Hi all, I received an offer by two guys who are interested in becoming partner of my algorithmic trading firm to assist with business development as they have quite long experience from the financial industry. Now, I've received a "valuation" so as to put a price tag on a 30% stake, however, I'm not sure whether the model used is appropriate since it's the first time I'm doing this exercise (see below). First of all, the valuation model only takes existing size into consideration, and not the fact that the AUM is growing rather fast (5-10x per year), also the current offer applies a very conservative 30% ROC, whereas it was almost 80% for 2014. Also the final clause which seems to put any shortfall on profits on me as founder seems very risky - shouldn't you as an investor shoulder such risk?! Thanks in advance for your comments. ### 1. Facts: a. AUM of $3.5M as of Feb. 2015 b. Methodology: 4 times EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization – essentially net income) i. This multiple of 4 times can be discussed further but it is not an unusual multiple but typically there would be a discount of approximately 20 to 30% applied because it is private and there is no ready market to sell into. c. Management Fee of 2% and Incentive Fee of 20% i. Management Fee: $70,000 = $3.5M x .02 ii. Incentive Fee: $210,000 = $3.5M x .3 (30% Assumed Return) x .2 (20% Incentive Fee) iii. Gross Earnings: $280,000 2. Valuation as of Feb. 2015 a. Gross Valuation of XYZ, LLC as of Feb. 2015 is $1,120,000 which is 4 times $280,000 (Gross Earnings). i. This valuation will need to be adjusted with more accurate information and does not include expenses, which would adjust down the valuation. b. Proposed 30% interest of Investment Manager is approximately $336,000. 3. Proposed Option Agreement re Purchase of XYZ, LLC a. Structure: The purchasing parties will have the guaranteed option to purchase an interest in the investment manager based on the valuation as of Feb. 2015 and proposed valuation methodology. Further, once the option agreement is exercised, all distributions made as of Feb. 2015, if any, on a pro-rata basis, will offset the purchase price. In the event of a resulting negative capital account, the new managing member will have the option to have the investment manager carry the negative capital account balance until it is fully offset by future distributions or the new managing member may apply paid in capital in the amount of such negative capital account balance at the date of purchase or a later date. ###
I have no expertise here, but isn't this the equivalent of selling 30% of your future earnings for a couple hundred grand?
Yeah, keep it to yourself. If inflows are 5-10x year, one could reasonably expect a 5-10x increase in net per year, no?
But if the two partners, bring increased value that will result in increased revenues/profit, then it could be worth looking at. Partnerships usually end badly though.
If you're both returning that much and raising at that rate, it appears to me that you'd have $100m-$1billion AUM within two years. Why even bother partnering under such circumstances? Yet, it could be that your recent returns represented (at least in part) a string of good luck, and you realize this, in which case partnering might make sense. A return of 30% doesn't seem like a very conservative expectation to me, regardless of how well you did in a single year. Of course, I have no idea what your algorithm does (or even if you're just trolling), so take that all with a grain of salt. If I were in such circumstances, I'd find a good attorney who has lots of experience in this specific area and get a consultation.
Given your small size, how'd these guys sniff you out? I'd do your due diligence on these guys before you get to far along in the process... You should find out their angle first before offering them a piece...
One of the guys is an ex AT Kearney consultant, and the other is currently working at UBS - if things work out, their intent is to quit their current full-time jobs and pursue this to 100%. Reason why I'm considering this opportunity is to accelerate the business by getting access to highly experienced people with the right connections. Currently the business is developing well, but mostly attracts retail and smaller institutional players. One of the reasons I started this business is to enjoy the freedom and have the leeway to do what I want, but obviously this gets harder and harder the larger the company gets. Even though the business is doing well, resources are still constrained due to investments I have to finance personally, and if the price for a stake isn't right, I'm not very keen on assuming additional risk and liability. The game plan is to use my existing LLC as a launch pad for a conventional hedge fund (currently it operates as an RIA) by letting these two guys raise sufficient capital that can finance their stakes, and use proceeds to cover expenses to set up the legal/physical infrastructure for an LP in the Carribean. One thing that would make me feel comfortable would anyhow be to perhaps set up a new LLC for the hedge fund GP role, and keep the existing LLC for retail clients. In this way I could still keep the retail side for myself with 100% control, and do the hedge fund thingy as a JV, in this way having something to fall back onto with 100% ownership if things don't turn out well. Any thoughts or ideas?
And what if you bring these "partners" into your tent, and they don't perform? Or if they actually harm your business? It can happen. What then? Be extremely cautious when taking on partners, especially when they haven't previously been in a position that specifically demonstrates skills that are important to your growth. You're already demonstrating success. So reject any agreements that don't keep you fully in command. Best of luck!