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veserog88


Total Posts: 5
Joined: Jun 2013
 
Posted: 2013-06-17 06:17
I am having a situation at hands when I believe you guys could give me a much better advice than any lawyer and/or any other paid consultant, so thank you everybody in advance for your inputs.

About half a year ago I started a hedge fund with three other partners all having equal shares. My contribution was a very promising hft algorithm with excellent back tests results but very limited live track record, which nonetheless given my credentials was accepted as good enough. Their contribution was the whole infrastructure on Wall St. and readiness to pay for any expenditures. As we all initially legally agreed I retained all ownership rights for the algo. We didn't legally define any usage rights.

Time passed and today we have a track record with mind blowing results, infrastructure set up and clients lined up eager to go. My partners all of a sudden have gotten very upset with the fact that they don't have any rights for the software and the fund will stop functioning if I leave or die tomorrow. My position is that I am ready to sell it to the firm but the price will be in the low seven figures depending at what point it is purchased and I also will keep my stake in the company. They are asking me for an indefinite license that would give them a right to use not only the software but the source code paying nothing or very little for this license. I don't think in this situation possessing the source code by some license is very different from actually owning it due to the amorphous nature of any programming code and thus endless possibilities for my partners to potentially screw me. Subsequently I am only considering selling or quitting. And so my concerns are:

1. What is the approach to price the algo at this point? What is reasonable? Should I even sell it? Few words about it - hft, sharpe ratio close to 5, scalability without affecting performance about $100 million. Excellent back tests on 10 years tick data as well as live results.
2. What are potential viable routes for my partners to screw me that I could prevent legally today if I sell the product to the firm while keeping my stake in the firm. For instance, can they change few lines in the code, declare it to be a completely new product and open another firm without me?

Any other thoughts are welcome and thank you again for your time.

astar


Total Posts: 175
Joined: Mar 2007
 
Posted: 2013-06-17 19:17
The price of any illiquid product is what someone will pay for it. Just to get some negotiating leverage try and get some independent quotes that could serve as exit strategies for you. A market quote is much more valuable than any advice from an internet phorum

sasquatch
Certified Headhunter

Total Posts: 318
Joined: Aug 2006
 
Posted: 2013-06-17 21:26
Give me a shout. Email is in my profile.

sasquatch
Certified Headhunter

Total Posts: 318
Joined: Aug 2006
 
Posted: 2013-06-17 21:26
* Redacted

NeroTulip


Total Posts: 873
Joined: May 2004
 
Posted: 2013-06-18 05:48
You do not have to sell your algo. You can take the position that you have a deal with your partners and if they don't like it they can walk away. It will not be hard for you to find a COO and/or a marketing person to form a new fund, and it will not cost you 66% of the equity. Heck, if your algo is that good, I'll be happy to give you capital and infrastructure for 66% of the equity.

Inflatable trader

FDAXHunter
Founding Member

Total Posts: 8251
Joined: Mar 2004
 
Posted: 2013-06-18 06:24
Trading strategies don't fetch high prices, and there is a reason for that. Especially High-Frequency strategies tend to break without much notice. Now, there's a few problems with this set-up:

- Strategies as you describe them are not public fund material. This is the world of prop and it's not clear to me why this ends up in an investable fund. Here, anything with low-capacity, high Risk-adjusted returns goes into one of the prop vehicles (which runs firm money only). Again, not clear what's going on here.

- Defining IP ownership but no usage rights is kind of weird. It's like owning land, but forgetting to apply for a building permit. Having said that, it's already happened.

- the paranoia problem you want to solve is easily address by the intellectual property phrase "... or any strategy substantially derived from it." You can get very specific as to what "describes" your strategy in an agreement.

- Setting up a new firm is a very significant effort and likely eclipses the problem that is at hand by an order of magnitude. There is little to be gained from a (especially high-frequency) piece of code. I'm not sure your existing partners have much to gain by jettisoning you. It's a relatively small increase in stake size for them. Or maybe not, because they need someone else to look after this aspect of the enterprise. So again, the motive you worry about, I don't see as a real motive.

- Again, these sort of strategies don't last forever (yes, I'm sure this time it's different). I think cooler heads should prevail and everyone should pull together, resolve your respective paranoias and worries and make hay while the sun shines.

The Chaos Army seems suspiciously well-organized.

temnik


Total Posts: 202
Joined: Dec 2004
 
Posted: 2013-06-19 03:19
I am yet to see an HFT strategy that scales to $100MM in margin - as opposed to some vague "notional." The very definition of HFT is that you need technology more than you need capital.

