Partnership - Money Management

[Eddie Willers]

OK, so say you just set up a GP, LP, fund, etc....

 

Who do you use as the custodian / brokerage firm?  What software or methodolgy do you use to track the unit holders entries, exits and account balances?

 

What are the accounting nuts and bolts of running such an enterprise?  What should we do to ensure that deposits and redemptions are all recorded correctly?

 

Advice here would be greatly appreciated.

 

Thanks all and best regards,

 

Eddie

[SharperDingaan]

Eddie, for most folks, you will need ....

 

(1) An investment policy outlining what the GP can invest in, max/min weightings to specific asset classes, concentration limits, maximum D/E etc. Look to the OSFI Prudent Person guidelines for the basics.

(2) LP agreements outlining the terms of the LP investment. Return, sale/purchase, sinking fund terms, no say in decisions, expulsion conditions, provisions for renewal, etc.

(3) You will need a corporate account at your local brokerage in the name of the partnership. Per the KYC & AML regulations, a copy of pretty much all your documentation will be filed with the brokerage.

(4) There are no deposits/redemptions as you are not a fund. All investment transactions (initial deposit, trades, int/divs, etc) are recorded on the monthly statement, by the broker, the same as any other account. If the partnership buys the prefs the monthly statement shows a debit for the amount of cash returned to the LP.

(5) If you're GP, you're also enough of an accountant to be able to do the monthly financials. Accpac software & the monthly statement to support the transactions. Reclaim HST on a bi-annual basis - if you bother with it at all.

(6) Year-end tax documentation is supplied by the brokerage. Hire an accountant at year-end to audit the books & review your tax filing. $600-$1200 on a bad day.

(7) GP is not paid, but the partnership usually reimburses for incidentals (telephone, partnership meetings, etc.)

 

You should be very clear as to what you are NOT. You are NOT a MM firm, you are NOT marketing to clients, you are NOT paying commission for AUM, there is NO office &/or support staff, NO 'apparatus'.

 

Your business model is not to grow AUM for the fees, by marketing past performance & hiring PM's in the upper quartiles to achieve it. The partnership model fires the 'apparatus' & keeps the PM. Partners get rich based on how well the GP (PM) invests their capital, & not on how well the 'apparatus' collects AUM.   

 

End of the day the GP (PM) has $X for a period of Y years, the GP (PM) can invest it how he/she wants within the investment policy parameters, there is minimal admin burden, & the GP (PM) can run the whole thing from his/her laptop - off the side of their desk.

 

SD

 

[original mungerville]

Sharper or others,

 

I already understand how to, and have set-up, a LP and GP with the GP incorporated as you describe for other business purposes. This is not the nut that is difficult to crack. What I am talking about is in terms of securities law, where is the exemption found allowing the general partner to get payed for providing investment management services to the limited partnership without having to comply to federal or provincial laws for investment management?

[SharperDingaan]

“ where is the exemption found allowing the general partner to get paid for providing investment management services to the limited partnership without having to comply to federal or provincial laws for investment management”

 

There isn’t one, because it isn’t necessary - the GP is not providing investment management services, & is not getting paid for the provision of any services. If you go the common & pref share route - the GP’s reward is 100% of the market return on the pooled funds - less any incidental costs & agreed upon pref share dividends & participation - & it could be negative in a down year. Add in the unlimited liability the GP has & the tests for comp clearly fail. As there is no comp, there is no services contract, & the investment management laws don’t apply.

 

(1) Pref shareholders did not give you their money to manage for them, they gave it to you for the stated objective of the partnership; invest it to do ......

(2) The GP is not advising the LP’s in any way or form.

 

Example: If the investment were an apartment block; the GP would build surplus net CF from leasing up a declining pool of vacant units, & would use the CF + annual depreciation to replace windows/insulation/H&E. Just before the partnership expires the GP would sell the apartment block for a gain (rent rolls & higher CF capitalized at a lower discount rate), LP’s would get their funds back + any agreed upon participation, & the GP would keep the rest. The only difference is that the apartment block is now an investment policy + cash of X.     

