Partnership - Money Management

[Crip1]

 

A question for the group, but first, a brief story.

 

I have reached out to several friends, family members and co-workers to gauge interest in an investment partnership I am contemplating, similar in structure to the early Buffett Partnership. Interest has been encouraging, though more moderate than I would like with some trepidation due to our current economic malaise. A couple of the responses indicated a willingness to invest but questioned the relative lack of liquidity. “What if I really needed to access the money?” was the question asked. As it turns out, the people who inquired about this would look to have a disproportionately large percentage of the partnership’s assets. Because of this, selling to cash them out could impact the performance of the rest of the partnership. For those of you running these partnerships, is this a concern and how do you address it?

 

I did have the following thought. We could have these folks establish a separate brokerage account which I would control. It would be solely individual money so if they did need to sell, there would be no impact on the others and they would absorb fully the tax ramifications (under the supposition that there would be Cap Gains and not Cap Losses!). We would institute the same 6% - 25% compensation arrangement and could create a simple contract (though simply contract in the US is rather oxy-moronic) specifying the limitations of either party’s actions.

 

So….the question…does anyone have such an arrangement? If so, what benefits and pitfalls have you encountered in doing so? This seems to make sense but, inverting, why does this NOT make sense?

 

As always, thanks much.

 

-Crip

 

[returnonmycapital]

I started a partnership-like mutual fund in Canada in October 2007.  Prior to setting up this fund, I was managing individual accounts.  This became cumbersome: individual desires/restrictions of each account holder, difficulty with aggregate performance reporting of even slightly different mandates, the requirement to follow CFA Institute performance standards (as is required by any serious prospective investor), tax reporting, execution across a growing number of accounts, etc., etc.  The fund route solved all of my problems and even though I have outside administration and an audit requirement, the benefits outweigh any extra costs.

 

To overcome the problem of one big investor affecting the performance/tax implications of others, I decided to be the fund's largest investor.  No shareholder can invest more than I do.  To my mind, this solves two problems:  1) it demonstrates an alignment in interest between manager and investor, and 2) it acts to 'lead by example' (I always write shareholders with my own savings plans with regard to the fund).  Through this means of operation, you will probably find your investors less eager to retract their funds in times of uncertainty.

 

This may mean that your fund starts small.  So be it.  In my short experience, the benefits to managing even a small fund far outweigh the individual account route.  I would encourage anyone with integrity and some competence to try out this route, it is great fun.

[scorpioncapital]

You can either always hold a large amount of cash and invest say 60% of all funds only or you can tell your investors that the money they put into the fund should be money they don't need for the next year and have an annual cash-out date (I think Buffett did something like this). How can you run a fund when investors are going to be so unpredictable they are going to demand cash at any time. Best thing is to tell them if you need the money or you are afraid you may need it it is emergency funds and I won't take the money because it isn't long-term capital.

[Parsad]

I have reached out to several friends, family members and co-workers to gauge interest in an investment partnership I am contemplating, similar in structure to the early Buffett Partnership. Interest has been encouraging, though more moderate than I would like with some trepidation due to our current economic malaise. A couple of the responses indicated a willingness to invest but questioned the relative lack of liquidity. “What if I really needed to access the money?” was the question asked. As it turns out, the people who inquired about this would look to have a disproportionately large percentage of the partnership’s assets. Because of this, selling to cash them out could impact the performance of the rest of the partnership. For those of you running these partnerships, is this a concern and how do you address it?

 

You have to decide the culture of your fund.  If you believe that you cannot run the fund efficiently by being liquid, then you will have to set the mandate that withdrawals are restricted (either once a year, etc.).  If you believe that investors should have the right to their capital, then that should be your mandate and you will have to retain liquidity in the type and size of assets you invest in.  For us it was the latter.  We allow our partners to redeem their capital at any time.  We have a very good relationship with each of them. 

