Spin-outs and New Fund Sponsors

Episode Summary

Beyond marketing a fund, which we spotlighted in our last episode, there are other issues that founders of a new fund business need to consider.

In this episode of “The Preferred Return” podcast, Skadden attorneys Greg Norman and Abigail Reeves focus on critical considerations for first-time fund managers. They highlight the importance of a broad team, including investment professionals and individuals with skill sets in operations, tax, legal and regulatory compliance, and potentially risk management. They also discuss the significant role of governance, fund structuring and remuneration considerations. The episode concludes with insights into the importance of partnering with key service providers to be successful.

Key Points

• Fund Management Team Composition and Governance: Having a well-rounded team with various skill-sets is essential for new fund managers. This includes investment professionals as well as a broader team with skills in operations, tax, legal and regulatory compliance, and potentially risk management. In addition, governance is also a key aspect.
• Governance Strategy: Having a clear and robust set of systems and controls, which allows the different parts of the business to operate, will be critical to long-term success, and having these functions properly mapped out will be a key consideration when presenting the business to potential investors.
• Importance of Engaging Service Providers: Engaging legal counsel, placement agents and fund administrators is important for first-time fund managers. These professionals not only provide essential services, but can also help align the fund manager's story with investor expectations and assist with investor communications and reporting, among other functions.

Voiceover (00:03):
Welcome to The Preferred Return, Skadden’s investment management podcast covering legal and regulatory developments in the UK and Europe.

Abigail Reeves (00:15):
Hi, and welcome back to The Preferred Return. I’m Abi Reeves and I’m here with my co-host, Greg Norman. The Preferred Return is a Skadden podcast series providing short summaries of legal, regulatory, and other topical developments in the EU and UK investment management space.

Greg Norman (00:30):
Our podcasts are intended to be accessible by professionals across the sector. We welcome any feedback, particularly if there are topics people would like us to discuss. Today, we’re going to spend a bit of time discussing first-time funds and some of the key things we talk to potential fund sponsors about at the outset. These topics can be relevant to both spin-outs and teams looking to start a brand new venture.

Abigail Reeves (00:52):
We spent some time in an earlier podcast looking at marketing a fund, which is clearly critical to getting any fund business off the ground, but what are the other topics founders of a new fund business need to consider? Today we’re going to spend a bit of time looking at the fund manager, by which we mean the entity which will form the core of the business going forward. We are also going to discuss some of the elements that may need to be incorporated into the team running a fund management business, including a brief look at compensation considerations. We are also going to touch on some thoughts around fund structuring. So Greg, can you start us off with some observations on setting up a fund manager?

Greg Norman (01:28):
I certainly can. As you said, Abi, when we’re referring to the fund manager, we mean the entity which is at the heart of the fund management business. Terminology may vary, and the entity could equally be a portfolio manager, an investment manager, or an investment advisor. This classification will often depend on the regulatory regime it is operating under, and so that is my first observation.

(01:50):
Typically managing another person’s capital is a regulated activity. If you layer in a fund structure, there may be additional regulatory considerations attaching to the fund. For example, in the UK, portfolio management is a regulated activity itself; while managing or operating a fund is a separate regulated activity. Fund managers can of course do both, but those regimes can bring in overlapping regulatory requirements. As another example in the US, a new fund manager needs to consider whether it is necessary to register with the SEC as a registered investment advisor. At the same time, if the fund manager is going to launch a private fund, it must also factor in the law’s governing investment companies.

Abigail Reeves (02:29):
Thanks, Greg. We can delve into more detail on regulatory considerations in our other podcasts, but suffice it to say the regulatory structure should be tailored to the circumstances of the fund manager to seek to optimize efficiency and practicality.

(02:42):
Another important consideration will be the form of legal entity chosen for the fund manager. In the UK, first-time fund managers would typically choose between a limited company or a limited liability partnership. Tax will be an important consideration to seek to ensure founders and other key persons can participate in the business effectively. LLPs can provide a lot of flexibility as regard the corporate operations of a fund manager, but in a number of situations, a limited company may be more appropriate choice.

Greg Norman (03:11):
That leads us into the next topic for consideration, which is building a team for the fund manager. It is fairly common for a new fund manager to be led by investment professionals who will be critical to the fund’s success. More often than not, these individuals can demonstrate a shared or combined track record that aligns with their investment thesis so as to present a credible opportunity to potential investors. But a successful fund manager will also have to have a broader team that will bring a variety of skill sets to the business, including operations, tax, legal and regulatory compliance and potentially risk management.

