The importance of a robust business plan in managing process and risk.
By Malcolm Goddard, COO, Zetland.
A robust business plan is a critical tool for managing the process and the risk involved in what is an expensive undertaking. In addition to simple cost budgeting, your business plan must consider a myriad of other factors — not least of which is timing and sequencing.
Main takeaway:
You must consider many things when starting a new venture. However, having a robust and flexible business plan, with the strategy at its core, is the key to mitigating risk, keeping costs controlled and having and applying the right resources at a sensitive stage.
A business plan should lay out all aspects of the business that are necessary to achieve objectives and offer a realistic assessment of what is affordable. While not necessarily a road map to certain success, a business plan can reduce the risk and potential cost of failure. A plan is also essential for other early stakeholders as they may be taking business risk. This includes any seed investors and potentially early-stage fund or product investors. Additionally, regulators will want to see it to check that the business is established in a manner that it will be able to continue to provide services without interruption.
Starting point
Is a brief assessment of what is needed (rather than desired) and how it’s paid for. Investors will want to see a resourced operation if they are to invest — but they need to invest to pay for this operation in the longer term. So, this conundrum must be dealt with by looking at...
Next steps
…an assessment of and the timing of fee income. It's essential to the timing/risk levels, and there are a number of things to consider: What is the nature of the start-up? Is it a spin-off with an existing team and track record? Is there a track record? This tends to make fundraising more straight forward/quicker as there is a demonstrable record. If not, how can it be developed and how quickly? Is there a seed? Is a managed account or white-labelled product a first step? Where are potential investors based (this bears on fund structure, documentation, costs and regulatory environment)? What will it cost to raise this money (placement agents, pay-aways, etc.) and what is the give-up, if any, to early-stage investors? It could be better to play a longer game by using things like managed accounts or managed transactions to establish an independent track record before going headlong into fundraising. Most fund investors will want to see evidence of this prior to investing. Setting up a fund is also expensive and comes with risk. Regulation
Since the last edition the regulatory landscape has changed significantly, which has added to complexity and cost. Brexit, the loss of passports and the unclear nature of post-Brexit arrangements makes raising or managing assets in Europe significantly more difficult and more expensive. Cayman has come under fire (by Europe) and has had overhauled its rulebook, not necessarily to 'hedge funds' advantage. If the aim is European investors, there are hosted or platform solutions available, but these add cost and operational complexity. So it is more likely all of this means early-stage investors will be based in the United States, where this is less of an issue.
Fund costs
I have deliberately not commented on issues like fund administration, establishment and legal costs associated with setting up the fund — these are normal fund costs, and the outsourced model is standard. However, this is if a fund is successful. If not, the costs revert to the principal - so more risk. So, be absolutely certain that the marketing legwork has been done and reviewed before commissioning, and know what the break-even AUM is at various fee levels (taking MFN potential issues into consideration).
In addition, there is the manager’s contribution to the fund. Despite the cost of setting up the management entities there is an expectation that the manager will also invest in the fund. This will either be part of the fund docs or a side letter, so this (and other significant side letter terms - including expense caps) must be discussed and agreed on with early investors to close these points and give a clearer vision of what is left.
Establishing all of this determines what infrastructure is needed to support the offering — fundamentally this is the basis of viability and what can be afforded at the start.
All of this should demonstrate that raising money is the hard part. Although confidence is necessary to starting a business, overconfidence is a danger. A good guide for the plan: unless the fees are guaranteed, take a 30 to 40 percent haircut. If things are not viable at this point, move on.
Cost base
Having determined the revenues, then determine the cost base. Above the base requirement, this is what can be afforded against the timing of revenues and the principal’s contribution. This must be limited to must-haves rather than nice-to-haves — which can wait until the business is sustainable. Following are six strategies to keep a lid on fixed overheads and to divert resources to their maximum benefit - usually people and systems.
1. Outsource where possible
The more staff directly employed, the greater the cost — in both direct and indirect terms (office space, supplies, management, etc.). Using external resources, although somewhat costly, negates the need to hire expensive staff to perform these functions and also reduces potential tail-costs in things like software licenses and staff costs in the event things are unsuccessful.
