Transcript
Page 1: Investment Advisers:

Investment Advisers: Where to Find Financial Info &

How to Make Sense of It All

Roslyn Clarke

Conference Sponsored by

Research Track Sponsored by

Page 2: Investment Advisers:

Disclaimer I originally presented this material at a conference in the summer of 2014. It should be considered a general guideline with conceptual examples of how typical private equity and hedge fund investment advisers organize and operate. Many firms do not fit these models. I have not included or addressed all methods and/or topics relevant to Investment Advisers, SEC forms, or industry compensation.

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Session Outline

1. Basic Firm Structure

2. Owners, Partners & Clients

3. Assets & Fees

4. Compensation - Structure, Practices & Data

5. Examples & Case Studies

6. Reference Material (ADV Map, Guide & TMI)

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Before we get started… • The Securities and Exchange Commission (SEC) says Investment Advisers are individuals

or groups who advise and/or manage investment assets or analyze securities for a fee, including private equity funds, venture capital funds and hedge funds – the focus of this presentation. When they meet certain requirements, they’re regulated by the SEC. (Basics available in Handout)

• The Dodd-Frank Wall Street Reform Act changed/clarified which firms qualify as Investment Advisers. The status & requirements changed for some firms in 2011/2012.

• Not every private equity, venture capital and hedge firm files the SEC’s Form ADV found at http://www.adviserinfo.sec.gov/IAPD/Content/Search/iapd_Search.aspx. (See 6. TMI for more.)

• Exempt Reporting Advisers, including firms with a VC Exemption, file but don’t answer

ALL the questions & don’t have to create a Brochure. (See 6. TMI for more.)

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1. Basic Firm Structure

Firm

Directing Entity

Fund A Fund B

Directing Entity

Fund C

The more you know about the firm’s type & structure and where your prospect is located in the org. chart, the better your results will be. Note: There are 7 private fund types including hedge, private equity, and venture capital. One firm may have multiple fund types.

“Directing Entity” is not an official term of any kind. I just made it up.

Presenter
Presentation Notes
Each firm can have multiple funds of different types. There are 7 “private fund” types in the Form ADV. We’re going to talk about the 3 most common. The key concepts apply to all three.
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1. Basic Firm Structure

Fund A

Investment or Company 1

Investment or Company 2

Investment or Company 3

Each fund may have a portfolio of investments or companies The Directing Entity is the person or entity overseeing Fund A’s investments.

In the Form ADV Schedule D, Section 7.B.(1) Private Fund Reporting: • find the fund’s Directing

Entity in Question 3

• find the Fund Type in Question 10

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1. Basic Firm Structure - Types of Legal Organization

• The majority of Private Equity & Venture Capital

firms based in the US are legally organized as Limited Partnerships (LPs).

• The next popular option is Limited Company (LC)

aka Limited Liability Company (LLC). Unlike LPs, LLCs can be owned by a single member.

• Hedge Funds may also be organized as LPs, but

LLCs are more common among HFs than among PE/VE firms.

• Interests in both LPs and LLCs are considered

“securities” and are therefore regulated by the SEC.

See Form ADV, Part 1A Item 3 Form of Organization.

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1. Basic Firm Structure - Three Groups in Limited Partnerships

Limited Partnership

General Partnership

Managing Partnership

Legal Structure of Firm: • The distinction between the three is

mostly for legal and tax reasons.

• “Investment Adviser” refers to the entity in charge of investment decisions and raising capital, which is frequently the General Partnership.

• “A fund’s ‘sponsors’ refer to the individuals or entities that own the general partner or the investment manager of the fund… Investment authority may also be shared within the general partner through the use of investment committees.” (Breslow & Schwartz, 1:2.5 [A])

Presenter
Presentation Notes
For firms that are not legally organized as LPs, the same basic concept, structure, and roles are the same – mostly it’s the terminology that differs.
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Limited Partnership

General Partnership

Managing Partnership

At the FIRM level:

• Members of the MP are often members of the GP, too. But firm-based members of the GP are almost always members of the MP.

“Clients” are mostly outside investors who do not participate in investment decisions or firm operations. Don’t confuse the LP clients with the firm organized as an LP.

“Owners” are members or shareholders of the GP.

“Partners” usually have an equity stake in the firm representing voting rights or a type of compensation, not ownership of assets or fees.

2. Owners, Partners & Clients in LP Structures

Presenter
Presentation Notes
This is my preferred language. These terms are frequently used elsewhere, but sometimes applied inconsistently.
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2. Owners, Partners & Clients - Limited Partners

Limited Partnership

More about LPs: • Members agree to keep their money

in the fund for a specified amount of time.

• At PE and VC firms, it’s usually 10

years (the usual life of a fund).

• At HF firms, the “lock up” period may be monthly, quarterly or as much as 2 or 3 years. Withdrawals are allowed as specified monthly or quarterly redemption periods.

• Some LP members can negotiate

different terms and rates than other members.