 

The one caveat we have is that if a partner withdraws capital because of necessity, then that is fine.  But if a partner withdraws capital because of fear of the markets or our investment strategy, then we won't allow that partner to return once they've withdrawn their capital.  This does two things...they have access to their capital when needed (medical, debt, retirement, etc) and it automatically purges the type of investor that would not be ideal in the fund.  We have not had a single redemption in the three years of operation of the MPIC Fund I, LP, during one of the worst economic periods in the last 70 years.

 

I did have the following thought. We could have these folks establish a separate brokerage account which I would control. It would be solely individual money so if they did need to sell, there would be no impact on the others and they would absorb fully the tax ramifications (under the supposition that there would be Cap Gains and not Cap Losses!). We would institute the same 6% - 25% compensation arrangement and could create a simple contract (though simply contract in the US is rather oxy-moronic) specifying the limitations of either party’s actions.

 

So….the question…does anyone have such an arrangement? If so, what benefits and pitfalls have you encountered in doing so? This seems to make sense but, inverting, why does this NOT make sense?

 

We've had a few investors in the past who wanted us to do this for them.  We refused their money.  Again, it comes down to what is important.  For us it was that all partners should be treated the same.  We also wanted the simplest way to manage the total assets, and that was through one single fund, not seperate brokerage accounts.  The one thing we decided from day one is that the culture won't be compromised and that all investors will be treated the same, regardless of account size or emotional constitution.  Best of luck.  Cheers!

 

 

[scorpioncapital]

"then that is fine.  But if a partner withdraws capital because of fear of the markets or our investment strategy, then we won't allow that partner to return once they've withdrawn their capital"

 

How are you able to determine the reason for the withdrawal- Truth serum?

[Parsad]

How are you able to determine the reason for the withdrawal- Truth serum?

 

No, we are a small group, so we talk to our partners regularly.  You can get a pretty good idea of why a partner would want to withdraw capital if you are honest with them and ask them.  If a partner is desperate to get out, they aren't going to care whether or not you let them back in, and they will just tell you flat out that they want to get out and now!  Cheers!

[Crip1]

Thanks for the knowledge, folks. A couple of thoughts:

 

Regarding privately managing money is to remove an objection from a couple of potential investors. The benefit is that it allows me to establish a track record of managing OPM and requires less time/effort to establish. Also, for at least one of these folks, they are held in high esteem by many others, personally and professionally, and would be a teriffic reference/networking source of future money. The partnership/fund is the ultimate desire to be sure, but privately managing funds seems like it can be a stepping stone.

 

I like Sanj's logic regarding redemptions but would find it hard to police if the fund grows appreciably.

 

-Crip

[arbitragr]

In my experience if someone wants to pull their money out, they should be able to whenever they want. If you don't allow them to, they'll just get irritated and more annoyed at you and you end up harming the relationship down the road.

If you don't want this, then you have to put it in legal terms that there will be a lockup period and do this beforehand.

Managing money is a professional and serious business, especially after and in-light of Madoff. Things can (and in this crisis it has) turn out worse than expected.

If you think you might lose some friends (and possibly family) over this, then I would think very carefully about taking this on. Money/business and friendship don't mix IMO. Madoff screwed over his closest friends and even family to try in vain to keep a good thing going. Unfortunately for him, he didn't realize when he was getting delusional. I personally don't like to manage my friends and families money, not because I don't love them, but because I care about the relationship too much.

 

If you've never done this before, then I would suggest that you try and get a job within the industry somewhere first, even if it's just back-office doing trade reconciliations or working on distribution dealing with client matters, and learn the ropes and soak up all the knowledge you can.

 

Legal and admin fees will only get more prohibitively expensive going forward as a result of this past crisis, and most funds that have started up in the last 2-4 years have completely gone out of business or are sitting on -20%+ with very little funds under management. Try and give a presentation to new investors and showing them -20%+ returns ... it doesn't look to good and is hard. If the current downturn is going to be long and protracted, which I think it is, then most new funds that have started up recently will likely stay in negative territory for a longer while yet.

