---
title: "Launching a Fund and Raising Capital"
book: "The Desk and the Firm"
subject: quant
language: en
chapter: 25
exercises: 8
source: https://one-course.com/books/quant/16/en/chapter/25-launching-a-fund-and-raising-capital
---

# Chapter 25 — Launching a Fund and Raising Capital

A new manager with a two-year track record at a Sharpe ratio of 1.5 wants a hundred million dollars. The record is barely two standard errors from zero; the fund loses money on every dollar below its break-even size; and the seeder’s term sheet asks for a fifth of the firm’s revenue for as long as the fund exists. Each of the three numbers is negotiable, and each decides whether the fund survives its first three years.

## 25.1 The first hundred million

**Definition 25.1 (Emerging manager).**

An *emerging manager* is an investment manager early in its life, typically with a short track record and assets below the size that large allocators require, often run by people who managed money at another firm before.

A fund’s costs arrive before its assets. People, the administrator, the auditor, lawyers, data and technology (chapter 4’s service providers) cost the chapter’s manager $2.2 million a year before a dollar is managed, plus 5 basis points of assets. Its fees are 1.5% of assets and 20% of gains: on a 10% gross year, 3.2% of assets ([Listing 25.1](#lst-fm-launching-a-fund-and-raising-capital-model), with Book 1’s fee engine). The fund breaks even at $69.8 million of assets; with a seeder taking 20% of the fee revenue, at $87.6 million.

**Proposition 25.2 (Break-even size).**

With fixed costs $F$ a year, variable costs $v$ per dollar of assets, fee revenue $f(g)$ per dollar in a year of gross return $g$ and a revenue share $s$, the fund covers its costs from assets of

$$
A^*=\frac{F}{(1-s)\,f(g)-v}.
$$

**Proof.** Net revenue $(1-s)f(g)A$ covers $F+vA$ exactly at $A^*$. ∎

```python
def annual_fees(aum, gross, terms):
    """Management and performance fees on `aum` over a year with gross return `gross` (firm.fees, one period)."""
    _, m, p = ff.accrue(terms, ff.InvestorState(1.0, 1.0), gross)
    return aum * (m + p)


def breakeven_aum(launch, gross):
    """Assets at which fees net of the revenue share cover fixed and variable costs, for an expected gross return."""
    terms = ff.FeeTerms(mgmt=launch.mgmt, perf=launch.perf)
    per_dollar = annual_fees(1.0, gross, terms) * (1 - launch.revenue_share) - launch.variable_bp * 1e-4
    return launch.fixed_costs / per_dollar if per_dollar > 0 else math.inf


def tstat(sharpe, years):
    return sharpe * math.sqrt(years)


def years_for_t(sharpe, t=2.0):
    return (t / sharpe) ** 2

```

***Listing 25.1.** Fees from firm.fees, the break-even size, and the t-statistic of a Sharpe ratio and the years it needs. code/firm/fundlaunch/firm_fundlaunch.py*

## 25.2 Seed capital and its price

**Definition 25.3 (Seed investor, revenue-share agreement, capacity right).**

A *seed investor* provides a new manager’s first large allocation, usually locked up for several years, in exchange for economics beyond the fund’s returns. A *revenue-share agreement* gives the seeder a share of the manager’s gross fee revenue, sometimes for the life of the business and sometimes until a buy-back. A *capacity right* entitles an investor to add to its allocation later, even when the fund is closed to others.

**Definition 25.4 (Founders’ share class).**

A *founders’ share class* offers the earliest investors lower fees, for example a lower management fee or performance fee, for as long as they stay invested, often closed once the fund reaches a stated size.

The seeder’s share is expensive: it raises the break-even by $17.8 million and takes a fifth of every future fee. It buys time. The chapter’s manager either launches with $50 million from a seeder that takes 20% of revenue, or with $15 million from friends and family and no seeder; everything else is the same ([Table 25.1](#tab-fm-launching-a-fund-and-raising-capital-cases)).

## 25.3 What a track record proves

A Sharpe ratio estimated from $T$ years of returns has a standard error of about $1/\sqrt T$ (Book 4), so its $t$-statistic is $S\sqrt T$. A record at a Sharpe ratio of 1.5 over two years has $t=2.12$; a Sharpe ratio of 1 needs four years to reach $t=2$, and 0.5 needs sixteen. Investors who wait for statistical evidence therefore wait years, and the fund must survive them. Book 4’s deflated Sharpe ratio sharpens the point: a manager who tried several strategies before launching one has a weaker record than its $t$-statistic says.

