Portfolio managers may be the rock stars of the hedge fund industry, but the rest of the management team is just as important to the success of a fund. J. Patrick Gorman and Jodi M. Wechsler, co-founders of executive search firm iFind Group, explain why investing in human capital, specifically a chief financial officer, should be a top priority for a hedge fund firms.
Why does a hedge fund need a CFO?
Hedge funds need a CFO to be relevant. Post-Madoff, investors generally require one. Investors want a guardian over their capital, a designated officer to produce precise performance reporting and a strong accountant to manage proper tax and legal disclosures. Investors want a professional organizer to segregate duties within the fund, allowing the portfolio manager to focus on generating alpha. Without a CFO, funds are unlikely to grow in assets or reputation.
How will a manager know when it’s time to consider hiring a CFO?
The decision to hire a CFO should be concurrent to the decision to start a hedge fund. It is next to impossible to take the “step by step” hiring approach in an industry that demands greater transparency and accountability. As the alternative asset sector has become more institutionalized, hedge fund managers have to act more institutional. One of the “cornerstone” ways to build a successful hedge fund is to hire a CFO prior to launch.
The wrong plan is to consider hiring a CFO when, as the manager, you have a strain on your time and your resources. Funds that take this last minute approach run the risk of being rushed to hire and cannot be as deliberate, considerate and thoughtful as they could be. The CFO is as important of a hire as the investment professionals that support the fund manager. As such, the CFO should be hired at the same time and with the same sense of importance as the front office.
What’s the CFO’s role? What qualifications should hedge funds demand?
Depending on the size and nature of the fund a CFO’s role is varied. General responsibilities include preparing and reporting financial statements, budgeting and forecasting, managing independent auditors, outside counsel, outside fund administrators and prime broker relationships, and finally, overseeing operations, including trade settlements, technology and vendor management.
If there is no tax officer within the fund, the CFO might take on tax research and reporting duties. Likewise, if there is not a dedicated compliance officer, the CFO might ultimately be responsible for complying with federal, state and local regulatory agencies.
Due to the Madoff scandal and the subprime debacle, the qualifications to become a CFO are more stringent than ever. Nowadays, the CPA designation is generally required. Funds are more inclined to hire CFOs who have previously excelled in managing the accounting and operations of similar strategy hedge funds.
In addition to the hands on operations experience, funds increasingly like their CFOs to have a background in public accounting. They want a professional with a sound accounting background who has gained exposure to multiple clients and strategies. These professionals can leverage their industry contacts to bring real time relevant accounting and tax solutions to their respective funds.
Can another professional fill the CFO role without having the CFO title?
Funds will sometimes hire a Controller who acts as the “functional” CFO rather than the “named” CFO. Typically, this strategy is seen in start-up funds that have less than $50 million assets under management and therefore have a smaller human capital budget. These Controllers possess a pedigreed background -- top schooling, top grades, top performance ratings at big brand, well-known former employers -- along with the accounting qualifications necessary to perform.
Over time, these Controllers can be promoted to CFO as they prove themselves and the fund grows. If the fund grows and the Controller doesn’t have the goods to be the CFO, the fund will typically bring in a seasoned CFO above the Controller.
In established funds, there must be a designated CFO.
How do you determine which candidate is the right “fit” for the position? What should managers consider before hiring?
The recipe for fit is going to be different for every candidate and every fund, but there is always one essential ingredient: listening. As recruiters, we must listen to what our candidates want in a new CFO role and what our fund managers want to hire in a CFO. We ask a series of proprietary questions that are technical, personal and situational in nature and really listen to the answers we get.
When screening candidates, we spend hours understanding their backgrounds and motives for change. When talking to fund managers, we have to understand their history and technical requirements as well as the unique culture they have.
Determining the right personality fit can be the most challenging task in selecting a CFO. In order to get it right, you have to be honest about your fund, your expectations and what you need in a CFO candidate.
How should a CFO be compensated? What deals have you seen?
Within the hedge fund industry, CFOs are paid a base salary and a performance bonus. Start-ups often pay their CFOs a base salary and a minimum guaranteed cash bonus for the first year. Fund managers may also grant carry points on the fund’s incentive fee or management fee.
In the last year or two, fundraising has been difficult, and funds are managing their fixed costs by structuring base salaries with growth in assets under management. For example, a starting base salary for a CFO is $175,000 at $150 million AUM, which then gets raised to $200,000 when AUM hits $200 million.
Not every deal is going to be right for every candidate, but being fair and consistent and defining performance is a good place to start when determining how to compensate your CFO.
What do CFOs want? What do managers need to offer to bring them on board?
In our experience, CFOs want four things. First is partnership. Whether that’s synthetic, like offering carry points, or offering equity, they want to be invested in the success of the fund. Second is compensation that is fair, consistent and matches the CFO’s professional ability. Third is autonomy to make decisions on all operational matters. And finally, CFOs want flexibility -- they don’t want to be micromanaged.
If a manager wants to attract and retain the best CFO candidates, he must have an environment that offers these four things.
What mistakes do managers make in hiring their first CFO? How can they avoid them?
There are a few common mistakes that we see: waiting until the last minute to begin the search process, not understanding the compensation requirements of a good CFO, not listening to what your candidate is looking for in a new role and not being able to meet those expectations.
In general, the successful hiring and managing of an ongoing CFO relationship can be boiled down into three words: communicate, delegate and compensate.
Listen to your CFO. Make them feel that their voice matters in the organization. Encourage positive debate and the sharing of ideas that will better the fund.
Let the CFO be the CFO and give them the latitude to run the back office. Micromanaging the CFO shows a lack of trust and is one of the fastest ways to dissolve this important partnership.
Finally, nothing ensures the exit of a high-performing CFO faster than not compensating them when the firm is successful. Keep abreast of industry compensation and reward your CFO accordingly.