 

 

[Mungerville]

Returnonmycapital,

 

I am also thinking about starting a partnership-like mutual fund in Canada possibly in the next 12 months or so.  I have a CFA (but no CIM qualifications).  I would be very interested in your answers to a couple of questions:

 

1) Did you run into any legal issues with OSC requirements in terms of education, certification, etc... and how did you comply with those; what are the options here in your experience.  (Last time I looked into at high level it seemed you needed to have managed over x million for 10 years as a requirement for starting an investment management firm.); and

 

2) What do you figure is the minimum size of the fund to get started given accounting/audit and other costs?

 

I guess I am primarily really interested in the first question with some elaboration and in any other board member views on that first question.  Wondering maybe if starting in certain provinces other than Ontario is easier, etc.

[NormR]

A word of warning to those looking to start out in Ontario.  The regulations are due to change at the end of September.  IIRC, the changes are likely to pinch small operators.  Higher capital requirements, etc.  See http://www.osc.gov.on.ca/HotTopics/RegReq/ht_regreq_index.jsp.

 

Now, don't bug James, but he's run a small OM fund with minimal expenses for a long time (Malachite Aggressive Preferred Fund).  As of the last audited statements, total net assets were $253k and expenses were $1640.  He runs are rather tight ship. 

 

I'll also point out that the fund business is about asset gathering.  To be successful, it's helpful to be a good salesman.  The asset gathering part is likely to take more time and effort than expected.

[bookie71]

I'll also point out that the fund business is about asset gathering.  To be successful, it's helpful to be a good salesman.  The asset gathering part is likely to take more time and effort than expected. 

.

.

Sad but true, I've e watched one company (locally) lose people's money, and they have gone back to it several times, because the owner is such a good salesman.  He has almost been indited several times, but always dodges the bullet. Basically he practices the "momentum" style of investing.  :(

[racemize]

I know this is a rather old topic, but it is around what I was going to ask, so I thought I would revive it.

 

Basically, I'm in a similar situation where friends and family want me to manage money (in the US), and I'd like to set up an investment partnership.  I've set up an LLC before and it was fairly inexpensive, but some of the information I've read were indicating costs at 20-30k to set up an investment partnership, which is prohibitively expensive at current levels. 

 

I know I'll need to talk to a lawyer, but I'd like to get some ball park costs and education (e.g., on the right set up) before hand, so any advice/information would be appreciated.

 

Also, with these partnerships, I assume there is a structure where you can easily add new partners rather than having to dissolve and recreate with a new partner (or require resigning by current partners)?

 

 

[jberkshire01]

If you want to go cheap and not have to spend higher $ to set up a partnership, then.....

 

If you're going to have few than 15 accounts and not planning on marketing to the public, then I'd look into the Friends & Family option from Interactive Brokers: http://www.interactivebrokers.com/en/p.php?f=friendsFamilyAccounts

 

If you're going to manage more than 15 accounts and/or want to market to the public, then you may have to register as an investment adviser (which requires passing the Series 65). You can get all that set up for about $3k: http://www.riainabox.com/our-fees

[racemize]

If you want to go cheap and not have to spend higher $ to set up a partnership, then.....

 

If you're going to have few than 15 accounts and not planning on marketing to the public, then I'd look into the Friends & Family option from Interactive Brokers: http://www.interactivebrokers.com/en/p.php?f=friendsFamilyAccounts

 

If you're going to manage more than 15 accounts and/or want to market to the public, then you may have to register as an investment adviser (which requires passing the Series 65). You can get all that set up for about $3k: http://www.riainabox.com/our-fees

 

Well that was almost awesome--it appears that TX requires me to register as an investment advisor and to have passed some examinations in order to use the account.  At least, unless I misunderstood the texas ssb web page.

[SharperDingaan]

Crip. You might want to consider setting yourself up as an everyday limited partnership. Family/friends/backers buy pref shares, receive an annual dividend, and an annual sinking fund redemption based on the the years results. You get the equity, & your loss is limited to your initial capital investment.

 

The reality is that you cannot avoid illiquidity, but you can reduce it by buying down the exposure. If someone really needs to sell their prefs, the others/new backers get first crack at purchase, then the partnership buys them - hurting everyone equally. If you're doing well your pref share holders don't want their money back, & are usually more than happy to have the opportunity to buy more. Liquidity materially improves.