Also - 10 years of _true_ tick data... nobody uses/stores that - not even the NSA.


Mon m├ętier et mon art, c'est vivre.

veserog88


Total Posts: 5
Joined: Jun 2013
 
Posted: 2013-06-19 05:00
Thank you everybody, especially FDAXHunter, for your time and inputs. Saquatch and NeroTulip - if I end up quitting relationship with my partners I will contact you. Temnik - I am talking about HFT not about UHFT but I agree about technology part.

veserog88


Total Posts: 5
Joined: Jun 2013
 
Posted: 2013-06-20 01:13
Another paranoidal question - The reason I dont join any propshop is because i've heard that they try to reverse engineer any successfull strategy and having all the data it is only a matter of time before they actually do. How truthful is that and how do you protect yourself against that?

FDAXHunter
Founding Member

Total Posts: 8251
Joined: Mar 2004
 
Posted: 2013-06-20 07:49
That's nonsense. There are maybe instances where this has happened in the past and there are firms that may be less-than-reputable today, but as long as you stick to a reputable firm, this should not be a major concern. Obviously with any trading strategy there is a risk of leakage, so a permanent minimum level of caution is warranted.

The Chaos Army seems suspiciously well-organized.

Aleph


Total Posts: 76
Joined: Jul 2006
 
Posted: 2013-06-20 09:03
It's easy now to find shops with good infrastructure who will give you a large-ish cut (50%) and leave you to be. I think you want to be a bit careful with how much of the details you reveal as I have heard that if you're a one trick pony and a bit too open they some have been rumored to pass on details to other desks on a smaller cut, and then on down the line..

Along those lines:

"Trading strategies don't fetch high prices, and there is a reason for that. Especially High-Frequency strategies tend to break without much notice. "

This is key. Don't be a guy with -a- strategy, be the guy who creates strategies. Those people are far fewer and more valuable. Most people with -a- strategy usually got it by working with someone who built it and really understands it and think the ones who 'take' it and leave believe they can replicate it elsewhere. They rarely can. The devil is always in the un-sexy, seemingly unimportant details.

If you're the only who's able to build new things, someone will eventually try to copy it and leave. It won't really matter though as they'll do a poor job and it'll decay in a few months leaving them with nothing.You''ll already be on to the next one.

veserog88


Total Posts: 5
Joined: Jun 2013
 
Posted: 2013-06-21 19:45
Thanks for the input, Aleph, it makes a lot of sense.

ESMaestro


Total Posts: 127
Joined: Jun 2009
 
Posted: 2013-06-22 00:36
Nm.

#edited

Tradenator


Total Posts: 1371
Joined: Sep 2006
 
Posted: 2013-06-23 11:51

Another approach to the valuation issue is a factor model using listed managers.  Factors to consider include AUM and length of track record (longevity).  I would think that the AUM factor convolutes a mixture of performance plus distribution.  To back out the distribution component you can try to get data on listed managers that are more about distribution than actual trading.  You might also consider adjusting for the difference between a listed manager and the specific type you are dealing with, such as a family office or prop shop.  Such a value would likely carry wide error bars around the result.

I think FDAX's advice on being positive and getting things going quickly is very important.  I am not a lawyer, so definitely seek advice on the following thoughts which are not legal advice in any way.  They are just my thoughts, without knowledge of your circumstances and requirements.

To placate yourself and your existing partners without selling the algo, you can set up a holding company and license the software to the manager with exclusivity and with the source code held in escrow with an agent you trust. To protect the licensee, they will likely want the license to be perpetual, but it can be for, say, N years instead.  People need to see that the system will be around for a long time, otherwise they won't invest.  They should also ask for minimum performance/drawdown to be agreed (don't overpromise and under-deliver).  To protect the licensor there should be IP protection clauses (no attempt to recreate...).  The agreement should include tough clauses that trigger or nullify escrow if either side violates the license.  IMHO the escrow agreement is best done separately, and referred to in the license agreement.  The license should cover not just the code, but all of the IP, using words such as "knowhow" to include the human element.

EDIT: If you license any software, make sure that anything it is built on allows you to license the results.  Check any open source, Microsoft, Sun, etc licenses that cover what you have built before spending too much on lawyers.  I like open source, but the licenses aren't always amenable to commercial application so be careful and get good advice.


veserog88


Total Posts: 5
Joined: Jun 2013
 
Posted: 2013-06-28 08:16
Tradenator, thanks a lot for the super informative post. I've just read it, and it is quite a coincidence but after all I and my partners are now following the route you described almost word by word.
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