 

SD

 

[original mungerville]

Sharper, I think I see what you are saying but am not sure. Have you done this yourself? 

 

Has anyone else done this in Canada? Sounds like Parsad did something similar in BC?

 

...with legal advice

[Eddie Willers]

SharperDingaan,

 

Thanks for the reply.  Greatly appreciated.

 

Best regards,

 

Eddie

[SharperDingaan]

For our Cdn GP-LP partnership I am the GP. The LPs are either family members or close family friends, & the partnership exists to make/manage investments on the TSX.  Setup & agreements were reviewed & prepared by Cdn legal. The partnership has operated for 9 years & we’ve never been challenged.

 

What counts is overall context, & how it is evidenced.

• Memoranda of Understanding (MOU):  Outlines the intended nuts & bolts as to how the partnership will operate, how the GP & LPs earn their money, what are eligible partnership expenses, liquidity arrangements, etc. The GP does not get paid a management fee for services provided, as it gives the appearance that the GP is acting as an agent/employee of the partnership.

• Preferred share agreements. Objective evidence that LPs gave up control of their funds in return for specified dividends &/or participation. Redemption/liquidity provisions evidence there is no intent to trade.

• Detailed Investment Policy & strategy. Evidences there is no intent to give LP’s investment advice.

• Nature of the quarterly reporting.  Lead off with pref share div coverage, LP partnership transactions (if any), investment strategy versus actual variance analysis, & add copies of broker statements & the current financials. Speak only to historic results, & not a TSX benchmark.

• Some kind of formal strategy review & publication process.       

 

You are not allowed to use the MOU as an alternative solicitation; it is only to evidence how the proposed partnership will operate. However there is some wiggle room, as in the early stages - it is a draft document only. Discretion.

 

For many the stumbling block is the different business model, & getting rid of the marketing ‘apparatus’. It is because of the marketing, that we have the investment regulation. 

 

Obviously our docs are confidential, so we will not release them – but direction should be clear.

 

The best of luck to you.

 

SD 

 

[Cardboard]

"The partnership has operated for 9 years & we’ve never been challenged."

 

And it will never be if there is no complaint. If there is one, then you will find out quickly that you need to be a registered portfolio manager to do what you are doing. They would simply challenge your structure to demonstrate that it is what you are doing. Anyway, that is what I have found out in all my research on the topic under the OSC. Sticking with family members and close friends as you have done should keep you away from trouble.

 

Hence the problem, unless they are "rich" and contribute a lot upfront (minimum $50,000), then it is a waste of time. Well, I should say that you will learn a lot and may feel good about helping your close ones making money, but you will not make big money out of it. You won't turn into Buffett, Ackman or other hedgie.

 

IMO, you will be sacrificing options that are valid to an individual investor in order to be a good fiduciary: no or very little debt/margin, no or very little stock options, diversification (no massive overweight). Remember that these are your friends and family members. They will be the most patient, but losing their hard earned capital is not an option. So if you invest your funds along with them, you may lose some options negating the benefit of managing other people money, while if you don't put most of your money into this venture, then why would they trust you to manage theirs in the first place?

 

You also don't want them to invest more than they can afford with you. It has to be funds that they will not need for a long time. If not, you will get into trouble with redemptions and if you have only something like 10 partners, just one redeeming his or her fund could create you a lot of trouble in managing the portfolio. One of them could also die, divorce or turn ill. You have to consider these things upfront.

 

The goal of setting up an LP is to manage a lot of money and to benefit from a 2/20 or 0/20 structure. It is 0 cost float. I know that Buffett started with only $105,000 in partners money, but this was in 1956. Today you would need something like $1,000,000 to match that. And, then he did quickly setup 9 more partnerships before merging them into the Buffett Partnership in 1962. By then, he was managing $10.6 million and if I recall properly, he had about 100 investors including partnerships since some had to setup their own partnership to avoid triggering the 100 limit. Again that would be close to $100 million today. This is a big business guys. I don't care what your returns are, but to garner that kind of money, you need to advertise in some form or you need rich connections.

