The difficulty in building a money management business

Had an interesting dinner last night with a couple of guys who work for other people but are thinking about going out on their own to do deals.

Found myself explaining the difficulty inherent in doing so and think it might interest you, my readers.

The money management business is fundamentally amazing at scale. Here’s an extreme example: A good friend of mine used to work at Lone Pine, a hedge fund where something like 15 investment professionals (of whom about 5 were senior) ran $15B or something.

Assuming a standard 2/20 (2% of assets management fee plus 20% of the upside), Lone Pine was taking in something like $300MM / year from the management fee alone. Even if you want to be conservative and assume they were discounting the fee to 1%, you’re still looking at a ridiculously large amount of money flowing to a small handful of money managers.

The problem, though, is how to get started. If you’re a normal human (eg not from a spectacularly wealthy family), it’s pretty likely that you’re going to start out managing a much smaller amount of money… say, $1-2MM pulled together from everyone who ever knew you growing up, etc.

Even if you get your 2% (which is unusual in real estate; it’s usually more like 1%), you’re looking at $20-40k. That’s not nothing, but it’s not enough to live and run the kind of organization you need to succeed.

So, you need to figure out a way to bridge the gap between $0 under management and, say, $50MM (when you’ll have $500k / year coming in, which is enough to run a business and eat).

For us, the bridge is:

  • Fees from the deals themselves (acquisition fee, construction oversight fee, etc. – think of these as payment for the huge amount of work we do on the buildings)
  • Fee for service deals (where we get paid cash fees to oversee deals on behalf of other groups / high net worth people)
  • Brokerage (initially by me and now by our agents)
  • Property management (which we need to do anyway to make our deals successful; might as well do it for others, too)

Over time, I expect the revenue from money management will far outstrip the revenue from these other sources. But, for now, we need the money from these less-scalable businesses to pay the bills (and, by the way, are incredibly thankful and happy to have it!).

Want to get into the money management business yourself? Got to figure out how to build your own bridge.