• Terms can be broken under certain conditions…

LP members can be individuals, pension funds, endowments, insurance companies and other investment advisers. To see the breakdown, see Form ADV, Item 5. Information about Your Advisory Business, Clients.

Presenter
Presentation Notes
Source: Private Equity Funds: Formation and Operation by Stephanie R. Breslow and Phyllis A. Schwartz, (2009)
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(Certain Conditions Might Include…)

Part 1A, Item 11: Disclosure Information – Information on disciplinary history, including criminal, regulatory or civil judicial actions in the last 10 years. Disclosure Reporting Page (DRP): If the firm answered “yes” in Item 11, the details are reported here...

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The General Partnership

At the FIRM level, there is an ultimate GP & MP.

The Managing Partnership

Presenter
Presentation Notes
If the firm is a LLC, “owners” (aka the GP) will be called MEMBERS.
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2. Owners, Partners & Clients

General Partners

More about GPs: • They have no employees and

expenses are limited.

• Members are usually the firm’s founders and superstars.

• Skin In The Game - For tax purposes, the GP invests alongside the LP to be considered a true partner.

• Additional co-investing by top investment managers or execs also aligns interests and bolsters investor confidence.

If the firm is legally organized as a LLC, instead of forming a GP, owners will be called “members” or “managing members” who will have limited liability. If the firm is legally organized as a LP, the GP will be organized as a corporation or LLC to limit itself form debts and obligations.

Presenter
Presentation Notes
Source: Practicing Law Institute, Private Equity Regulation , Chapter 2: Terms of Private Equity Funds
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2. Owners, Partners & Clients – GP Tax Recommendation

“Although the IRS has dispensed with an earlier requirement that, for entities to be classified as partnerships for tax purposes, the general partner must contribute 1% of the total capital contributions, it is still common industry practice to use this number… Oftentimes, a minimum contribution equal to the lesser of 0.2% of total contributions of the partnership or $500,000 is recommended by tax advisors.”(Breslow & Schwartz,3:2.5 [A])

The General Partnership

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2. Owners, Partners & Clients – FIRM Level

Managing Partnership

More about MPs: • The MP usually takes

care of business operations for the fund(s) and offers investment advice to the GP as opposed to making investment decisions.

• It has employees and covers expenses like base salaries, rent, software and hardware.

• It does not typically make a capital contribution to the fund.

Sometimes, the MP will have authority to make investment decisions if the fund’s form of organization is an entity (e.g. corporation or business trust) without a GP.

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2. Owners, Partners & Clients

Limited Partnership

General Partnership

Managing Partnership

At the FUND level: • The Directing

Entity is often, but not always, a member of the MP or GP.

• Sometimes, the

Directing Entity is a Relying Adviser of the firm - a subsidiary or affiliated entity under common control, collectively conducting a single advisory business and filing a single Form ADV.

Members of the LP at PE & VCs buy a stake in a particular fund. At HFs, they buy into a particular fund or a separate “series” of the firm’s securities.

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At the FUND level, there may be additional entities or individuals serving as a “junior”

GP or MP...

Firm

Directing Entity

Fund A Fund B

Directing Entity

Fund C

GP

GP2

MP

MP2

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So, this is why I made up the term “Directing Entity”

The DE can be a an affiliated person, persons, or entity acting in a similar capacity as a GP or MP. It can also be called the trustee or director.

Directing Entity

MP

GP * At the FUND level

MP2

GP2

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2. Owners, Partners & Clients

Firm

DE #1 = Funds’ GP, Manager, Trustee

or Director

Fund A Fund B

DE #2 = Fund’s GP, Manager, Trustee

or Director

Fund C

Remember, you can find the Directing Entity in the Form ADV Schedule D, Section 7.B.(1) Private Fund Reporting: Question 3

Overview: • The DE – which can

be a GP, MP or individual(s) - usually has a profit sharing interest in the fund(s) it oversees.

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Example of a Directing Entity -

Real Hedge Fund Firm * At the FUND level at Viking Global Investors LP

Smith Lang Horn

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Another Directing Entity - Same Hedge Fund Firm

GP

Q: How do you know this is a subsidiary GP, not The GP? A: Go to Schedule A Direct Ownership chart or Part 2 Brochure next…

* At the FUND level of Viking Global Investors LP

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Schedule A Direct Owners &

Executive Officers • Viking Global Partners LLC is GP at the firm level

• Viking Global Investors LP is a director & shareholder of a relying adviser • No mention of Viking Global Performance LLC here…

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Schedule B Indirect Owners

• Viking Global Partners LLC – The Firm GP – has two members: Halvorsen & Ott. • Viking Global Investors Europe Management LTD has two shareholders: Purcell & Viking

Global Investors LP • But no mention of Viking Global Performance LLC here either…

* At the FIRM level of Viking Global Investors LP

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Part 2 Brochure

Viking Global Partners LLC is The GP of the FIRM.