**Definition 25.5 (Track record portability).**

*Track record portability* is the extent to which a manager may present performance achieved at a previous firm as its own: in the United States it is allowed in advertisements only under the conditions of the SEC’s marketing rule ([Box 25.1](#dat-fm-launching-a-fund-and-raising-capital-marketing)).

**As of September 2026 — Advertising performance in the United States.**

The SEC’s marketing rule (17 CFR 275.206(4)-1, adopted in 2021) forbids an adviser to advertise gross performance without net performance of at least equal prominence; requires one-, five- and ten-year periods for performance other than private funds’; and allows predecessor performance only if the people primarily responsible for it manage accounts at the advertising adviser, the accounts are sufficiently similar, all substantially similar accounts are included unless excluding them would not materially raise the results, and the advertisement discloses that the performance was achieved at another entity. This box summarises the rule’s text and is not legal advice.

Aggarwal and Jorion’s study of emerging hedge funds and managers (2010) is the reference on whether new funds perform differently from established ones; for the chapter the point is narrower: whatever a new fund’s true skill, its investors can see little of it for years.

## 25.4 Tutorial: the first hundred million

**Goal.** Simulate a fund’s first five years with and without a seed deal: its assets, the probability of reaching $100 million, and the value of the deal to the manager and the seeder. **End state:** the fan chart ([Figure 25.1](#fig-fm-launching-a-fund-and-raising-capital-fan)) and the probability curves ([Figure 25.2](#fig-fm-launching-a-fund-and-raising-capital-reach)).

1. **The strategy.** A true Sharpe ratio of 1 at 10% volatility; monthly returns drawn independently (illustrative).
2. **The investors.** Each month assets grow by an inflow of up to 4% of assets, scaled by a logistic function of the track record’s $t$ -statistic (half confidence at $t=2$ , none in the first six months), and shrink by 10% in months when the fund is more than 10% below its peak.
3. **The economics.** `firm.fundlaunch.simulate` gives 2 000 paths of assets and net fees; `manager_value` discounts fees less costs at 8%; `seed_value` values the seeder’s revenue share.
4. **The comparison.** `fm_launch.summary()` for the seeded and the unseeded launch.

|  | seeded, 20% share | unseeded, $15 million |
| --- | --- | --- |
| break-even assets ($ million) | 87.6 | 69.8 |
| probability of $100 million within 3 years | 43.2% | 0.25% |
| median month of reaching it (paths that do, in 5 years) | 32 | 51 |
| assets at 3 years, 10th / 50th / 90th percentile | 30.7 / 88.9 / 186.0 | 9.2 / 26.7 / 55.8 |
| below break-even after 5 years | 32.3% | 64.5% |
| manager’s value, 5 years ($ million) | 7.52 | $-2.85$ |
| seeder’s revenue share, 5 years ($ million) | 4.21 | – |

***Table 25.1.** A fund’s first five years with and without a seeder (2 000 simulated paths each; values discounted at 8%). Data: `fm_launch.summary`.*

![Assets of the seeded fund over its first five years: percentiles of 2 000 simulated paths, and the break-even size with the seeder’s revenue share (dashed, $87.6 million). A third of the paths are still below it after five years. Data: fm_launch.fan.](https://one-course.com/images/onecourse/chapters/quant-16/fm-launching-a-fund-and-raising-capital/fig-1c27232081c0.svg)

***Figure 25.1.** Assets of the seeded fund over its first five years: percentiles of 2 000 simulated paths, and the break-even size with the seeder’s revenue share (dashed, $87.6 million). A third of the paths are still below it after five years. Data: `fm_launch.fan`.*

The seed changes everything in the model. With $50 million the fund has a 43% chance of reaching $100 million within three years, typically in month 32; with $15 million the chance is a quarter of one per cent, since the inflows that a track record attracts are proportional to the assets already there, and a small fund grows slowly even when its record is good. Over five years the seeded manager’s business is worth $7.52 million after the seeder’s $4.21 million; the unseeded manager’s loses $2.85 million. The seed is worth $10.37 million to the manager, and the revenue share costs it $4.21 million of that: a price worth paying in the model, and a large one ([Figure 25.3](#fig-fm-launching-a-fund-and-raising-capital-values)).