 

And don't forget that if you are very successful that at some point, you have no choice, but to register if you invest a lot of money in the stock market. I believe it is $25 million in Canada and it is also necessary for individual investors.

 

Cardboard

 

 

[original mungerville]

Sharper,

 

My feeling is Cardboard is right.

 

Also I am not sure what structure you are using as a preferred share is usually associated with a corporation whereas you are talking about a LP.

[SharperDingaan]

Cardboard, Munger:

 

Thanks for the heads up. I hold a FCSI designation so I don't expect any issues with registering, but perhaps its also getting time to either dissolve or revert the partnership back to its original intent. My few partners each contributed > 200K, & would be considered more sophisticated investors. To ensure that we understood the risks, all GP & LP agreements were witnessed by their own legal. Estate planning was added after the fact to deal with the death/divorce issue. The common & pref share structure was a corporate overlay to facilitate wealth attribution, evidence LP agreement with the IP, & enable the payment of different returns consistent with the nature of the GP-LP arrangement - not elegant, but serves the function. Great structure for the original purpose, but any material growth obviously causes issues.

 

My interest is owner-management of a single venture/company project - much more modest, hands-on stuff. The serious money is a way different ballgame, & frankly I would rather work for others doing it, than do it myself. Basically money as servant, not the master. 

 

SD

[Mephistopheles]

If I wanted to open up a partnership with less than $25 million in capital and have a 0/20 fee structure, and I live in New Jersey, would I have to register as an investment adviser with the SEC and/or with the New Jersey Securities Bureau? I want to manage just one account with pooled capital, instead of managing a different account for each client, so would the friends and family group account work for that? I read this thread and tried searching online, but the laws are so confusing. Would anyone kindly be able to explain to me in baby steps on how I would go about setting this partnership up and how much it would cost me?

 

Thanks, I really appreciate your help.

[Mephistopheles]

If I wanted to open up a partnership with less than $25 million in capital and have a 6 - 25% fee structure, and I live in New Jersey, would I have to register as an investment adviser with the SEC and/or with the New Jersey Securities Bureau? I want to manage just one account with pooled capital, instead of managing a different account for each client, so would the friends and family group account work for that? I read this thread and tried searching online, but the laws are so confusing. Would anyone kindly be able to explain to me in baby steps on how I would go about setting this partnership up and how much it would cost me?

 

Thanks, I really appreciate your help.

 

Bump. Can anyone point me in the right direction?

 

Also, would my investors have to be accredited? Would this technically be a "hedge fund"?

 

Also, do all my investors have to be milli

[VAL9000]

The answer is, if you're serious then you should speak with a lawyer who specializes in this work.  A referral is best, but you can also search for them online.  They will be able to advise you on the state-specific structure you need, the filing requirements, and other regulations that you will need to operate under.  Beneficially, they can also introduce you to other people you will need to work with to get this going properly.  e.g. accountants.

 

Keep in mind that if you are unwilling to pay for legal advice, you should think deeply about how serious you are about embarking on this kind of thing.  I'm all for keeping a low cost profile, but starting a partnership isn't something you can jump in and out of easily.  It is something where you want to be certain that you have the requisite legal protection and that you don't run afoul of regulators and such.

 

Just my two cents.

 

 

[Mephistopheles]

The answer is, if you're serious then you should speak with a lawyer who specializes in this work.  A referral is best, but you can also search for them online.  They will be able to advise you on the state-specific structure you need, the filing requirements, and other regulations that you will need to operate under.  Beneficially, they can also introduce you to other people you will need to work with to get this going properly.  e.g. accountants.

 

Keep in mind that if you are unwilling to pay for legal advice, you should think deeply about how serious you are about embarking on this kind of thing.  I'm all for keeping a low cost profile, but starting a partnership isn't something you can jump in and out of easily.  It is something where you want to be certain that you have the requisite legal protection and that you don't run afoul of regulators and such.