 

As GP, you get to invest in whatever you want with minimal restriction. As long as you can pay the annual dividend, &/or fund some kind of annual partial redemption, your LP's have no say.   

 

Cheap, no fuss, but you are not a fund manager ......

 

SD

 

[Mathieu]

I would agree with the comment that the money management business has become too much about "the skill in gathering assets" than investing. One has to hope that the pure "asset gatherers" will sooner or later be recognized as such by rational investors (or the market whichever comes first)

 

The interactive brokers option is definitely a good starting point in order to establish a good track record while avoiding the usual set-up fees of a partnership.

[SharperDingaan]

Just a brief add on:

 

If going the GP route, you need to make a decision as to whether your interest is primarily as the investment, or the finance guy. You can be the finance guy in an investment business (Goldman Sach Partnership), or the finance guy in a regular business (manufacturing, etc.). Which route, depends largely upon how much hands-on involvement you want, & how you believe a business should be run to generate wealth.

 

The typical non-invstment-business investment may be a 40-70% direct equity investment in a manufacturing facility, brewery, apartment building/hotel (in Paris, Madrid, Rome), insurance syndicate, etc - where the investment is you & 2-3 partners. You are CFO, your partners may also be some of the other LPs, there are no stock options, & the entire partnership is private. The assets are bought at/near their valuation low point, you run the partnership for a while, & ultimately sell out to a bigger player at a higher bid.

 

The typical investment-business investment may be a time limited 10-20% stake in an existing fund business, with the proceeds essentially buying out the firms capitalized defered sales charge. If you have a partner, they will be silent, & you will be expected to grow AUM through what you bring to the table. The primary advantage is that there is an existing business, you're not building from scratch.

 

You can of course also go between the poles, & build an investment business from scratch, as many on his board have done. Our preferance is to not concentrate our investment and personal risk in the same entity, but kudos to those who have.

 

SD

 

 

 

 

 

[racemize]

 

You can of course also go between the poles, & build an investment business from scratch, as many on his board have done. Our preferance is to not concentrate our investment and personal risk in the same entity, but kudos to those who have.

 

 

Would you mind sharing what kind of set up you are using?

[SharperDingaan]

Keep in mind that you tailor a partnership to suit your purpose, so each will be different....

 

We’re structured in a partnership using a Canadian GP with 100% common equity, & family member LP’s holding  100% prefs. The prefs have a par of 100, pay a non-cumulative 6%, & are subject to sinking fund repurchase at 110% of PAR if the partnership realizes a return > 20% in any given year. LP’s may sell their prefs to each other at 90% of PAR, or the partnership as a whole, but have no say in what the GP does.  We also have a UK partnership with a UK GP, under a broadly similar approach – so can look North American, or European, as circumstance requires.

 

As in any partnership, LP’s rely on the judgement of the GP. If the partnership BK’s they get nothing - if it does well they get their money back as rapidly as practical (& based on realized return); but in the meantime they get 6%. The GP gets to build meaningful capital, & concentrate equity funds on a single endeavour.

 

Our partnership was originally created to facilitate the funding of a material & meaningful start-up equity stake in a micro-brewery. A way of leveraging a modest equity stake at up to 8:1 if needs be, & spreading some of the risk. Although we ultimately chose not to pursue the start-up, we have kept the partnership, used it to invest as we see fit, & refined it a little through estate planning.  There may still be a brewery at some point ...... but not until the GP actually retires!

 

We used an initial capitalization in the low 7 digits at 40% common equity, & 60% prefs, with a sinking fund lasting 20 yrs. You will need a minimum 10-20% common equity capitalization to cover unforeseen sudden liquidity demands amongst your pref holders. The partnership could be more tax efficient, but it has minimal overhead as the GP is not paid. After 9 years, today’s outstanding pref position is < 50% of what it was, equity is up materially, & LP’s are pressing to issue more prefs. LP partnership liquidity essentially cures itself. 