GP

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Part 2 Brochure - Continued Viking Global Performance LLC is a subsidiary GP or Investment Manager at the FUND level

GP

Presenter
Presentation Notes
Long only funds typically don’t charge performance fees.
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50% Owners

via Viking Global Partners LLC:

Halvorsen Ott

Confirmed: GP Members at the FIRM Level

(We’re back at Schedule B Indirect Owners.)

The code key for “D” says they each own at least 50%.

But that doesn’t mean that they get the same percentage of fees or that either gets 50% of the fees…

Presenter
Presentation Notes
For LLCs, investors are considered “members”
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Indicated: MP Partner at the Fund/Directing Entity Level

(We’re still at Schedule B Indirect Owners.)

Q: What about Purcell and his 50% - 75% interest in Viking Global Investors Europe Management LTD (“VGE Management LTD”)? A: VGE Management LTD doesn’t appear in the Brochure or Schedule D, but it looks like the MP of European FUNDS. And Viking Global Investors LP (the FIRM) has an interest of at least 25% - 50%...

Partner via VGE Management LTD:

Purcell

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Indicated: MP Partners at the Firm Level

Partnership via Executive Committee:

(Halvorsen) & Ott Purcell

Sundeim

• Although it doesn’t say that Halvorsen is a member of the Exec. Committee, he probably is. If not, it probably doesn’t matter for voting rights/power or compensation.

• Purcell, Ott & Sundheim definitely are. • Halvorsen & Ott are listed as LP members here,

reflecting the Brochure’s reference to their direct ownership in VGI.

• It *looks like* the only difference between Halvorsen & Ott is the CEO title/role…

(We’re back to Schedule A Direct Owners & Executive Officers .)

Presenter
Presentation Notes
In this case, the MP is a committee, not a distinct legal entity or sub-entity.
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But what about the 3 from VGE III?

By going back to the Part 2 Brochure, I can chart both VGE III Portfolio and Viking Global Equities II LP…

Smith, Lang & Horn

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Back to Description in Part 2 Brochure

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What The Brochure Says – Summary Firm has 2 groups of funds: • “VGE Funds” (Viking Global Equities Funds) • “VGF Funds” (Viking Long Funds) – more on these later “VGI” (Viking Global Investors LP), which we already confirmed as the FIRM’s GP, also serves as MP to: • Viking Partners Fund LP* • Viking MVI I LLC* • Viking MVI II LLC* • Viking MVI III LLC * • Viking Global Equities LP • Viking Global Equities II LP* • Viking Global Equities III LP (“VGE III”)

Both Viking MVI III & VGE III invest substantially all of their assets in VGE III Portfolio Ltd!

* Only firm principals, qualified employees and related persons can invest in these funds, which affects fees!

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Viking Global Investors LP

Viking Global Equities II LP

Viking MVI II LLC

VGE III Portfolio LTD

Viking Global Equities III LTD

Viking MVI III LP

Partial Chart of Viking FIRM Entities

GP

Smith, Lang & Horn

• VGE III Portfolio is not a GP or MP entity at any level.

• No sign that Smith, Lang & Horn are members, partners or shareholders of a GP or MP at any level.

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2. Owners, Partners & Clients – Summary & Caveats

• For employees, interests may be in a GP, MP or DE. • Form ADV, Schedule A Direct Owners and Executive Officers can report both

types. Schedule B Indirect Owners will often reveal the relevant layers and entities and Part 2 Brochure may explain ownership and the relationship between entities in plain language.

• In the Ownership Charts, the total percentage may be over 100%. Each

person or entity’s total is the total possible across all “accounts” or entities, so interests may be double-counted. (See Examples & Case Studies)

• But the total percentage owned may also total less than 100%. Firms will

often “leave something on the table” for future hires or promotions.

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2. Owners, Partners & Clients – Summary & Caveats

• Shares in the GP usually represent an equity stake (ownership) which may be

cashed out, but usually has significant restrictions. Shares may also represent

the right to a percentage of the performance fees or carried interest (profit

sharing).

• Shares in the MP usually represent voting rights (partnership) which indicate

higher responsibility, risk, and potential compensation. Sometimes, at larger

firms, MP shares may represent an equity stake (ownership) or entitle the

owner to a percentage of the management fees. (See Examples & Case

Studies)

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3. Assets & Fees

Fees

Management Fee - Charged to LP

- % of Assets

Performance Fee - Charged to LP

- % of profits or return

Other Fees (applicable to PE firms) - Charged to Portfolio

Company - e.g. monitoring,

transaction, financing, redemption, etc.

Fees can get complicated, so we’re going to focus on the two that really affect compensation, how they are calculated and where they end up. For fee rates, look in the Form ADV Part 2 Brochure, industry databases, or business publications. For fees types, see Item 5, Information About Your Advisory Business, Section E.

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Warning: Not All Assets Generate Fees

While you should try to get as close to fee-generating assets, committed capital, or net assets as possible, the relevant info is not always available. “Clients” may include the firm owners, staff, and their family members who pay lower fees or no fees at all. Assets may include profits reinvested in the fund, which do not generate fees.