![The probability that the fund has reached $100 million by each month, with and without the seed. Data: fm_launch.reach_curve.](https://one-course.com/images/onecourse/chapters/quant-16/fm-launching-a-fund-and-raising-capital/fig-92c93de70a84.svg)

***Figure 25.2.** The probability that the fund has reached $100 million by each month, with and without the seed. Data: `fm_launch.reach_curve`.*

![The seed deal’s value over five years to the manager and the seeder, against launching alone with $15 million. Data: fm_launch.summary.](https://one-course.com/images/onecourse/chapters/quant-16/fm-launching-a-fund-and-raising-capital/fig-f6781488e8aa.svg)

***Figure 25.3.** The seed deal’s value over five years to the manager and the seeder, against launching alone with $15 million. Data: `fm_launch.summary`.*

## 25.5 Due diligence

**Definition 25.6 (Operational due diligence, due diligence questionnaire).**

*Operational due diligence* is an investor’s review of a manager’s non-investment functions: governance, valuation, trade processing, cash controls, service providers, compliance, technology and business continuity. A *due diligence questionnaire* is the standard document of questions a manager answers for it, usually in an industry association’s format, with the supporting policies attached.

[Operational due diligence](#def-fm-launching-a-fund-and-raising-capital-odd) fails funds that pass the investment review: a single person able to move cash, marks set by the trader (chapter 15), an administrator that only records what the manager tells it. The chapters of this book are the answers a new manager needs: the risk function (chapter 12), operations (chapter 13), compliance (chapter 16), the legal documents (chapter 18), crisis plans (chapter 27).

**Method 25.7 (Raising the first hundred million).**

1. Compute the break-even size and the months of costs the firm can fund before reaching it, on pessimistic inflows.
2. State what the track record proves, with its $t$ -statistic and the number of strategies tried, and what it cannot.
3. Negotiate the seed on the revenue share’s size, duration and buy-back, the lock-up, [capacity rights](#def-fm-launching-a-fund-and-raising-capital-seed) and information rights, valued on the firm’s own model of its growth.
4. Prepare [operational due diligence](#def-fm-launching-a-fund-and-raising-capital-odd) before the first meeting: policies, service providers, controls, a completed questionnaire.
5. Offer a founders’ class to early investors, closed at a stated size.

## 25.6 Raising: investors, consultants and the pitch

An allocator that will not own more than a small share of any fund cannot invest much in a small one, and one that waits for a statistically convincing record waits years (the previous section); the consultants many allocators use screen the same way. The early money therefore comes from the manager’s network, seeders, family offices, funds of [emerging managers](#def-fm-launching-a-fund-and-raising-capital-emerging) and platforms (chapter 3), each with its own price. The pitch is the track record, the strategy’s capacity and the operational answers; the negotiation is over fees, liquidity and the [side letters](https://one-course.com/books/quant/16/en/chapter/4-the-asset-manager-and-the-fund#def-fm-the-asset-manager-and-the-fund-side) (chapter 4) that the largest early investors ask for, subject to the [most-favoured-nation clauses](https://one-course.com/books/quant/16/en/chapter/4-the-asset-manager-and-the-fund#def-fm-the-asset-manager-and-the-fund-side) they will later trigger.

## 25.7 Build: the launch model

**Purpose.** A fund launch’s economics: costs, fees net of the revenue share, break-even size, inflows driven by the track record, the probability of reaching a size, and the seed deal’s value to both sides.

**Interface.** `firm.fundlaunch`: `Launch`, `annual_fees` (on `firm.fees`), `breakeven_aum`, `tstat`, `years_for_t`, `simulate`, `prob_reach`, `first_month`, `manager_value`, `seed_value`.

**Rules.** Fees are computed by Book 1’s engine; the revenue share is taken from gross fees; no inflows before six months of record; assets never fall below zero.

**Acceptance tests.** `code/firm/fundlaunch/tests/`: fees and break-even on hand numbers; path shapes; the helpers on small arrays.

**Stretch.** A buy-back of the revenue share; founders’ class fees; the seeder’s own return on its capital; serial correlation of returns.

Sources and further reading

- 17 CFR 275.206(4)-1 (the SEC marketing rule).
- V. Aggarwal and P. Jorion, “The performance of emerging hedge funds and managers”, *Journal of Financial Economics* , 2010.

## 25.8 Exercises

**Exercise 25.1 ★.**

Compute the fee revenue per dollar in a 10% gross year at 1.5 and 20, and the break-even size with and without a 20% revenue share.

**Solution of Exercise 25.1.**

$1.5\%+20\%\times(10\%-1.5\%)=3.2\%$. Without the share, $2.2/(0.032-0.0005)=\$69.8$ million; with 20%, $2.2/(0.8\times0.032-0.0005)=\$87.6$ million.