 

Lot of hassle to initially set-up, but day-to-day operation is very straight forward. An accountant to annually audit the books. The quarterly financials & tax filings, you can probably do yourself.  Obviously not for everybody, & very dowdy, but also just as effective as being a partial owner of one of the many AUM firms.

 

SD

 

[Hershey]

I considered investing for friends and sought counsel from a respected lawyer.  The lawyer responded with the following analogy:  It is a lot less fun driving somewhere when somebody is in the back seat critiquing your driving.  Of course, the point was that if I wanted to invest for friends, it was going to be a markedly different experience than investing for myself.  And like most irrational humans, I ignored the advice, but the lawyer was right.  Investing for friends is no picnic regardless of the results.  Tread carefully.

[racemize]

I considered investing for friends and sought counsel from a respected lawyer.  The lawyer responded with the following analogy:  It is a lot less fun driving somewhere when somebody is in the back seat critiquing your driving.  Of course, the point was that if I wanted to invest for friends, it was going to be a markedly different experience than investing for myself.  And like most irrational humans, I ignored the advice, but the lawyer was right.  Investing for friends is no picnic regardless of the results.  Tread carefully.

 

Thanks--when you did do it, what structure did you use?  Could you expound on why it was unpleasant?

[Hershey]

I was given access to their personal accounts, and made the investment decisions for those accounts.  It was unpleasant because they did not/could not understand long-term investing strategies.  I felt intense pressure to have my results be immediately successful.  Also, I tried to impress them with "cute" decisions and bought things that I would have normally ignored.  Over time, I did better than the S&P 500, especially after taking into account taxes, but it was not fun.  Also, my friends wanted to talk about my investments, and it affected my decision-making.  The good news is that I learned a lot from the experience, and if I ever wanted to do this full-time, I understand the parameters that I would put in place.  PS, I still have access to the accounts and am asked to make decisions.  I have shared all of the above thoughts with my friends, and respectfully decline to make any more decisions.  If I ever do it again, the ground-rules will be very clear.  Good luck.

[SharperDingaan]

Racemize: Keep in mind that when you start out it's pretty much ONLY family & friends money - because that is all that is available to you. Once you are independent - it is others with similar interests & experiences, who just want to have fun doing whatever the venture does. We would suggest though, that at least one of those others be of the opposit sex - as the thinking really is different.   

 

SD

[original mungerville]

I am very interested to understand if there are similarly simple Canadian versions of limited partnerships or other forms for managing people's money that do not run into securities law issues. For example, is it easier to set-up in Ontario, Quebec or British Columbia? and is there a similar legality that if you have fewer than a certain number of investors, you do not have to register under securities regulation.

 

Any Canadians who have done this recently and can share some details on how best to set something small up - say for less than a dozen Ontario investors?

[SharperDingaan]

Munger we can't speak to BC or Quebec, other than Quebec will be under french law & all the registration documents will be in french.

 

You would want both legal & tax advice, but the below (for Ontario) will get you started:

(1) Copy the Ontario Limited Partnerships Act  http://www.e-laws.gov.on.ca/html/statutes/english/elaws_statutes_90l16_e.htm

(2) Go to the Ontario Forms  http://www.forms.ssb.gov.on.ca/mbs/ssb/forms/ssbforms.nsf/FormDetail?OpenForm&ACT=RDR&TAB=PROFILE&ENV=WWE&NO=007-07191

(3) Fill out Declaration 3 http://www.forms.ssb.gov.on.ca/mbs/ssb/forms/ssbforms.nsf/GetFileAttach/007-07191~1/$File/07191E.pdf

(4) Register http://www.newbusinessnow.com/LAW/partnership.htm

 

The GP has unlimited liability, but the GP's risk can essentially be mitigated by making the GP a limited liability corporation controlled by the GP. Key to remember though is that you are not a mutual fund soliciting $ (& therefore attracting the securities restrictions); you are just a few partners pooling your funds on a venture in the nature of trade - for a limited period of time.

 

May we wish you the best.

 

SD