How to Assemble Your Hedge Fund Team

January 27, 2011

Starting a hedge fund is the ultimate small business launch: low barriers to entry, loose regulation and, if you know what you’re doing, transcendent profitability. But, like any other entrepreneur, the fledgling hedge fund manager needs to understand how and when to bring in the pros. Everybody has skill gaps. Nobody can be in two places at once.

So where do you start? Early on in your process of starting a hedge fund, safe to say, you’ll have to call a lawyer.

“An attorney can help with the fund formation process, establish[ing] appropriate entities and document drafting,” says Bart Mallon , a San Francisco-based attorney practicing investment management law. A lawyer who knows the hedge fund industry can also provide you with guidance as to “who the other service providers will be: administration firms, audit firms, prime brokerage firms.”

Even so, an attorney need not be your first call.

“Start out with either the prime broker or legal counsel,” advises Howard Eisen, co-founder and managing director of FletcherBennett, a New York-based hedge fund capital raising and consulting firm. He notes that most prime brokers have a similar capacity for introducing you to the right service providers. Still, he wouldn’t push back if you chose to secure your attorney first. “They can give you some of that same referral intelligence and, in reality, you’re going to have to get those legal documents moving.”

There are some stakeholders who must remain outside your direct control. Prime brokers are among them, as are auditors and third-party marketers. But what about the rest of the talent you may need as you grow your hedge fund? When is it time to bring them in-house?

You might think that a group that’s two principals and an assistant might not need to hire a lot of personnel outright. But Eisen, whose background was in prime brokerage at UBS, takes a view driven more by the money you hope to raise by marketing a hedge fund than the money you have in hand as you’re starting a hedge fund.

“You need working capital as well as investment capital. It’s an ill-advised path to think you’re going into this on the cheap,” Eisen says. “Time was, operations was almost an afterthought but, after the crucible of 2008, that is no longer the case. You must invest in infrastructure.”

He says that the big, institutional money wants to see full-timers in the CFO, COO and compliance officer roles before they make big bets on you. He also advises you to hire investment analysts as well early in the process. As perfectly capable as you are of crunching the numbers, you can’t do that, engage in marketing a hedge fund, and handle the operations all at the same time. The number of analysts you should hire will depend on your strategy, according to Eisen. He says that a “fundamental, plain-vanilla, long-short equity strategy” might require only one hedge fund analyst, but more complex strategies might require more firepower.

If up-front money is an issue, “you can build team with equity rather than cash,” he says.

That may be more true now than ever. As new regulations are promulgated in the wake of Dodd-Franks, you can expect a lot of very talented people at all levels to be leaving the banks — which must unwind their control of hedge funds — for smaller outfits.

So there is no shortage of skilled employees to be brought on board, but the pace at which you move your talent from service providers to in-house employees is highly subjective; the word “chemistry” came up often in conversations with industry experts. Each successful job candidate’s skill set and prior experience must be a fit for the corporate culture you’re building and the strategies you’re pursuing.

But when do you stop sending 1099s and start handing out W-4s?

“The desire and ability to move upmarket and improve infrastructure” should drive hiring decisions, according to Eisen. “There’s no dollar number I can cite in terms of [assets under management]. But I don’t know of any hedge fund with $50 million to $75 million [of funds from] real institutional investors that doesn’t have a CFO.”

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