3. Assets & Fees

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3. Assets & Fees Note: The farther away from fee-generating assets you are, the less reliable your calculations will be, esp. with hedge funds. • AUM refers to net assets (excluding any debt/leverage). But some web sites

and publications don’t make a distinction when reporting assets under management. Check the Form ADV Part 2 (Brochure).

• RAUM refers to gross assets (including any debt/leverage). Check the Form

ADV, Item 5 Regulatory Assets Under Management to compare with assets reported elsewhere.

• Committed Capital refers to assets promised for investment from

outside/fee-paying clients at the beginning of the fund’s life. This is the best choice for PE or VC funds.

• Invested Capital refers to the amount of committed capital actually invested to date.

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3. Assets & Fees Management Fees are typically: • 1% to 2 % of net invested assets or committed capital (fee-

generating assets) • Charged on a quarterly or annual basis • Used to cover the basic cost of running the business • Used to cover payroll (base salaries, not bonuses)

– Sometimes, the amount received exceeds combined expenses. – On average, approx. 65% to 70% of management fee income is

spent on payroll at private equity & venture capital firms. – The remainder might be shared with top execs, but is more

likely saved to supplement compensation in lean years.

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3. Assets & Fees Performance Fees (aka Incentive Fees, Carried Interest or Carry) are typically: • 15% to 25% of profits after certain requirements (e.g. high water

mark at HFs or hurdle rates at PEs & VCs) have been met. • Most of it is shared by members of the GP. • A smaller portion will be used for bonus payments, which may be

either: – Discretionary bonuses (decided by managers) – Profit & Loss (P&L) or contract bonuses (based on a set

percentage in advance) • The percentage may be based on the profits across the firm or

just the fund(s) overseen by the manager (aka his/her portfolio or book).

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3. Assets & Fees For More on Both Fees: • We’ll take a look at some

recent numbers from industry insiders, executive search firms, academic papers, and survey data.

• We’ll also see how to apply these numbers when calculating estimated compensation.

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4. Compensation – Structure & Practices

1

2

3

4

Job function/role is more informative than job title. The very same role may have a different title at another firm. These 4 tiers are mostly distinguished by bonus type & source.

Presenter
Presentation Notes
In this industry, titles can be tricky. They mean different things at different firms. Sometimes, title is all you have. But if you have additional information about the prospect’s course of study, specialty, career history, association with a particular deal or fund, it’s usually more informative with respect to compensation tier and amount.
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4. Compensation - Structure & Practices

1

2

3

4

Tier 1 – GP Members; share majority of performance fees; highest risk & most variable income. Tier 2 – MP Members and other top execs; bonus is from pre-set percentage of performance fees.

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4. Compensation - Structure & Practices

1

2

3

4

Tier 3 – Other investment pros; discretionary bonus influenced by firm performance. Not based on set % of performance fees or carry. Tier 4 – Entry-level investment pros and administrators; lower discretionary bonus more influenced by work produced than firm performance; least variable income.

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4. Compensation – Structure & Practices

1

2

3

4

How do you tell where your prospect is? What is the range for bonuses by tier and type? We can get Tier 4 (the least mysterious, complicated and variable) out of the way first.

We’ll review examples and sources for Tiers 1, 2 & 3 in Section 5 – Examples & Case Studies.

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4. Compensation - Data for Tier 4

I-Bank Analyst (years 1 to 3)

PE Analyst (years 1 to 3)

VC Analyst (years 1 to 3)

HF Analyst (years 1 to 3)

Est. Avg. Base Range

$70K - $110K $65K - $75K $70K - $80K $90K - $120K

Est. Avg. Bonus Range

$50K - $70K $50K - $65K $30K - $50K $50K - $240K

Total Avg. Pay Range

$120K - $180K $115K - $140K $100K - $130K $140K - $360K

Approx. figures for non-MBA holders with no previous professional experience

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Approx. figures for undergrad or MBA holders with some previous experience

4. Compensation – Data for Tier 4

I-Bank Assoc. (MBAs or analyst program stars)

PE Assoc. (less than 5 years total work exp.)

VC Assoc. (less than 5 years total work exp.)

PE Assoc. (4 to 7 years total work exp.)

VC Assoc. (4 to 7 years total work experience)

Est. Base Range

$110K - $140K

$90K - $115K $95K - $175K $135K - $170K

$130K - $155K

Est. Bonus Range

$80K - $150K $75K - $130K $35K - $60K $125K - $185K

$45K – $90K

Total Est. Pay $190K - $290K

$165K - $245K

$130K - $235K

$260K - $355K

$175K - $245K

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HF “Rookies” (1 to 4 years exp.)

HF “Sophomores” (4 to 10 years exp.)

HF “Seniors” (PMs with 7+ years exp.)

HF “MVPs” (Firm founders, partners & industry stars)

Est. Avg. Base

$70K - $150K $125K - $280K $200K - $400K They decide (but it’s close to “seniors”).

