You can have the best trading ideas, strategy and implementation, but without sufficient capital to fuel it, it’s just a great idea. Raising capital for your trading becomes important once you have exhausted your funds, you have a solid track record of great performance and opportunities & ideas are everywhere. Once you are really ready to bring in clients money you always need to be cautious as to not oversubscribe investors or even raise too much money that doesn’t really fit in with your strategy. This could be of detriment to you and your ego that may result in underperformance of your strategy. It is not about raising as much money as possible rather raising justified amounts that perfectly fit into your current trading paradigm. Usually, the best way to raise capital is not to do it at all, rather reinvest your profits back in the business and grow organically alongside the market opportunities presenting themselves with time. You can always look into scaling with outside capital if successful at first and have reinvested profits numerous times. Although many times you are spot on with your working ideas and strategies so you have to get that cash injection as soon as possible to keep pushing forward. Even then one must always comply with all the requirements and pre-requisites by investors making sure there is transparency and the promised delivery of results is evident. A business start-up is it trading or selling physical products shouldn’t be looking for additional rounds of cash without a clear strategy and having reinvested significant amounts of their profits back into the business beforehand. Investors should be wary of companies and start-up funds requiring second rounds of funding in a short period of time one after the other. This is highlighted with ones without significant cashflows or negative performance. For market caps going in the millions where the operations are on a bigger scale and institutional clients come in the growth and scale rates would usually slow down. There wouldn’t be a rush the more the fund/business progresses to raise capital.
Capacity is the amount of equity a strategy can generate good returns on. It is far, far easier to generate a high Sharpe ratio trading a $100,000 account than a $100 million account. There are many simple and profitable strategies that can work at the low capacity end that would be totally unsuitable to hedge funds or any fund in general. (Chan, 2008) On the more practical aspect, algorithmic trading generally requires a far larger capital base that would be utilised for retail discretionary trading, this is simply due to the fact that there are few brokers who support automated trade execution that does not also require large account minimums. The most prolific brokerage in the retail automated space is Interactive Brokers, who require an account balance of $10,000. Furthermore, the Pattern Day Trader requirements as defined by the Securities and Exchange Commission require a minimum of $25,000 in account equity to be maintained at all times, in certain margin situations.
If you are not completely familiar with the sources of capital or the ways to approach them, you might need a dedicated professional who would assist you in this matter. Fundraising and Investors relations is a subject area that requires a high level of skills, manners and most important networks. Being able to communicate your idea, strategy or business in the right way and to the right audience can make or break your capital raising process. Most of the times the founder or the main company officer would act as the fundraiser where trusted associates with appropriate networks may bring additional value and capital. Moreover, investors would also expect the generator of the strategies or business to be able to stand behind any proposal with an equal or significantly high proportional base of capital as well. As the old saying goes “you have to put your money where your mouth is“. Additionally, founders and people with significant interest and control in the business putting a large portion of capital or proportion of their whole net-worth behind a trading strategy or business provides a real reassurance and guarantees commitment and confidence in the venture. Alignment of interest between the management and the investor should be demonstrated by the founder’s/management commitment of capital at all times. In addition, the due diligence performed on the team behind the trading business is of great importance as well. Important factors are ones such as previous educational and qualification background, verified track record and past experience. On-boarded advisors and partners that can help you raise funds and run your business are also of crucial importance. You can also attract investors with your unique cost structure.
Potential Sources of Investors:
- Non-institutional capital sources
- Friends and Families – The first people most would refer to in their fundraising process start with friends and family. As these are trusted sources and no due diligence is required on their side it makes it fast and easy source of capital. Although this is restricted by the particular size of capital that can be committed. This makes for a great start as well as the support of relatives received, but it puts additional pressure and really tests your confidence in your performance and strategies. You are putting forward more than reputation or clients’ money on the line – healthy relationships if things are to go wrong.
- Retail Investors & Peers in the Industry can substitute a great knowledgeable investor in your start-up that may also bring fresh advice and ideas to the table.
- Private Accredited Investors in the face of Ultra-High Net-worth Individuals(UHNI) and High Net-worth Individuals(HNI) – minimum due diligence as they would come prepared with their KYC/ AML and credentials. the amount of attention and requirements they have to contribute to your business. They also require constant attention and keeping up the relationship and the ongoing roadmap and progress.
- Venture Capital (VC) /Seeders/Angel Investors are a great source of initial capital that comes with its costs. Angel Investors would usually have experience in the particular fund/strategy/business or have had their previous exit in a very similar company. They will bring along a myriad of knowledge, experience and advice as well as marketing and operational guidance. Although they would also require larger and deeper checks and due diligence passed as well as share revenue or equity in the company. Many business owners find it hard at first to give away part of their coveted companies at the start.
- Financial Advisors – can bring a good amount of capital if you are willing to pay the price and really spend the time to build a proper relationship and connection with them. On the downside, they may only bring the capital without the connection with investors or advisory assistance.
- Institutional Capital Sources
- Family Offices are usually set up by a number of wealthy families, investment professionals or wealthy individuals who have gathered together to manage their fortune and grow the value of their portfolios together. They would usually bring a large amount of capital knowledge and sophisticated risk management. One of their main targets is the preservation and growth of their capital. They would be very cautious and require a lot of relationship building and due diligence passed.
- Funds of funds would have a sophisticated investment team with professionals that have a proven track record and credentials. It may take a long period of time before a fund of funds invests in your fund as they would require all the traditional checks as well as close monitoring of the operations and performance of the fund for a set amount of time before committing capital.
- Foundations and endowments manage assets for non-profit organisations which are very cautious about where exactly they invest due to significant reputational, ethical and moral standards that they have to comply with considering the source of their capital. These organisations would usually have a long-term time frame and very low turnover of investment vehicles they put money in. Great risk controls, infrastructure and years of proven track records would be some of their main requirements which make them a very unlikely source of funds for a start-up investment business.
- Pension Funds are quite similar in their investment and decision-making process to the foundations and endowments as they have long-term views requiring low volatility strategies and consistent returns. As these funds manage the pension pots of many companies through different industries they are super sensitive to where they invest and their requirements are high making them also an unlikely start-up funder.
- Sovereign Wealth Funds would be usually one of the biggest investment funds with whole countries behind them and massive amounts of capital to invest. Very large size, long track record and significant connection with the particular fund/government would be required to get in capital from these vehicles. If you are not one of the biggest funds out there it is unlikely that you would ever cross paths with these funds.
- Ernest Chan, Quantitative Trading, John Wiley & Sons Nov – 2008, ASIN: B017QQRK4E