**Exercise 25.2 ★.**

How many years does a Sharpe ratio of 1 need to be two standard errors from zero? A Sharpe ratio of 0.5?

**Solution of Exercise 25.2.**

$(2/1)^2=4$ years; $(2/0.5)^2=16$ years.

**Exercise 25.3 ★.**

Which conditions must a manager meet to advertise performance achieved at its previous firm in the United States?

**Solution of Exercise 25.3.**

The people primarily responsible manage accounts at the new adviser; the accounts are sufficiently similar; all substantially similar accounts are included unless excluding them would not materially raise performance; and the advertisement discloses that the results were achieved at another entity.

**Exercise 25.4 ★★.**

Why does the unseeded fund almost never reach $100 million within three years, although its strategy is the same?

**Solution of Exercise 25.4.**

Inflows are proportional to assets already managed and scaled by the record’s $t$-statistic: a $15 million fund with the same record attracts less than a third of the seeded fund’s inflows, and its record needs years to convince.

**Exercise 25.5 ★★.**

What is the seed worth to the manager over five years, and what does the revenue share cost it?

**Solution of Exercise 25.5.**

$7.52-(-2.85)=\$10.37$ million over five years; the revenue share costs $4.21 million of it.

**Exercise 25.6 ★★.**

Why do [operational due diligence](#def-fm-launching-a-fund-and-raising-capital-odd) failures stop funds that pass the investment review? Give three examples.

**Solution of Exercise 25.6.**

Investors cannot recover from operational failures by diversifying: a single signatory on cash, marks set by the trader without independent verification, an administrator that does not check the manager’s records.

**Exercise 25.7 ★★★.**

*Coding.* Rerun the seeded launch with a revenue share of 10%. What happens to the break-even size and the manager’s value?

**Solution of Exercise 25.7.**

The break-even falls to $77.7 million; the manager’s value rises to $9.62 million, and the seeder’s share to $2.10 million; the probability of reaching $100 million is unchanged (43.2%), since fees do not affect assets in the model.

**Exercise 25.8 ★★★.**

*Find the flaw.* “Our two-year Sharpe ratio of 1.5 proves our skill; investors will come.”

**Solution of Exercise 25.8.**

Two years at 1.5 is $t=2.12$, barely significant and weaker if several strategies were tried; investors who wait for evidence wait years, and the fund must survive until then.

## 25.9 Problem: The First Hundred Million

**Problem 25.1.**

Weekend problem — the first hundred million

A manager leaving a large firm must decide whether to accept a seeder’s offer or launch alone.

**Part I — The economics.**

1. Define an [emerging manager](#def-fm-launching-a-fund-and-raising-capital-emerging) .
2. State and prove [Proposition 25.2](#prop-fm-launching-a-fund-and-raising-capital-be) .
3. Give the break-even size with and without the revenue share.
4. Define a [seed investor](#def-fm-launching-a-fund-and-raising-capital-seed) , a [revenue-share agreement](#def-fm-launching-a-fund-and-raising-capital-seed) , a [capacity right](#def-fm-launching-a-fund-and-raising-capital-seed) and a [founders’ share class](#def-fm-launching-a-fund-and-raising-capital-founders) .

**Part II — The record.**

5. What is the standard error of a Sharpe ratio, and the $t$ -statistic of 1.5 over two years?
6. How long does a Sharpe ratio of 1 take to reach $t=2$ ?
7. Define [track record portability](#def-fm-launching-a-fund-and-raising-capital-port) and state the US rule.
8. How does the number of strategies tried change what the record proves?

**Part III — The launch.**

9. Describe the inflow model.
10. Give the probability of reaching $100 million within three years, seeded and unseeded.
11. Give the assets at three years and the share below break-even after five.
12. Give the manager’s and the seeder’s values.
13. What does the model leave out?

**Part IV — The decision.**

14. Define [operational due diligence](#def-fm-launching-a-fund-and-raising-capital-odd) and a [due diligence questionnaire](#def-fm-launching-a-fund-and-raising-capital-odd) .
15. What would you negotiate in the seed deal?
16. Would you accept the seeder’s offer?
17. Who else could provide early capital, and at what price?
18. What would you prepare before the first investor meeting?
19. State the *named result* : the break-even AUM and the months to a hundred million dollars under a 20 per cent revenue share, and the track-record length at which a Sharpe ratio of 1 is two standard errors from zero.
20. In two sentences, write the launch plan.

