This article was co-authored by Romney Navarro and Chris Ragland.

Foster healthy friction between your team for the benefit of investors and long-term fund stability.

You’ve spent years immersed in the private lending industry. Perhaps your journey began with syndicating loans. Or, you may have started as a broker, aligning with several of the prominent programs across the country. Regardless of the path you took, one thing is clear—you have steadily positioned yourself to generate profits for others.

Take a moment to reflect on that last statement.

There comes a time when most private lenders realize the only obstacle standing between them and their ambitions is access to a reliable source of capital fully in their control. Relying on external sources of funding, whether from individual investors or institutions, often means working within someone else’s constraints. Many private lenders begin to explore options for creating their own efficient vehicle for managing capital. This almost inevitably gives rise to the concept of a fund.

Navigating the Waters of Fund Creation

Establishing a private fund offers several significant benefits to private lenders. First, it provides a flexible pool of capital that is under the lender’s direct management, allowing them to act fast in a competitive market and take advantage of opportunities that might otherwise be lost due to delays in securing financing.

Moreover, a private fund enhances efficiency. A fund typically operates under a clear investment thesis or set of guidelines that aligns with the lender’s strategy, reducing the time spent deliberating over each investment.

Lenders also benefit from increased control. With external investors, private lenders often find themselves negotiating terms on a deal-by-deal basis, balancing the desires of different stakeholders and facing restrictions on how they can deploy capital.

Another key benefit of operating a private fund is the potential for larger margins. Managing a single pool of capital allows for economies of scale that are difficult to achieve when working with multiple smaller sources of funding.

Still, it’s important to recognize that creating and managing a fund comes with added responsibility and complexity. Lenders must ensure they comply with regulatory requirements, particularly regarding securities laws and investor protections, as well as maintain the trust and confidence of the fund’s investors. Poor fund performance or mismanagement can have serious consequences for the lender’s business and their reputation in the industry.

Challenges and Risks

The devil, as they say, is in the details. Nowhere is this truer than in the realm of fund management, where the pitfalls are far more numerous and insidious than they first appear. Managing a fund is a more complex undertaking than most anticipate, and the real question quickly emerges: Does the private lender truly have what it takes to operate a fund effectively?

The ability to originate loans does not automatically translate into the skill set required to successfully manage a fund. Fund management demands a deeper understanding of financial strategy, investor relations, regulatory compliance, and risk mitigation. Without mastering these elements, even experienced lenders can become overwhelmed, or worse, put their reputation and capital at serious risk.

Funds, by their very nature, require a delicate balance to function properly. The most successful funds are typically managed by teams composed of individuals with competing, sometimes conflicting, interests. This may seem counterintuitive, yet in a well-run fund, these differing perspectives are not just inevitable, they’re actively encouraged. A healthy level of internal competition, where originators and underwriters frequently find themselves at odds, is a sign of a fund operating as it should. Their divergence of opinion can serve as a safeguard, preventing hasty decisions and ensuring that every investment is scrutinized from multiple angles.

However, this is where the skepticism lies. Does the typical private lender, accustomed to unilateral decision-making, truly understand how to foster and manage these competing viewpoints?

A successful fund manager must not only tolerate but actively embrace the friction that arises between these roles. It requires a rare skill: the ability to listen and give equal weight to both sides without being swayed too quickly by one over the other. Too often, we see funds run by individuals who, rather than appreciate the value of internal tension, prefer an environment of unchecked agreement, which can lead to disastrous oversights.

What Qualities Should a Fund Manager Possess?

Without a doubt, a keen eye for regulatory and compliance is critical. If the fund is not set up properly or doesn’t conform to legal requirements, it won’t be long before a regulatory body will come knocking.

Second, a fund manager needs to understand processes and procedures. No, you can’t just override everyone and make a single-handed decision. The policies are in place and your investors make informed decisions based on your policies. To throw them to the wayside is to invite harsh criticism from your investor pool, regardless of the fine print or the power you may hold.

Finally, a fund manager should possess soft skills that we all hope and wish for in a partner: honesty, accountability, transparency, and access.

Although you may hold the title of fund manager, you will inevitably need to engage a range of specialized professionals to support the fund’s operations. This includes fund administrators, auditors, asset managers, underwriters, legal counsel, and a variety of software providers, all of whom must not only understand the intricacies of the fund but also elevate your reporting and compliance processes to a highly professional standard. The complexity of these collaborations underscores the importance of a cohesive and well-coordinated team.

So, where do things often unravel?

For many private lenders, the unspoken challenge—the proverbial elephant in the room—is the constant pressure to generate fees. This industry is characterized by an insatiable demand for fees, which are essential not only for covering payroll but also for bolstering other aspects of the business or, in some cases, for simply sustaining the viability of the overall business model. Ironically, the greatest risk to a fund frequently comes from the fund managers themselves, as the drive to generate these fees can sometimes lead to decisions that compromise the long-term health and stability of the fund.

Ultimately, managing a fund is not suited for everyone. Exceptional fund managers must possess not only patience but also the unwavering discipline to reject unnecessary risks, combined with a fiduciary responsibility so deeply ingrained that it verges on obsession. The ability to consistently prioritize the interests of investors, even in challenging or turbulent times, is paramount. This requires a steadfast commitment to upholding the highest standards of stewardship, often in the face of immense pressure, making the role both demanding and highly exacting.

You may believe you’re ready to step into the role of a fund manager. And perhaps you are. But it’s imperative to arm yourself with the wisdom of those who have walked this path before you. Read as many cautionary tales as you can find. Study the missteps, the overlooked details, and the hard-earned lessons of others.

The world of fund management is littered with the remnants of promising ventures that faltered under the weight of unforeseen complexities and misjudgments. The road ahead is littered with risk, but also graced with opportunity. Only those who are fully prepared—both mentally and strategically—can hope to navigate it successfully. Proceed with caution, for this is not a decision to be taken lightly, and the consequences of overconfidence can be as swift as they are unforgiving.