- Seeder funds
- First loss funds
Not all investors, however, have the same profile. Some may have shorter sales cycles than others and can be of value in building AUM quicker.
Step 9: Be Prepared for Consultant Due Diligence
More recently, potential investors have hired consultants to perform due diligence on a firm and many of these consultants may have more expertise than the investors themselves. Consultants will report their findings to the investor and assign the fund a letter grade based on its performance and the potential it holds for the investor.
It’s important to note that due diligence will take two forms:
- Investment Due Diligence (IDD)
- Operational Due Diligence (ODD)
While the strength and uniqueness of your investment process will be what gets you to the second round, the ODD holds equal importance. Knowing that you are capable of running a business and meeting client service needs and that you and your team make a good impression as ethical and responsible stewards of someone’s money also plays an important role.
Step 10: Complete Your Own Due Diligence on Potential Investors
Now that we’ve covered the other steps of raising capital, let’s talk to investors.
Remember to develop a list of criteria regarding exactly what you’re looking for from potential investors so you can target marketing to your ideal LP.
Also, feel free to turn the tables on your potential investor and ask for references on them as an LP. The investors will be your partners, so you want to do your due diligence, just as they will do their due diligence for your firm.
While the types of investors you have might not seem important, it is.
LPs with the resources to write big checks are necessary, so they can grow as you grow. Ideally, your investors will be focused on a long-term relationship and not concerned with the inevitable volatility of the firm’s performance. Disgruntled investors will likely require you to spend time away from investing in the portfolio and time is the most precious commodity a manager has. Make sure to do your due diligence in evaluating investors to drive your firm to success.
The Bottom Line
Raising capital is the number one challenge for startup funds.
But following the 10 steps above can prepare your firm for fundraising success.
Revisit this list periodically to ensure your firm is making progress and you know what’s coming ahead for it.
Looking to strengthen your firm from the inside out? Arootah’s Hedge Fund Advisory leverages our experience across the key areas of a firm: investments and operations. Our industry veterans support you throughout the entire life cycle: from start-up to raising capital to ongoing operations and beyond. Reach out for a free, 30- strategy call today to see how we can support you.
Disclaimer: This article is for general informational purposes only and does not constitute legal, investment, financial, accounting, or tax advice, or establish an attorney-client relationship. Arootah does not warrant or guarantee the accuracy, reliability, completeness, or suitability of its content for a particular purpose. Please do not act or refrain from acting based on anything you read in our newsletter, blog, or anywhere else on our website.