For Managers Facing Strong Headwinds, Sales of the Advisory Business Offer a Means of Preserving the Franchise While Avoiding Fund Liquidations
Hedge Fund Law Report
Many hedge fund managers, especially those with relatively lower levels of assets under management, find themselves between the Scylla and Charybdis of declining revenues and rising costs. On the revenue front, performance declined an average of 18 percent across hedge fund strategies during 2008, meaning that many managers did not collect performance fees last year, and are unlikely to collect such fees until they regain their high water marks – which can take years. Also, declining performance during 2008 and substantial redemptions shrunk assets under management, which reduced management fees. At the same time, the exposure of various investment frauds, combined with widespread losses, increased scrutiny by major investors of hedge fund manager operations, compliance, risk management and reporting. In short, as revenue has dwindled, the cost of doing business as a hedge fund manager has increased. Managers faced with this daunting set of circumstances generally have the option (subject to the language of fund documents) of liquidating their funds and returning the proceeds to investors. But many managers have invested a significant amount of time, effort and personal reputation in building a hedge fund management company; recreating that complex web of relationships among employees, investors, counterparties, creditors and others following a liquidation can be a herculean task. Accordingly, instead of liquidation, various managers have evaluated and in some cases consummated sales of the management company to other, generally larger hedge fund managers or others in complimentary lines of business. We explore in detail various aspects of sales of hedge fund advisory businesses, including: recent precedents, the scope and focus of due diligence, deal structures and consideration (including the increasing prevalence of earnouts), investor consent issues and key personnel retention mechanisms.