 

Just my two cents.

 

Thanks for your reply.

 

I don't mind paying for legal advice, but I want to know what I'm getting into in terms of costs. Since I'll only be managing a very small pool of money (couple million at most) and since I don't have a very large amount saved up as of yet, spending like $100,000 would be too much for me.

 

Would anyone be able to give a ball park estimate on what the startup cost would be? I would run it on an ultra low cost structure, out of my home, and do all the administrative work on my own.

[Tim Eriksen]

If I wanted to open up a partnership with less than $25 million in capital and have a 0/20 fee structure, and I live in New Jersey, would I have to register as an investment adviser with the SEC and/or with the New Jersey Securities Bureau? I want to manage just one account with pooled capital, instead of managing a different account for each client, so would the friends and family group account work for that? I read this thread and tried searching online, but the laws are so confusing. Would anyone kindly be able to explain to me in baby steps on how I would go about setting this partnership up and how much it would cost me?

 

Thanks, I really appreciate your help.

 

I am not a lawyer but have started a hedge fund in Washington state. If you are less than $25 million in AUM you will not be required, nor likely allowed, to register with the SEC.  It will be on the state level.  I cannot speak to NJ requirements.  Every state is different.  Some follow SEC rules exactly, others are more strict, some probably less.  You need to find out NJ law.  Six years ago it cost around $30 to $50k in legal costs to set up the partnerships and write the fund documents.  You might want to call a reputable firm and ask for an estimate.  Expect ongoing legal costs as well if the state is strict. 

 

What you describe has a performance fee which can only be charged to "qualified" clients.  I'm pretty sure there are articles online on How to Start a Hedge Fund.  Lastly, you said later that you would run it out of your home and handle the administration.  That may or may not be doable.  In my state you would not be allowed to self-administer.  I must have a custodian, a third party administrator, a yearly audit, and an independent representative to authorize all disbursements from the fund.  This adds to yearly operating costs. I know in other states you can self administer.

 

Lots to think about.  If it is overwhelming then it may be that you are not cut out for running your own fund.  You end up being more than an analyst.  You have to be an administrator and marketer as well.   

 

 

[Mephistopheles]

If I wanted to open up a partnership with less than $25 million in capital and have a 0/20 fee structure, and I live in New Jersey, would I have to register as an investment adviser with the SEC and/or with the New Jersey Securities Bureau? I want to manage just one account with pooled capital, instead of managing a different account for each client, so would the friends and family group account work for that? I read this thread and tried searching online, but the laws are so confusing. Would anyone kindly be able to explain to me in baby steps on how I would go about setting this partnership up and how much it would cost me?

 

Thanks, I really appreciate your help.

 

I am not a lawyer but have started a hedge fund in Washington state. If you are less than $25 million in AUM you will not be required, nor likely allowed, to register with the SEC.  It will be on the state level.  I cannot speak to NJ requirements.  Every state is different.  Some follow SEC rules exactly, others are more strict, some probably less.  You need to find out NJ law.  Six years ago it cost around $30 to $50k in legal costs to set up the partnerships and write the fund documents.  You might want to call a reputable firm and ask for an estimate.  Expect ongoing legal costs as well if the state is strict. 

 

What you describe has a performance fee which can only be charged to "qualified" clients.  I'm pretty sure there are articles online on How to Start a Hedge Fund.  Lastly, you said later that you would run it out of your home and handle the administration.  That may or may not be doable.  In my state you would not be allowed to self-administer.  I must have a custodian, a third party administrator, a yearly audit, and an independent representative to authorize all disbursements from the fund.  This adds to yearly operating costs. I know in other states you can self administer.

 

Lots to think about.  If it is overwhelming then it may be that you are not cut out for running your own fund.  You end up being more than an analyst.  You have to be an administrator and marketer as well.   

