Key considerations for hedge fund succession planning – Part I
By Joel Press (pictured), Press Management – It’s a new year and for some, a time to explore new options. Earlier this month, James Simons, the legendary founder and chairman of Renaissance Technologies LLC, announced he was stepping down from the firm and passing on the baton to Peter Brown, who has served as CEO since 2017.
Arriving at the right time to step back as the founder of any hedge fund is never easy, and when it comes to thinking about succession planning, there is no right or wrong answer or approach. It is a personal decision, and depends on what is right for the individual at that time. Having worked on more than 600 succession plans over my career, a common thread running through each and every one of them is that they require a lot of work, and a lot of soul searching. We will be discussing voluntary departures from day to day activities in this column. Unfortunately there have been circumstances, due to illness, disability or death, where these type of transitions must occur without any planning. (Alert – that is why I advise on documenting a succession plan before it is ever needed).
Eric Mindich at Eton Park Capital Management, Jon Jacobson at Highfields Capital Management and Leon Cooperman at Omega Advisors, not to mention John Paulson of Paulson & CO, and Stan Druckenmiller of Duquesne, have all decided to shut their hedge funds and return external capital to investors in recent times. Managers may choose to manage the remaining, personal capital, within their existing fund structure, or create a new entity, a family office to manage their personal assets.
Then there are those like David Shaw of DE Shaw, Bruce Kovner of Caxton Associates, and now, Jim Simons, who have stepped away from their management roles and decided to leave their firms but provide a path for the organisation to hopefully survive and grow while others take on portfolio and operational management of their organisations.
Creating a succession plan that allows the firm to continue involves a great deal of work, planning, time and effort accomplish a transfer of leadership. The decision to encourage firm continuity is one that cements the founder’s legacy, not necessarily to ensure a continued stream of a share of management and performance fees. I will elaborate in Part II what considerations are for the continuing and organisation. I will leave you with one key element of continuation: the person or persons chosen to lead after the founder’s departure has to be someone the founder believes he can trust to run his or her money.
For those that decide they no longer want to run the fund any longer, they must move quickly to shut down trading and minimise risk.
Firstly, when do you announce you are shutting down? Normally, many firms will shut down year-end, or in June but a manager might consider exiting the portfolio early and making preliminary partial distributions before year-end so that investors are able to redeploy their capital quickly. Either way, you need to think about when is the best time to stop trading, and maximise the returns on the portfolio as the fund winds down.
My experience has been that the moment a founder makes this decision, and it’s clear in their mind, they are going to want to shut down quickly. Within a month, the founder should announce their intentions to the firm’s partners and call key investors, the Primes and other key relationships.
Secondly, how do you take care of your people, some of whom might have worked with the fund for many years? The costs of shutting down are not insignificant; aside from office rent, you need to think about the right level of severance and bonus packages for employees; to some extent, this will be dictated by the time of the year, and the fund’s performance. In many situations the bonuses may be significantly more than in prior years as at wind down the bonus, when feasible, is showing appreciation for years of service as well as insuring that at least some of the team stay to assist in tying up all of the loose ends.
Thirdly, you’ve then got to keep staff and their morale up during the winding down period, to make sure the portfolio and its risk profile doesn’t go off kilter and there is an orderly process.
This is all part of the pre-closure thought process one must consider, so that when you’re ready to make the decision, you’ve thought through every detail.
The CFO, potentially along with some members of the finance team, will often be the last person to turn off the lights. Often, they have to do a lot of cleaning up work related to tax returns, financial audits etc. You’ve got to ensure all of this is done well and in an orderly fashion. Keeping the last few employees can be tricky as they are immediately looking for other opportunities and their attention to detail and desire to work at the old firm is not their main priority any longer.
One other key consideration for any US manager who decides to wind down their hedge fund business relates to tax issues. This issue applies not only to the fund manager, but also the fund’s investors. All investors could find they have a significant amount of capital gains tax to pay on the unrealised appreciation that has accumulated over the life of the portfolio represented by the difference between the partner’s capital account and their tax basis. That difference at closure can be very substantial.
When I’m advising on any succession planning and the fund will wind down, I work with the manager to quantify this exposure and consider alternative strategies to minimise tax issues for the manager, and the fund’s investors.
Whatever the reasons for shutting down a hedge fund, careful planning and preparation will go a long way to ensuring that one’s next activities, whether it be focusing on a family office and/ or philanthropic interests, can be realised with as little stress as possible. It’s never easy. But when the time is right, it’s best to act with speed and alacrity.
In Part II, next month, I’ll explore the factors involved in preparing for succession planning, for those who want their hedge fund to continue to operate after the current leadership transitions out of day to day involvement.