Raising capital is the most vital part of the hedge fund start-up process. If the manager cannot raise sufficient capital to cover the cost of starting up and running the fund, the manager will soon be out of business. Because raising capital is difficult, and because hedge fund managers cannot publicly advertise pursuant to the Regulation D offering rules, third party marketers (3PMs) are an oftentimes invaluable service provider.
Third party marketers are firms which are registered as broker-dealers with the SEC and also registered with the securities commission of the firm’s resident state(s). These firms have contacts within the hedge fund industry and work to raise money for the hedge fund. All of the people who raise money for the third party marketing firms are registered as brokers which will generally mean that they have both the Series 7 license (the General Securities Representative Examination) and the Series 63 license (the Uniform Securities Agent State Law Examination).
Third Party Marketing Fees
Third party marketing fees will be different for each 3PM firm. Most all firms will charge a fee for placing assets which will be calculated as a percentage of the hedge fund manager’s fees – both from the management fee and the performance fee or allocation. For example, one fee structure might be that the manager pays the third party marketer 20% of all the management and performance fees earned on the assets raised by the third party marketer. The percentage stated above will be larger (up to 50% or more) for smaller funds because it is easier (and more lucrative to the third party marketer) to raise money for larger funds.
These groups may also require a monthly retainer. These retainer fees will not typically be paid by the hedge fund but by the management company. In certain circumstances, especially when the fund is very small or just starting out, the third party marketing firm may negotiate for an equity stake in the hedge fund manager.
The Third Party Marketing Agreement
The relationship between a hedge fund manager and the third party marketer is solidified through a third party marketing agreement. These arrangements are typically initiated by the third party marketing firm and should be reviewed by the manager and the manager’s attorney before signing. There may be several back and forth iterations of the agreement and the hedge fund lawyer can help a manager with the drafting of certain parts of the agreement based on the business points agreed to with the third party marketer. A hedge fund manager should never enter into a third party marketing agreement without first having an attorney review the agreement.
Other Asset Raising Considerations
All funds are different and the capital needs of each manager will vary according to a number of factors; however, most all managers are interested in adding assets. Start-up and emerging hedge fund managers may also want to discuss their strategy with a hedge fund seeder which is basically like a third party marketer except that the seeder will usually provide a large capital contribution to the hedge fund and potentially will take an equity stake in the management company. Other groups also, such as prime brokers and mini prime brokers, may offer capital introduction services. While such groups will never commit to raising a certain amount, or any, assets for the fund, it would be worthwhile for the hedge fund manager to discuss this point with the fund’s broker. Additionally, a hedge fund manager may want to submit its performance results to a hedge fund database.
It goes without saying, but start-up hedge fund managers should not take your eye off the ball when trying to raise assets – attractive returns over time is the best way for the manager to raise money over the long run.