“Are you crazy?”
That was the first thought that entered my mind, when a friend – let’s call him “Warren” – told me he wanted to start an asset management business.
Warren has just left his employer after a 20-year career, which I’d characterise as pretty successful. As a lead portfolio manager, he has managed assets on behalf of clients exceeding R50 billion and delivered good returns which ranked above average and sometimes top quartile in the performance surveys.
At the ripe young age of 45 he feels now is the time to fulfill his dream – a dream to own and run a business. Given his successful track-record and his networks, he feels he can make a success of a start-up business. He knows it will be hard as most small businesses ultimately fail. But, he’s a very smart person with a deep passion for investing and has the results over 20 years to prove his worth to potential clients.
Surely this is something worth doing? Well for almost everyone my answer is, No, no and no – just like it’s a really bad idea to leave your corporate job and use your retirement money to start a coffee shop.
Notwithstanding the dream to run his own business, Warren also confided in me that his previous employer recently experienced management changes. Personally, he thinks the new CEO is a lunatic who will turn the company into an asylum – so, leaving now at the top of his game, is opportune. Given that he is now jobless, I’ve decided to limit my dissuasion of his idea and rather point out some of the challenges he faces.
Success is improbable but not completely impossible, and maybe Warren is up for the extreme challenge.
Given my 20 years of researching and selecting asset managers, I can say with some confidence that managing investments well and managing an investment business well are two completely different things. There is no evidence I know of that supports a notion that good portfolio managers automatically become good business managers – nor create successful startup investment firms. Yes, a minimum requirement may be deep passion for your craft and a successful previous track-record, which Warren has, but that in no ways means he will succeed. There are many issues Warren must consider, not least being the state of the industry. Here, I don’t mean markets themselves, which just happen to currently be incredibly tough, but rather the state of play in terms of the structure and forces at play in the investment management industry presently.
A basic Porter’s Five Forces analysis of our industry would likely conclude that it’s become a very unattractive industry to enter. One, where the cumulative effect of these 5 forces reduces profitability, and worse, where even disruptive new entrants will struggle to gain traction and market share, to build a sustainable organisation. Nevertheless, Warren’s passion, self-belief, drive, and joblessness, lead him to push ahead with his new venture.
Once Warren clears the initial regulatory hurdles to register a new asset management company, he needs to put in place a business structure and strategy which will give him the best chance of attracting some initial or seed capital. He may be able to convince family and (less likely) friends to invest their hard-earned savings in his portfolio, and he may also have a little personal money if he saved his corporate bonus money over the years! This may enable him to start with an amount sufficient to create an investable portfolio so he can start his new “Newco” track-record. Depending on what type of mandate he is running he would likely need up to R50 million, possibly R100 million to start.
Assuming he can charge a fee of 1%, which is quite high in today’s competitive market, his starting gross annual revenue will be in the region of R500,000 to R1 million. This won’t cover much – especially not salaries, nor other value-adding services. He’ll likely need to get somewhere over R1billion before he can breakeven depending on how he chooses to structure his business. So, he will need enough personal or external capital to fund his business – probably for a minimum of 3 years, but more likely closer to 5 years.
Borrowing money to fund a start-up in this environment is a potentially dangerous approach. The external equity funder approach is possible, but this often means giving up a material equity stake at inception, which Warren may be hesitant to do.
Part 2 on Warren’s journey – coming soon in the next blog post.