It is standard to outsource accounting, payroll, compliance monitoring, etc, and IT (depending on the complexity of the strategy requirements). And as this is a standard model, it will generally pass operational due diligence (ODD).
2. Use free stuff
There is plenty of free advice out there if you know where to look. Prime broker consultants are an obvious starting point (subject to the points below). Further, there is an active network containing plenty of free advice.
Use your initial meeting with potential suppliers to gather information. If you use the comps, they should be enough to point you in the right direction without the need for expensive commissioning studies.
3. Remember, suppliers can be homogenous
Prime brokering consultants are a useful source of contacts, although I would note that the smart suppliers have done their homework and have long-term relationships with them.
It’s amazing how you see the same names on the roster or sponsoring conferences. It's easy to be cynical, but is this an indication of quality or an indication that these suppliers have figured out the best way into this marketplace?
Recognize quickly what you need to pay for and what is homogenous. Is a lawyer, accountant, compliance consultant, etc., providing a differentiated product or service? Unlikely. Recognize this and either set them against each other or go off-script. At least see what deals are out there. Recognize what you need to pay for and challenge the rest.
4. Don’t own it
The key is flexibility. If it’s possible to lease, do so rather than buy. For example, serviced offices work fine for a start- up. There's plenty to choose from at varying quality and price points. Most will offer packages that include telecoms and internet. The good ones also have tested BCPs, thus will have policies that will pass regulatory and ODD muster. IT can also be leased. Indeed, in the current environment is it necessary to have a fixed-base, or will working from home with a place for meetings be sufficient? Most serviced offices can readily accommodate expansion or contraction and have no long-term contracts to inhibit future actions, and you pay just for what you use, thus avoiding the tendency to over-order. Also, given the present environment, there are deals to be done.
5. Share the risk
Capped fees (particularly among those who charge by the hour) are difficult to get, but plenty of suppliers will do a catch-up (a period of time with a reduced charge with a “catch-up” later on) if asked. Such an arrangement is useful, particularly in the early days when cash will be at its tightest. Equally, if looking at corporate structure, do you trade salary for equity? Can you pass the partnership tests for tax authorities? Do you use consultancy arrangements? If you don’t ask, you don’t get.
6. Hire an experienced COO
To mitigate significant financial risk (and with their own money) it really is essential for principals to have somebody who understands and is experienced with how all of this works. Taking on an experienced COO can be a difficult step for a principal who is emotionally attached to what is their “baby.” Indeed, the COO may be perceived as a threat as they can say “no” a lot. A good COO isn’t just the recs person, but is part business manager, part accountant and part lawyer and will challenge certain assumptions, strategies and goals. A really good COO is also a good communicator as such questioning may be difficult for a principal to hear and, inevitably, time will be needed for trust to build.
However, a start-up is no place for an amateur. An experienced COO will save both time and money, will have the necessary connections, and will recognize or know where the bear traps are, thus saving principles from expensive mistakes. Additionally, having another person take on COO responsibilities frees up bandwidth for the principal to focus on marketing and portfolio management, which helps towards success. Scrimping on this can in itself be expensive, but getting the right person will be the best money spent. Running a hedge fund is completely different from running infrastructure in a bank, and the role goes way beyond just doing recs.
A robust, flexible business plan is key
You must consider many things when starting up a venture. Write them down. Having a robust, tested and flexible plan with the strategy at its core is the key to mitigating risk and applying the right resources at a sensitive stage. It also can be the blueprint for building out, once breakeven has been reached.
But at the starting point be ruthless in considering what is needed (as opposed to desired) and know how, when and from what cash flows it is paid for. When does the venture wash its face? The rest can wait.
About the contributor
Malcolm Goddard, an award-winning COO, is presently COO of Zetland; a growing manager investing in special situations in Europe is currently raising its second fund. He has been involved in developing financial services businesses on the buy and sell side since the early 1990s. He spent 10 years as COO of an award-winning hedge fund and has also consulted to a number of new and existing managers. An active member of the alternative community, Malcolm was recently voted “COO of the Year” for 2020 in the Drawdown Awards.
