Hedge funds have long been the funambulists and contortionists of the circus that we call the financial sector. It was not so long ago that hedge funds pushed into real estate, purchasing thousands of single family homes in selected markets. Recently, the hedge fund industry has, once again, revealed its nimble nature by investing in entrepreneurial enterprises.

Does Venture Capital Have a Border Issue?

Not yet, but any imagined boundary between venture capital and hedge funds is blurring. While hedge funds have dabbled in start-up funding for the past decade or more, the practice seems to be gaining real momentum.

One significant example of this trend lies with Coatue Management’s $50 million funding round for Snapchat. Coatue also invested in the mobile travel start-up Hotel Tonite, and Box, a cloud storage and file sharing start-up. To the chagrin of venture capitalists, this San Francisco-based hedge fund is only one of several instances of this phenomenon.

Valiant Capital Partners and Maverick Capital are additional firms to have crossed over. Valiant Capital Partners invested in Dropbox, Evernote and Pinterest, while Maverick made seed investments in Zenefits and Estimote, establishing the fact that hedge funds are true players.

While venture capitalists are understandably intimidated, the facts would indicate they have little to fear from hedge funds. Venture capital has extended funding to the tune of $30 billion in the first three quarters of 2014, exceeding its funding levels for all of 2013.

Good for Entrepreneurs But What About the Hedge Fund Firms?

Cash for equity investments offer hedge fund firms extraordinary opportunities for colossal profits. Consider for a moment the gains reaped from Instagram’s sale to Facebook for $1 billion.

Although the tech sector has been held in some disregard by hedge funds, as a result of the dot com bubble burst in 2000, the teeter is starting to totter in their favor of late. A major contributing factor is that most tech companies are demonstrating greater restraint than in the past, waiting for revenue run rates in excess of $100 million and establishing a track record of global growth before going public—think Facebook and Twitter.

This level of patience has reduced the perceived level of risk for many hedge funds. More to the point, hedge funds are not the doting, nurturing and supportive investor that many early stage companies require. This makes hedge funds palatable investors for well-grounded companies in the growth stage.

Hedge Funds Offer Greater Flexibility

While hedge funds take a back-seat to venture capital in terms of support, they are more flexible in what they deem an acceptable return on investment. VCs, in the main, seek a much higher rate of return than their hedge fund counterparts.

As a result, hedge funds are carving out a niche by offering higher valuations and accepting lower returns than their venture capital firms are typically willing to accept. Let’s be clear, an investment that brings returns into the double-digits is very attractive to hedge funds accustomed to gains in single digits.

The real winners in this hedge fund intrusion are the tech start-ups and their founders. Fresh sources of capital are always welcome and hedge funds, at least for the moment, seem to be that source.

 

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Joseph B. Galbraith, former principal of Florida hedge fund Galbraith Capital Investment Management Corp., has made the rogue’s list, subsequent to his apparent refusal to return $1.483 million mistakenly deposited in one of his firm’s accounts by an arguably incompetent Credit Suisse Securities (USA) LLC. The aggregate $1.483 million consisted of three wire-transfers made to an offshore bank account belonging to another Galbraith owned entity, Galbraith Global Investment Management L.P., in the Bahamas.

Credit Suisse filed a complaint on April Fools’ Day, 2014, in the Supreme Court of the State of New York, after exhaustive in-house efforts, ongoing since the error was discovered on January 27, 2014. The transfers occurred on January 13, 2014. In short, the Credit Suisse books were out of balance for 2 full weeks—and by a rather significant sum.

It Gets Better

In the complaint, Credit Suisse argues that Galbraith was well aware that the account in question had a very nearly zero balance. Naturally, Credit Suisse had the same information and was equally aware of the near zero balance in Galbraith’s account, but, inexplicably, wired funds to Galbraith’s offshore account not once, but three times. It appears from the language of the complaint that Galbraith’s instructions were to transfer the remaining funds and no specific dollar amount was cited.

Galbraith, charged with seven counts ranging from unjust enrichment to fraud, subsequently lost the court action because he failed to appear. His whereabouts remain a mystery and he remains in possession of Credit Suisse’s $1.483 million.

Two Wrongs Do Not Make a Right

It is unfortunate that Galbraith chose to ignore the Credit Suisse complaint. Any competent attorney would have enjoyed defending him. After all, the proximate cause of the entire debacle was the mistakes made by Credit Suisse. How any institution can be short such a sum and, fail to notice it for two full weeks, is a head-scratcher to say the least.

Galbraith, of course, has no claim to the monies and no one believes that he should benefit from this ill-gotten gain.

However, there is another victim in all this—the hedge fund industry.

Public Perception

Hardly a week passes absent a headline featuring this hedge fund manager or that hedge fund office embroiled in scandal … unethical conduct, criminal behavior, or both. As a result, the public’s perception of the hedge fund industry and those working in it is on a par with congress and used-car salesmen. Their place in the queue is well known and some believe—well deserved.

However, the small percentage of rotten apples in the enormous barrel that is the hedge fund industry has a disproportionate role in shaping public perception. Even the casual observer must acknowledge that the majority of headlines on this matter included “hedge fund “and focused almost entirely on Galbraith’s role.

Public Relations Fail

Hedge funds spend time and money to grow assets under management. Hedge fund managers are attempting to grow the burgeoning retail market made possible when the Jobs Act’s passage lifted the ban on general solicitation. Start-up hedge funds are hard at work gaining investor confidence, while established funds are busy quelling the myriad concerns of anxious investors.

Then along comes a story like Galbraith’s and a parade of others, far uglier, on a weekly basis; all of them setting these efforts back several paces. The Galbraith story will not be the wake-up call the industry requires. It is too amusing, too absurd! What will be required? Hedge funds must recognize the need to address these perceptions – for the better of the industry as a whole.

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