By Eric Schultz, Founder & Managing Member, Reliant Fund Services
Emerging managers spend a lot of time modeling their fund.
How much capital will we raise? How quickly will we invest it? What will management fees look like? When do fees step down? When do we start raising Fund II?
But I think there is another model that is just as important and gets a lot less attention.
The management company.
Your fund is the investment vehicle. Your management company is the business you are actually building.
It receives the management fees. It pays your team. It pays for technology, compliance, finance, operations and investor relations. It also needs to generate enough cash to support the business and ultimately provide economics to the partners.
That is why I think every emerging manager should be asking a pretty simple question:
What does my management company look like five years from now?
Not just next year’s budget. Five years.
Because decisions that look perfectly affordable during Fund I can look very different when your team has grown, your fixed costs have increased, Fund I management fees have changed and Fund II takes longer to raise than expected.
Start With Four Things
When I think about a management company budget, I really think about four things.
Revenue. Cost. Timing. Cash.
- Revenue: What management fee revenue will the firm actually receive?
- Cost: What are we committing the business to spend?
- Timing: When does the next management fee stream begin?
- Cash: What happens if any of those assumptions are wrong?
For an emerging manager, all four are connected.
Your Management Fee Is Revenue to the Business
We spend a lot of time calculating management fees at the fund level, but from the management company’s perspective, that fee is revenue.
Before you build permanent expenses around it, you should understand how that revenue changes over time.
The LPA tells you how the management fee is calculated, what the fee base is, when it may change and what happens after the investment period. Every fund is different, which is why I would build the management company model using the actual terms of the fund.
The expense side is usually moving in the opposite direction.
You hire people. Compensation increases. Technology gets more expensive. Compliance grows. Investor relations grows. Finance and operations become more complicated.
Those costs do not necessarily go down when Fund I management fees do.
That is where the five year model becomes important.
What Happens if Fund II Takes Longer?
Fund II is usually a big part of the plan.
You may assume you will start raising in year three and close in year four. That may be completely reasonable.
But what happens if it takes another six months? Or twelve? Or eighteen?
The management company still has payroll, technology, compliance, insurance, legal and accounting expenses. The team you hired does not disappear because fundraising took longer.
I would model a base case and at least one delayed Fund II case. Then look at what happens to cash, hiring, reserves and partner distributions.
The purpose is not to predict exactly when Fund II will close.
It is to know what you would do if it does not close when you expect it to.
Don’t Forget About the Partners
I think this is one of the pieces that gets overlooked.
The management company is a business. And at the end of the day, the partners are building that business to make money.
So the question isn’t just:
How much can the management company afford to spend?
It is also:
- How much cash should we keep in the business?
- How much can the partners distribute?
- What happens to those distributions if Fund II takes another year?
- What happens if we hire three more people?
- What happens when Fund I management fees change?
Those are the tradeoffs I want to see in a five-year model.
Build the Finance Function You Actually Need
Finance is a good example of why this matters.
An emerging manager may need accounting, a controller, cash management, AP, payroll, budgeting, forecasting and CFO level advice.
That does not necessarily mean you need to hire a full internal finance department on Day One.
The better question is:
What finance function does the firm actually need today?
You may need accounting and operational support on an ongoing basis, controller level oversight of the close and CFO level advice when you are making bigger decisions about hiring, cash, Fund II or partner economics.
As the firm grows, that changes. At some point it may make sense to bring more of those functions in house.
That is fine.
The five year model helps you understand when that starts to make sense instead of making the decision because you think a firm of a certain size is supposed to have a CFO.
Accounting Tells You Where You Are. CFO Thinking Helps You Decide What Comes Next.
This is why I do not think management company accounting should just be viewed as bookkeeping.
Accurate books are the starting point.
Then you need to use those numbers.
I think about it this way:
Accounting: What happened?
Controller: Did it happen correctly?
Planning: What is likely to happen next?
CFO: What should we do about it?
And that last question can mean a lot of things.
Can we afford another hire? How much cash should we keep? What can the partners distribute? What happens if Fund II moves? When should we bring a function in house?
Those are the questions that actually help you run the business.
Your Fund Has a Model. Your Management Company Should Too.
An annual budget tells you whether the numbers work today.
A five year model tells you whether the firm you are building today still works if things do not happen exactly as planned.
Fund I management fees may change.
Fund II may take longer.
Your team will grow.
Your infrastructure will become more expensive.
The right mix of internal and outsourced resources will change.
None of that is necessarily a problem if you have thought about it before you need to react to it.
Your fund is the investment vehicle. Your management company is the business you are building. I think you should model both.
At Reliant, this is how we think about the emerging manager back office.
Fund administration protects the economics of the fund.
Management company accounting helps you understand the economics of the business.
Outsourced CFO support helps you decide what to do next.
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