Est. Avg. Bonus

$50K - $350K $110K - $2.1M $200K - $7M Depends on the year…

Total Avg. Pay

$120K - $500K $335K - $2.2M+ $400K - $7.4M Sky’s the limit…

4. Compensation - Data for Tier 4 (and higher)

For hedge fund investment pros at higher levels, the ranges for compensation are much wider and more volatile. These are approximations by role, with the biggest firms usually paying the most.

Tier 3 to 2 Tier 2 to 1

Presenter
Presentation Notes
Since some of these ranges are so wide, you need to dig deeper to get a decent estimate for income and philanthropic capacity.
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5. Compensation - Data for Tier 4

Note: This data includes students who actively sought and accepted a full-time position in Financial Services. It does not include those who were sponsored or started their own business. * Information not available. Data cannot be listed for categories reported by <1% of students seeking employment.

Harvard Business School Class of 2014

By Function

By Industry

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4. Compensation Tiers at Viking Global

1

2

3

4

Halvorsen & Ott GP Members Principal Owners

Purcell Shareholder in fund-level MP Exec. Committee & Portfolio Manager

Sundheim Exec. Committee & Portfolio Manager

Remember: The same compensation tier doesn’t mean the same compensation amount…

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Don’t Forget To Do A News Search

• The New York Times, 3/31/13: Purcell purchased a duplex co-op on Park Avenue, NYC, for $17.75M.

• Forbes, 3/25/13: Halvorsen is new to the list of Billionaires with $1.3B; he earned $325M in 2012.

• Reuters, 7/3/2014: Viking Global reshuffles top ranks; fund up by 6.6 percent

in 1st half – Co-chief investment officer (Purcell) to take a 6-month sabbatical leaving

other co-chief investment officer Sundheim as sole CIO and manager of the central portfolio.

– Ott left the firm in 2010. – For Viking, traditionally one of the industry's best performers, 2014 has

been difficult. Heavy losses on tech-oriented stocks hurt performance in March. But returns have come back, with the firm telling investors that it was up 1.1 percent in June, leaving it up 6.6 percent for the first six months of the year.

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4. Compensation Tiers at Viking Global

1

2

3

4

Smith, Lang & Horn Directors/Portfolio Managers Employee-only fund Viking MVI III would not generate performance fees

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News Search - Continued Chicago Tribune, 4/11/12: Hedge Fund Viking to Rely More on Junior Managers • "Our next four most experienced portfolio managers, Paul Enright, Ning Jin, Hani

Sabbagh and Scott Zinober, are at the center of idea generation," Halvorsen wrote...They will now directly control almost 60 percent of the Viking Global Equities fund.

• Halvorsen…told clients on Wednesday that he recently upped the aggregate credit lines

for a quartet of fund managers by 31 percent to $7.2 billion. The move comes less than a month after James Parsons, one of Viking's most senior managers, left the firm.

• [Halvorsen] also raised the credit lines for the next three portfolio managers to $1.5

billion from $1 billion, or 6 percent of the flagship fund. • Before Parsons left in 2012, David Ott, who co-founded the firm with Halvorsen,

departed in 2010 and Dris Upitis, who had also been a management committee member, resigned in early 2011. Several analysts have also left in the last year.

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5. Before Doing Any Math…

Manage your expectations and those of your fundraisers!

• Methods are varied, complicated, and time-consuming, even for professionals and academics

• There are many variables and numbers that just aren’t available • Your goal should be a potential range over a number of years, not hard

number. • Document and communicate clearly so everybody knows what you mean and

where you got the information.

The formula above is one used in A Model of Private Equity Fund Compensation by Metrick & Yasuda (2011)

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5. Real PE/VC Professional’s “Cowboy Math” – Part 1

• Fund A has $100M in committed capital • It returns $180M after covering losses of 20%, which means that winners

generated a 2.5 times return on $80M or $200M less the $20M in losses.

• Managements Fees total 15% or $15M (total over the fund’s life of 10 years).

• $165M is left to distribute, but the LP members get their $100M back first.

Roslyn’s note: These distributions usually take place between years 5 and 10 of the fund’s life. In most cases, it’s not “spendable” or available for gifts until year 10.

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5. Real PE/VC Professional’s “Cowboy Math” – Part 2

• There is a $65M gain of which the LP members typically get 80% or

$52M. Many funds have “hurdles” rates of about 8% per year. This means that the LPs get 8% per year on their capital first. If the fund returns less than 8% per year the GP doesn’t get any “carry.”

• LP members get $152M back or the median return of 1.5 times their $100M.

• The GP gets 20% or $13M in “carry” plus the $15M in management fees for their ten plus year efforts.

Roslyn’s note: Roughly ¾ of the $13M would be distributed to the partners in GP & MP. Most of the remainder ($3M+) would go to execs in Tier 2.

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5. Examples & Case Studies – Basic Clarkenomics 1.0!