**Solution of Problem 25.1.**

1. See [Definition 25.1](#def-fm-launching-a-fund-and-raising-capital-emerging) .
2. See [Proposition 25.2](#prop-fm-launching-a-fund-and-raising-capital-be) .
3. $69.8 million and $87.6 million.
4. See Definitions [25.3](#def-fm-launching-a-fund-and-raising-capital-seed) and [25.4](#def-fm-launching-a-fund-and-raising-capital-founders) .
5. About $1/\sqrt T$ ; $1.5\sqrt2=2.12$ .
6. Four years.
7. See [Definition 25.5](#def-fm-launching-a-fund-and-raising-capital-port) and [Box 25.1](#dat-fm-launching-a-fund-and-raising-capital-marketing) .
8. Each strategy tried is a chance of a lucky record; the deflated Sharpe ratio (Book 4) discounts for them.
9. Monthly inflows up to 4% of assets scaled by a logistic function of the $t$ -statistic; redemptions of 10% a month after a 10% drawdown.
10. 43.2% and 0.25%.
11. Seeded: $30.7, 88.9 and 186.0 million at the 10th, 50th and 90th percentiles; 32.3% below break-even after five years (64.5% unseeded).
12. Manager $7.52 million seeded, $-\$2.85$ million unseeded; seeder $4.21 million.
13. Serial correlation of returns, capacity limits, the seeder’s return on its capital, the buy-back of the share, and investor behaviour beyond a single inflow rule.
14. See [Definition 25.6](#def-fm-launching-a-fund-and-raising-capital-odd) .
15. The share’s size, its duration and a buy-back, the lock-up, [capacity rights](#def-fm-launching-a-fund-and-raising-capital-seed) and information rights.
16. In the model yes: it is worth $10.37 million to the manager and costs $4.21 million.
17. Its network, family offices, funds of [emerging managers](#def-fm-launching-a-fund-and-raising-capital-emerging) and platforms, each with its own terms.
18. Policies, service providers, controls and a completed questionnaire, and an honest statement of what the record proves.
19. $87.6 million, reached in a median 32 months on the paths that reach $100 million; four years for a Sharpe ratio of 1.
20. Accept a seed with a revenue share that falls away after a buy-back, launch with [operational due diligence](#def-fm-launching-a-fund-and-raising-capital-odd) ready, and offer a founders’ class; plan costs to survive four years, the time a Sharpe ratio of 1 needs to convince.

## 25.10 Interview questions

**Interview question 25.1 ★ researcher.**

What is the standard error of an annual Sharpe ratio estimated from five years of data?

**Solution of Interview question 25.1.**

About $1/\sqrt5=0.45$ for independent returns (more exactly $\sqrt{(1+S^2/2)/T}$).

*What the interviewer is looking for: the $1/\sqrt T$ scaling.*

**Interview question 25.2 ★ trader.**

Why do new funds offer founders’ share classes?

**Solution of Interview question 25.2.**

To attract the capital that gets the fund to break-even, paying with lower fees for the early risk investors take.

*What the interviewer is looking for: early risk priced by fees.*

**Interview question 25.3 ★★ researcher.**

A fund’s costs are $2 million a year and it earns 2% of assets in fees. What is its break-even size, and how does a 25% revenue share change it?

**Solution of Interview question 25.3.**

$100 million; with a 25% share, $2/(0.02\times0.75)=\$133$ million.

*What the interviewer is looking for: the break-even formula.*

**Interview question 25.4 ★★ risk.**

What would you look for in [operational due diligence](#def-fm-launching-a-fund-and-raising-capital-odd) of a new manager?

**Solution of Interview question 25.4.**

Segregation of duties over cash, independent valuation, a reputable administrator and auditor, compliance policies, and business continuity.

*What the interviewer is looking for: controls a small team tends to skip.*

**Interview question 25.5 ★★ trader, researcher.**

Can you show investors the track record you built at your previous firm?

**Solution of Interview question 25.5.**

In the United States only under the marketing rule’s predecessor-performance conditions, and subject to the previous employer’s rights over its records.

*What the interviewer is looking for: portability conditions.*

**Interview question 25.6 ★★★ researcher.**

How would you value a seeder’s revenue share, and what terms would you trade against it?

**Solution of Interview question 25.6.**

Simulate the fund’s assets and fees and discount the share of fees paid away; trade against it the seed’s size, a buy-back, a sunset, and the lock-up the seeder accepts.

*What the interviewer is looking for: simulation and negotiable terms.*