 

 

 

Thanks for the info. This makes me think that I should probably wait for some time until I've gathered enough wealth to be able to spend $50k in legal costs. Also, I would probably me managing friend&family money, many of them who are not "qualified clients". I think the whole "qualified client" rule is just ridiculous. Why do you have to be rich to be able to invest in hedge funds?

 

I'll call the NJ Securities Bureau to find out state specific rules, but thanks for giving me a rough estimate.

[Tim Eriksen]

If I wanted to open up a partnership with less than $25 million in capital and have a 0/20 fee structure, and I live in New Jersey, would I have to register as an investment adviser with the SEC and/or with the New Jersey Securities Bureau? I want to manage just one account with pooled capital, instead of managing a different account for each client, so would the friends and family group account work for that? I read this thread and tried searching online, but the laws are so confusing. Would anyone kindly be able to explain to me in baby steps on how I would go about setting this partnership up and how much it would cost me?

 

Thanks, I really appreciate your help.

 

I am not a lawyer but have started a hedge fund in Washington state. If you are less than $25 million in AUM you will not be required, nor likely allowed, to register with the SEC.  It will be on the state level.  I cannot speak to NJ requirements.  Every state is different.  Some follow SEC rules exactly, others are more strict, some probably less.  You need to find out NJ law.  Six years ago it cost around $30 to $50k in legal costs to set up the partnerships and write the fund documents.  You might want to call a reputable firm and ask for an estimate.  Expect ongoing legal costs as well if the state is strict. 

 

What you describe has a performance fee which can only be charged to "qualified" clients.  I'm pretty sure there are articles online on How to Start a Hedge Fund.  Lastly, you said later that you would run it out of your home and handle the administration.  That may or may not be doable.  In my state you would not be allowed to self-administer.  I must have a custodian, a third party administrator, a yearly audit, and an independent representative to authorize all disbursements from the fund.  This adds to yearly operating costs. I know in other states you can self administer.

 

Lots to think about.  If it is overwhelming then it may be that you are not cut out for running your own fund.  You end up being more than an analyst.  You have to be an administrator and marketer as well.   

 

 

 

Thanks for the info. This makes me think that I should probably wait for some time until I've gathered enough wealth to be able to spend $50k in legal costs. Also, I would probably me managing friend&family money, many of them who are not "qualified clients". I think the whole "qualified client" rule is just ridiculous. Why do you have to be rich to be able to invest in hedge funds?

 

I'll call the NJ Securities Bureau to find out state specific rules, but thanks for giving me a rough estimate.

 

You could always forgo the performance fee, charge a 2.0% management fee.  I would also look into Interactive Brokers.  IB appears to have a fairly simple platform for a registered investment adviser to trade in a master account and allocate to individual clients. 

[Mephistopheles]

 

You could always forgo the performance fee, charge a 2.0% management fee.  I would also look into Interactive Brokers.  IB appears to have a fairly simple platform for a registered investment adviser to trade in a master account and allocate to individual clients.

 

Interesting. I didn't realize that I could charge a management fee, but that makes sense given that non-rich people can invest in mutual funds.

 

Yea I've heard that IB has a good platform for this. Thanks again.

[oddballstocks]

I guess the question I'd ask is why do you want to do this? 

 

Do you want to manage money because you love investing?  Why not just manage your own money especially if the money you'd be managing is family money.  I've found that family and money don't go well together.  Everyone always seems to think their situation is different, but I have yet to see a relationship not changed when these two come together. 

 

I know this is unorthodox on this board, but when family asks me for investing advice I direct them to index funds.  It's like the saying "no one ever got fired for buying IBM."  Sure they're not going to beat the market, yet they won't do worse either, and it's no stress.

 

Do you want to manage money because you're good at sales and you want to run a business?  These are the skills you need, it's much easier to grow AUM by finding new clients rather than beating the market.  When starting out with a few million it's a lot easier to find a few new clients and double your AUM vs having your portfolio gain 100%.  Starting out you'd spend a lot more time marketing and meeting with new clients rather than bunkering down finding investments. 