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From “Hedge Funds 101” Presentation (3/26/14)

Here is some rough and conceptual math for annual HF revenue, assuming $1B in fee-generating assets under management with a 10% return. It does not take hurdle rates and past performance into consideration. Assets x 2% management fee: $1,000,000,000 x .02 = $20,000,000+ Assets x 10% return x 20% performance fee: $1,000,000,000 x .01 x .20 = $20,000,000 Management fee plus performance fee = $40,000,000 Total Net Revenue Compensation is Total Net Revenue divided (not equally) by headcount and depends on strategy. (Some strategies require more people and/or labor than others.) A typical $1B hedge fund will have 20 to 30 employees including 10 investment professionals. Key Roles (of job functions) at a hedge fund are: Portfolio Manager. Trader, Investor Relations/Marketing, Analyst, Technology, Operations & Legal

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Published List Methodology Forbes, 2/26/14 The 25 Highest-Earning Hedge Fund Managers and Traders by Nathan Vardi “To determine the highest-earning hedge fund managers and traders of 2013, we examined hedge fund returns and worked to understand the fee and ownership structure of a wide array of money management firms. Hedge funds generally reap fees equal to 20% of profits and 2% of assets, but we found all sorts of variations on this theme. In addition, our earning figures include the personal gain or loss of each manager’s interest in their funds. Our figures are pretax, account for firm expenses and profit-sharing arrangements, and exclude gains or losses stemming from ownership in the investment firms themselves or from investments held outside the managed investment pools.”

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5. Real Info From Academic Paper

on PE & VC Firms

• In general, PE buyout funds earn substantially higher revenue per partner and per professional than VC funds.

• Expect lifetime fees to be less than 20%.

• Over 93% of VC funds and over 83% of PE buyout funds in the study’s sample

charge performance fees based on committed capital.

• Virtually all funds with a hurdle use a rate between 6% and 10%. About 65% of VC firms and of 75% of PE firms sampled used a hurdle rate of 8%.

• A common maximum for the cost of establishing the fund is $1M.

Source: Metrick & Yasuda (2010)

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5. Examples & Case Studies A collection of real situations, reporting issues & math that demonstrate trends,

challenges, and limits for your compensation estimates such as:

• Which parts of the Form ADV are misleading and/or open to interpretation?

See Examples A & B.

• What other SEC forms may be helpful? Forms D, 13 F, 13G, 13D are relevant,

and informative for certain firms, but they don’t give you the whole picture.

The most detailed and informative is probably the Form PF, but it isn’t publicly

available.

Page 61: Investment Advisers:

5. Examples & Case Studies - Continued • What other facts or figures should you consider to arrive at a good estimate?

– Assets across time. How much of an increase or decreases was due to new investors

vs. performance?

– If you have access to specialized sources or databases, you might find detailed info

on performance and asset history.

– For PE & VC firms, gross returns of 18% + indicate profitability for the firm; net

returns of 11%+ to limited partners induce them to invest with the firm. (Source: Journal of

Investment Management, Vol. 11, Num. 4, Fourth Quarter 2013)

– Everybody should check for any details published in the news.

– Also, look for info on which investment strategies or sectors have been the most

successful in any given year.

Page 62: Investment Advisers:

5. Examples & Case Studies - Continued • Can the huge publicly traded firms tell us anything about compensation at

private firms? The ratios for fee income to compensation expense are public

info, but I’m not yet sure how comparable/informative hey are for private firms.

• What are Operating Partners and how do they get paid? There are two basic

categories of OPs. One is employed and paid by the PE/VC firm and assigned to

a fund or portfolio. The other is employed by another entity and mostly paid out

of fees charged to the portfolio company vs. the LP. Check out Heidrick &

Struggles 2014 Operating Executive Compensation Report!

Page 63: Investment Advisers:

5. Examples & Case Studies Continued

• How did one hedge fund decide percentages for each GP member? What

happened when one GP member left the firm? Check out the Viking Global

lawsuit! Halvorsen & Ott were sued by cofounder Brian Olson and details of

their respective compensation agreements are in the public record.

http://www.nybusinessdivorce.com/uploads/file/Olsen5-13-09.pdf

http://www.appellate.net/briefs/Olson_AppelleesBrief.pdf

• How much do fee and distribution schedules affect liquidity and philanthropic

capacity? The lifecycle of PE/VC funds creates income and liquidity spikes

every 10 years or so. At HFs, they spikes are more variable in 2 to 5 year cycles.

Page 64: Investment Advisers:

Example A: Ownership codes total more than 100% when counting joint interest with spouses

Page 65: Investment Advisers:

Example B: Ownership Questions in Schedule D, Section 7.B.(1) Private Fund Reporting

This is Smith, Lang & Horn’s VGE III Portfolio Ltd. The percentages seem lower than one might expect

based on the description in the Brochure. In other cases, I’ve noticed the percentages across funds

are far-fetched or impossible. This is most likely because some definitions are still open to

interpretation. As a group, industry attorneys and compliance consultants are still discussing and

working out best practices for their clients.

