"Of Market Makers and Hedge Funds"
Feb 23rd, 2007 | Filed under: Hedge Fund Industry Trends“Kat’s Meow”
By: Harry M. Kat, The Cass Business School, City University (London)
David and Ken both work for a large market making firm and both have the same dream: to start their own company. One day, David decides to quit his job and start a traditional market-making company. He puts in $10m of his own money and finds 9 others that are willing to do the same. The result: a company with $100m in equity, divided equally over 10 shareholders, meaning that each shareholder will share equally in the company’s operating costs and P&L. David will manage the company and will receive an annual salary of $1m for doing so.
Ken decides to quit as well. He is going to do things differently though. Instead of packaging his market-making activities in the traditional corporate form, he is going to start a hedge fund. Like David, he also puts in $10m of his own money. Like David, he also finds 9 others willing to do the same. They are not called shareholders, however. They are investors in a hedge fund with a net asset value of $100m. Just like David, Ken has a double function. Apart from being one of the 10 investors in the fund, he will also be the fund’s manager. As manager, he is entitled to 20% of the profit (over a 5% hurdle rate); the average incentive fee in the hedge fund industry.
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