Abigail Reeves (03:45):
That’s right, Greg. The operations officer of a fund manager will cover a range of functions and is often the lead for many back, middle office functions within the fund manager, including accounting, reporting, facilities and other aspects, as well as overseeing the administration of the fund.

Greg Norman (04:01):
New fund managers will also want to give careful thought to their tax, legal, and regulatory functions. These functions will cover compliance across those areas, but will also help shape important decisions across the business, whether it be fund structuring or team compensation. First-time fund managers will often outsource significant parts of these functions, but they will nevertheless require time and attention from the founders in various phases of the business. In addition, depending on the fund strategy, the fund manager may need a dedicated risk function, or this may be built into some of the functions we’ve mentioned already.

Abigail Reeves (04:34):
A key overlay over these aspects of the team is governance. Having a clear and robust set of systems and controls, which allows the different parts of the business to operate will be critical to long-term success. And this is not just internally facing. Having these functions properly mapped out and governed will be a key consideration when presenting the business to potential investors. Institutional investors may well be interested in the strategy, but their operational due diligence teams will carry out extensive diligence to understand the functioning of the fund manager business, and this will often be a gating item for approving any commitment to a fund.

Greg Norman (05:09):
First-time fund managers should also spend time thinking how they would prefer to structure remuneration across their teams. Fund managers in the UK and in the EU will likely need to consider the impact of remuneration rules imposed by regulations such as the AFMD. Beyond regulatory compliance, it can often be another area of focus for potential investors. Investors will want to ensure that team members are appropriately incentivized to drive the success of the fund. This typically translates into wanting to ensure that team members are entitled to a share of the carried interest, promote or other incentive amounts which may arise from the fund. Fund managers need to balance this with a desire to retain some entitlements for future growth of the team and the business. Also, incentives like carried interest can have a lengthy time horizon, and so fund managers also have to consider shorter term incentives, especially for more junior members of the team.

Abigail Reeves (06:03):
That’s right, Greg. First-time funds will want to achieve a balanced structure for remuneration that achieves as many of these aims as possible, as well as making sure that it’s fit for purpose for the future growth of the business.

(06:14):
Another key decision will be determining the appropriate fund structure. There are a range of different factors that will drive decisions around fund structuring, including investor demand, regulatory requirements, and tax. While there are a number of well-trodden paths, a first-time fund manager should give careful consideration to the pros and cons of potential structures. It is often the case that a fund manager seeking access to investors in Europe will need to consider an onshore structure in the EU, but these structures come with additional costs and obligations that may not apply to an offshore structure. A balance should be drawn with the anticipated capital raise from investors for which a particular structure may be needed.

Greg Norman (06:51):
With all of these different considerations to factor in, it’s not surprising that a successful first-time fund manager will need to engage with a range of service providers. It is, of course, self-serving to note that having expert legal counsel is critical, but there are a number of other relationships a fund manager should consider. Placement agents can be very important, both in terms of accessing investors, but also helping shape the fund manager’s story so that it aligns with investor expectations and demands.

Abigail Reeves (07:18):
Fund administrators are also a very important relationship. Once the fund is raised, a fund manager may interact with its fund administrator as much as any other service provider. As well as assistance in relation to investor onboarding, the fund administrator can be expected to assist with investor communications and reporting, as well as a number of other ancillary services. A significant amount of these services are provided electronically, and so the relevant members of the fund manager team will want to understand how the fund administrator operates to ensure their demands are met as well as the ever-increasing demands of investors.

Greg Norman (07:52):
Thank you, Abi. As any founders of a business will know, there are a myriad of issues and considerations to work through, and we’ve only picked a few for this podcast. As we said at the start, if there are other topics listeners are keen to hear about, whether on this theme or others, we welcome the feedback, but for now, that’s all from us.

Abigail Reeves (08:09):
Thanks again for listening, and we look forward to you tuning into our next episode. This was The Preferred Return. Stay invested.

Voiceover (08:16):
Thank you for joining us on The Preferred Return. If you enjoyed this conversation, be sure to subscribe in your favorite podcast app so you don’t miss any future episodes. Additional information about Skadden can be found at skadden.com.