Page 66: Investment Advisers:

6. ADV Map & Guide

http://www.adviserinfo.sec.gov/IAPD/Content/Search/iapd_Search.aspx

Page 67: Investment Advisers:

6. ADV Map & Guide Where to find what you need quickly… • Part 1A, Items 1 & 2: Quickly confirm you have the right fund & what size/type it is. • Part 2 (Brochure): Overview, strategy, fees and assets in narrative form. (ERAs are not required to

create a brochure.) • Schedule A: Names the direct owners and executive officers • Schedule B: Names any indirect owners • Schedule D: Information on each private fund

– If an advisers’ principal office is outside the US, it doesn’t have to file the Schedule D for funds not owned or offered in the US

– Section 7.B. (1) , Question 3 lists the name(s) of general partner, manager, trustee or director – Section 7.B. (1) , Question 10 lists 7 types of private funds for the filer to choose: hedge,

liquidity, private equity, real estate, securitized asset fund, venture capital or other – Section 7.B. (1), Question 11 lists the current gross asset value of the fund – Questions 12, 13 & 14 may also be helpful

Page 68: Investment Advisers:

Resources & Reading

• Managed Funds Association’s Hedge Fund Glossary http://www.managedfunds.org/hedge-fund-investors/hedge-fund-glossary/

• David Allison’s Learn the Lingo of Private Equity Investing (Investopedia.com, 7/17/2013)

http://www.investopedia.com/articles/stocks/09/abcs-of-private-equity.asp • Heidrick & Struggles has several great reports, including 2012 US Investment Professional

Compensation Survey Analysis • Article by former hedge fund trader with his compensation info - New York Times, 1/18/14: For the

Love of Money by Sam Polk • Article on other fees at PE firms – Wall Street Journal, 5/7/2014: SEC Finds High Rate of Fee, Expense

Violation at Private-Equity Firms by Gillian Tan • About Operating Partners - PEI (Private Equity International): Private Equity Compensation and

Incentives, Chapter 15 – How to attract and retain talent, by Simon Buirski and Simon Francis, Lancor

Page 69: Investment Advisers:

Resources & Reading

• Article about “skin in the game” - New York Times, 5/29/2014: Fund Within a Fund Creates a Conflict by William D. Cohan

– “It is common knowledge that hedge fund managers and their employees (proudly)

invest alongside other limited partners to show they have skin in the game, that they eat their own cooking. Setting up another vehicle just for the manager’s partners/employees seems awkward and redundant unless the manager can clearly explain to their limited partners the reason for the existence of this extra investment vehicle.”

– What typically happens at the big private equity funds is that, as Mr. Radonjic points out, top executives invest alongside limited partners in the same deals and in the same funds so there is no question that their collective interests are precisely aligned.”

Page 70: Investment Advisers:

Resources & Reading • Articles on financial institutions/bank subsidiary companies buying a minority stake in hedge

funds – New York Times, 3/14/07: As House Talks Hedge Funds, Lehman Buys Stake in One by Jenny

Anderson – New York Times, 5/21/14: For Sale: 20% Stake in Hedge Fund. Terms: Complicated by

Matthew Goldstein and Alexandra Stevenson • “One hedge fund manager with knowledge of the arrangements who spoke on

condition of anonymity, said precrisis deals assumed a higher valuation than many of the funds were now worth. The manager said those deals assumed that a hedge fund was worth 15 times as much as its revenue. Now, a single-digit multiple is more realistic.

• About valuing partnership stakes and the break up of general partnerships

– The Hedge Fund Law Report, Vol. 3, No. 23, 6/11/2010: Strategies for Avoiding Valuation Disputes in Connection with Breakups of Hedge Fund General Partnerships by Donald M. May, PhD at Marks Paneth & Shron LLP

– New York Times, 3/14/07: As House Talks Hedge Funds, Lehman Buys Stake in One by Jenny Anderson

– New York Times, 5/21/14: For Sale: 20% Stake in Hedge Fund. Terms: Complicated by Matthew Goldstein and Alexandra Stevenson

Page 71: Investment Advisers:

What Industry Publications Say Hedge Fund Law Report, Vol. 3, No 23 Strategies for Avoiding Valuation Disputes in Connection with Breakups of Hedge Fund General Partnerships by Donald M. May PhD • “The formulas by which GP limited partners are compensated are complex, and the

stakes are frequently high. In the best case scenario, the complexity inherent in valuing many of the assets held by hedge funds makes it challenging to accurately effectuate the compensation formulas for GP limited partners.”

• “The nature of hedge funds makes valuation of GP limited partners shares complex

and ambiguous….Guidelines for the valuation of investments – a fundamental input into the valuation of the general partnership – must be linked to the assets in which the fund invests and the fund’s investment strategy.”

Page 72: Investment Advisers:

What Industry Publications Say PE Manager, July 2013, Issue 107 Carry through the ranks by Pepper Hamilton lawyer Julia Corelli The firm’s policy on vesting carried interest is a key tool in retaining the next generation of senior management • “Vesting into carry is commonly recognized as a key retention tool and is typically done as ‘reverse

vesting’ where the person receives 100 percent of the interest up front, the interest is subject to forfeiture and the forfeiture risk is removed over the vesting period.”

