What is a Hedge Fund and can startups raise from them?

Background:

This article is based on an interview we had with Ryan Zhang and Mi Tu for Fundraising Radio.  Ryan Zhang and Mi Tu are partners and Co-Founders of  Standard Capital L.P. , a hedge fund.  Ryan is a Chinese immigrant who came to the U.S. when he was 17  and completed high school here in the states. He then went on to Penn State university. After Penn State Ryan worked for J.P. Morgan Chase (https://www.jpmorganchase.com) , became an associate then moved to New York for a proprietary trading position, which is where he met Mi Tu. Similarly, Mi also came to the states from China for education and studied economics and international relations at John Hopkins University. After college her first job was as a securities principle. Ryan and Mi started Standard Capital earlier this year with a mindset of long term investing. In fact Standar Capital only focuses on long term investment of equities. They are still in the process of talking to investors from China and the United States.This is because COVID-19 stalled their launch. Indeed, Ryan and Mi do not plan to fully launch their fund until March 2021. 

What is a Hedge Fund:

Ryan and Mi explain that a hedge fund is an investment company that pulls funds from accredited investors and invests their money for them. Technically, the hedge fund is in a partnership with the investors, because of this they are limited partners or “LPs”. In essence the investors are silent partners. Ryan and Mi are the general partners who are responsible for the day to day management of the fund. They also note that hedge funds aim to gain positive returns and outperform the market. Ryan adds that hedge fund is not a legal term and more like an incentive structure. This is because hedge funds make most of their money from the incentive fee. Basically, Ryan and Mi and other hedge fund general partners take a piece of the investment gains. 

Differences between a Hedge Fund and a Venture Capital Firm:

Ryan and Mi illustrate that hedge funds and VC firms are different because VC firms mainly look for equity in startups, while hedge funds focus more on financial assets, such as stocks, commodities, distressed debt and options. Moreover, hedge funds can  make money even if a company is failing, whereas venture capital firms cannot. Also hedge funds have more financial derivatives and tools at their disposal. Additionally, they tend to invest in a company in their later stages.

Furthermore, Ryan and Mi believe that venture capital firms are exposed to more risk. They give as an example the 80-20 rule in which 20% of venture capital investments make up 80% of their profits and upside. Also most of the companies a venture capital firm invests in fail. In addition, hedge funds can more easily sell their stock, while VC firms can’t because they mostly invest in private companies. 

Do Hedge Funds invest in Startups? :

Ryan states that he has witnessed hedge funds invest in startups and other primary market investments. He points out that the hedge funds who do invest in startups only dedicate 5% of their portfolio on startups and other primary market investments.  Ryan and Mi say that they are not considering investing in startups, they are only focusing on established companies on the Nasdaq and New York Stock Exchange. They also remark that they do not plan to change their strategy because institutional investors do not like when a hedge fund starts with one strategy than switches to another. 

Why they started Standard Capital:

Mi and Ryan started Standard Capital because they both share the long term value investing Buffett style principles. Moreover, they also received some funds from their friends and families to start Standard Capital. The hedge fund is called Standard Capital because Mi and Ryan won’t show that they have a down to earth mind set that focuses on what works. They also chose that name because they want to become the standard of the investing industry. 

Who should go into traditional investing(securities, financial instruments, etc.) and who should go into investing in startups?:

Mi and Ryan advise that people who are more risk averse should go into traditional investing because startup investing is very risky. Conversely, they suggest that those who have more risk tolerance should go into startup investing. Individuals should choose the one that is in their circle of competence, and choose the one they feel they will do the best in. 

Major issues they have faced in starting their Hedge Fund:

A surprising difficulty that Ryan and Mi have encountered when trying to raise money for their hedge fund is their age. Specifically, investors not trusting them because they perceive them as too young and inexperienced. So to get around this they are not approaching institutional investors for the first three years, they are currently only approaching and raising from their connections and network. This is because people in their network are more willing to trust with their money, irrespective of age. In the startup sector age is not so important, “the younger the better”. In fact, some might say that being old in the start up field is a handicap. 

How to find connections in the hedge fund space:

Ryan and Mi say that having previously worked in a financial firm like, JP Morgan is a great way to find connections and investors. However, if you have not worked at a financial firm because they are too competitive, you should try to find a job in the middle or back office of a financial instituiton. They also note that you have to be nice and put yourself out there from the very beginning, because the fundraising process starts way before you pitch. Indeed, you need to leave a good impression from day one and build trust with people. Jack and Mi also highlight that connections you build will also refer you to other people and that is how you build your network. Face to face meetings are supposed to be the best way to make new connections. In these meetings they recommend finding common ground, being respectful, finding common ground, and meeting with them as often as you can to build a solid connection.

Ryan and MI's Call to Action:

Not to hesitate and to start now and learn about it later. In essence, do not wait and it is never too early or too late. Ryan and Mi also suggest to think of it like a chess game , in that you have to make a slew of moves to get to the end point and being nice to everyone at the start is one of those moves. Also finding good contacts and building relationships is another of those moves. 

This blog post was written by : Luis Bravo