 

When you manage money you are running a business.  If you just want to do investments for fun with friends maybe an investment club is appropriate.  Tim said it well, book keeping, legal, compliance costs.  These things will take your time away from managing money but are all necessary.  In the eyes of the law the compliance and legal are the most important things, if you don't get those right you're out of business or in jail.

 

I think you really need to think long and hard about why you'd want to do this.  I get asked every once in a while why I don't manage money and it's because I've sat down and thought it through.  I don't think I could gather enough AUM quickly enough to support my family, and I'm not sure I want to run an investment business.  So instead I do what I enjoy, researching and writing about investments and investing my own capital.

 

There is a fantasy out there about turning passions into businesses.  People think they'll get to do their passion 100% of the time and it's a slam dunk.  What I've found is that usually the passion gets shrunk down to 50-60% at the most and the day to day running of the business, hiring, firing, accounting, sales takes over the rest.  It seems the longer someone stays in business the smaller portion of their day is that actual passion they started for.  If your passion is running a business there are thousands of companies that will compensate you very well for doing this without any of the startup risk.

 

If you happen to have a passion for running a company, and a passion for some hobby that makes money (investing in your case) and they intersect you have the potential to be successful.  I've seen a lot of entrepreneurs burn out because they become consumed with the stuff they hate and don't get to do the stuff they love and the reason they started their company.

[Mephistopheles]

I guess the question I'd ask is why do you want to do this? 

 

Do you want to manage money because you love investing?  Why not just manage your own money especially if the money you'd be managing is family money.  I've found that family and money don't go well together.  Everyone always seems to think their situation is different, but I have yet to see a relationship not changed when these two come together. 

 

I know this is unorthodox on this board, but when family asks me for investing advice I direct them to index funds.  It's like the saying "no one ever got fired for buying IBM."  Sure they're not going to beat the market, yet they won't do worse either, and it's no stress.

 

Do you want to manage money because you're good at sales and you want to run a business?  These are the skills you need, it's much easier to grow AUM by finding new clients rather than beating the market.  When starting out with a few million it's a lot easier to find a few new clients and double your AUM vs having your portfolio gain 100%.  Starting out you'd spend a lot more time marketing and meeting with new clients rather than bunkering down finding investments. 

 

When you manage money you are running a business.  If you just want to do investments for fun with friends maybe an investment club is appropriate.  Tim said it well, book keeping, legal, compliance costs.  These things will take your time away from managing money but are all necessary.  In the eyes of the law the compliance and legal are the most important things, if you don't get those right you're out of business or in jail.

 

I think you really need to think long and hard about why you'd want to do this.  I get asked every once in a while why I don't manage money and it's because I've sat down and thought it through.  I don't think I could gather enough AUM quickly enough to support my family, and I'm not sure I want to run an investment business.  So instead I do what I enjoy, researching and writing about investments and investing my own capital.

 

There is a fantasy out there about turning passions into businesses.  People think they'll get to do their passion 100% of the time and it's a slam dunk.  What I've found is that usually the passion gets shrunk down to 50-60% at the most and the day to day running of the business, hiring, firing, accounting, sales takes over the rest.  It seems the longer someone stays in business the smaller portion of their day is that actual passion they started for.  If your passion is running a business there are thousands of companies that will compensate you very well for doing this without any of the startup risk.

 

If you happen to have a passion for running a company, and a passion for some hobby that makes money (investing in your case) and they intersect you have the potential to be successful.  I've seen a lot of entrepreneurs burn out because they become consumed with the stuff they hate and don't get to do the stuff they love and the reason they started their company.

 

Thanks for your reply and advice. I've passed on the idea of opening up a small fund to run family any time soon. I've decided that I want training in the hedge fund field first, by working for a good value manager. I don't particularly love running a business, but I wouldn't hate it either. I do love investing and so eventually I hope to be in the fortunate position to be able to run a fund of my own, by having enough money to live off of until I would start to see a consistent profit. For the time being, like I said, I would just love to work for a good value manager, from whom I can learn a lot from.