• “The periods over which carried interest forfeiture restrictions lapse vary dramatically among

private equity firms.” • Four examples given to demonstrate additional considerations that may be influential. “In each

case, the manager had to be with the firm for the fund’s entire life in order to receive the full carry the manager was awarded.”

• “The more junior employees may need to receive their share of the carry through a separate employee ownership vehicle that is entitled to a pool of carry dollars, increasing costs of administration, but decreasing transparency and increasing control.”

Page 73: Investment Advisers:

What Industry Publications Say PE Manager, July 2013, Issue 107 Comparing notes by Torrey Hullum Firms registered with the SEC may use different tactics when completing their ‘Form ADV Part 2’; but some best practices are emerging. • “Registration with the Securities and Exchange Commission (SEC) last year has introduced many

private equity firms to a reporting requirement where agency guidance is sparse and the pool of previously filed reports to glean insights from is inconsistent.”

• “In just one period a fund may fall in and out of hedge fund or private equity status, and in order

to avoid inconsistencies…some firms tend to be more aggressive in their disclosures than others.”

• “Inconsistent messaging from third party resources also poses a barrier to disclosure uniformity. Firms are receiving different advice from law firms and consulting agencies who are assisting them in complying with Form ADV requirements, gripe industry sources.”

• “As time goes on, there is no question that these disclosures will become more consistent,

predict industry compliance experts.”

Page 74: Investment Advisers:

6. TMI (Too Much Information?) • Firms file as either a “Registered Investment Adviser” (RIA) or “Exempt Reporting Adviser” (ERA) • To qualify as an ERA, firms must fit 1of these 3 categories:

– Only manage venture capital funds (which means they qualify for the Venture Capital Exemption)

– Only manage private funds in the US totaling less than $150M – Have no place of business in the US, fewer than 15 clients in the US, and less than $25M in

aggregate AUM from those clients and investors • Firms with less than $25M in AUM are “Small” and don’t have to register with the SEC • Firms with $25M to $100M in AUM are “Mid-Size” (a new category)

– State authorities have primary responsibility for their oversight and regulation – Because of market fluctuations or client loss, advisers with $90M+ at the time of filing still

qualify as mid-size. At $110M+, they must register with the SEC. – 2 other reasons they will register with the SEC:

• The state where the firm maintains its principal office/place of business does not require it. (They include New York, Minnesota & Wyoming)

• If registered with in a state that does NOT subject the firm to examination by the state’s securities commissioner

Page 75: Investment Advisers:

6. TMI Continued

• Firms with $1.5B in AUM or more are “Large” and must provide the most detail

• Different provisions of the Dodd-Frank Wall Street Reform Act took effect on different dates. Most of those that apply to Investment Advisers were effective July 2011.

• Among other things, Dodd-Frank established the use of RAUM.

• The ADV is for 7 types of Private Funds listed in Schedule D, Section 7.B.(1), Question 10: hedge, liquidity, private equity, real estate, securitized asset, venture capital, and “other.” Most funds and firms identify as or focus on hedge, private equity and venture capital funds.

Page 76: Investment Advisers:

Sources & Credits • http://mashable.com/2012/10/15/light-speed-travel-possible/ (Einstein photo) • http://www.thecuttingedgenews.com/index.php?article=78218 (Barney Frank with gavel

photo) • The New Yorker, 1/12/09 (photo of Barney Frank) • Mike Twohy for The New Yorker (cartoons) • http://www.hbs.edu/recruiting/mba/data-and-statistics/employment-statistics.html • Private Equity Funds: Formation and Operation by Stephanie R. Breslow and Phyllis A.

Schwartz, (2009) • Hedge Funds and Other Private Funds: Regulation and Compliance by Thomas Lemke, Gerald

Lins, Kathryn Hoenig and Patricia Rube (2012-2013) • A Model of Private Equity Fund Compensation by Andrew Metrick, Ayako Yasuda & Wohnho

Wilson Choi (2011) • The Economics of Private Equity Funds by Andrew Metrick & Ayako Yasuda (2010)

Page 77: Investment Advisers:

Sources & Credits - Continued

• Hedge Fund Agreements Line By Line, Second Edition, by Gregory J. Nowack, Esq. (2009) • “Hedge Funds 101” presented by Howard Wolk, Jeffrey Kushner, Richard Blond & Joshua

Friedman (Harvard Kennedy School, March 2014) • (Managing Hedge Fund Managers by Edward J. Stavetski (2009)) • Venture Capital & The Finance of Innovation, Second Edition, by Andrew Metrick & Ayako

Yasuda (2010) • Journal of Investment Management, Vol. 11, No. 4, Fourth Quarter 2013: The Evolving

Structure of the Private Equity and Venture Capital Industry” by Mark A. Wolfson

Special thanks to student worker extraordinaire Bryce Mullins!

Page 78: Investment Advisers:

Questions?

Roslyn Clarke Assistant Director of Research Alumni Affairs & Development

Harvard University [email protected]


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