EM Pro Tips: SMAs

Separately Managed Accounts: What Sponsors Need to Understand Before Setting up an SMA

Separately managed accounts have become an increasingly common entry point for emerging managers, particularly in venture, growth, and specialized private markets strategies. For many first-time or early-stage sponsors, an SMA is often the most practical way to secure initial capital, demonstrate an investment process, or begin building a live track record without incurring the cost and complexity of launching a commingled fund. In some cases, an institutional investor will insist on an SMA as a condition to backing a new platform at all.

The leverage dynamics in these situations are rarely balanced. Investors proposing SMAs typically have experience, internal legal teams and a well-developed view of risk allocation. Emerging managers, by contrast, are often operating under time pressure and focused on closing capital rather than optimizing long-term economics, governance, and regulatory posture. As a result, SMA terms are sometimes accepted on the assumption that the arrangement is temporary or that it can be revisited once the platform matures.

That assumption is often wrong. An SMA is not a soft launch or a provisional structure. It is a bespoke, bilateral contractual relationship that can shape a sponsor’s economics, authority, liability exposure, operational burden and regulatory status for years. Unlike a fund, there is no standardized documentation and no body of market norms that quietly fills gaps. The agreement itself does nearly all the work. If an issue is not addressed clearly, it is usually resolved later in a way that favors the party with more leverage.

What follows is a discussion of the core issues sponsors should focus on when negotiating an SMA. The order is not intended to signal importance. In practice, these issues are interrelated and should be considered together.

Fees and Other Compensation

Most SMA discussions begin and end with the management fee, but that framing is incomplete. Sponsors should step back and consider the full economic picture of the relationship, including all forms of compensation that may arise in connection with investments made through the account.

This includes not only management fees and performance based compensation, but also origination fees, transaction fees, monitoring fees, structuring or advisory fees, break fees, board or observer fees, consulting fees, and similar amounts paid by portfolio companies, counterparties, or affiliates. In many strategies, particularly private credit or complex venture transactions, these forms of compensation are not incidental. They are a meaningful part of the sponsor’s overall economic model.

Sponsors should also be mindful that, in an SMA, performance based compensation is typically treated as a fee rather than as an allocation of profits. As a result, it does not receive the tax treatment commonly associated with carried interest in a commingled fund. Achieving allocation based economics generally requires a different structure, such as a properly designed fund of one vehicle, rather than a pure SMA arrangement.

From the client’s perspective, however, these amounts can be viewed skeptically if they are not clearly permitted by the agreement. Disclosure alone is rarely sufficient protection. If the right to receive a particular category of compensation, including performance based fees, is not expressly addressed, it may later be challenged as impermissible or inconsistent with the client’s expectations. The agreement should clearly describe what compensation is permitted, how it is calculated, whether any offsets apply, and how related conflicts are identified and managed.

Expense Allocation

Expense allocation is one of the most common sources of friction in SMAs, largely because it is often treated as boilerplate. In a commingled fund, expense allocation is informed by industry practice and investor familiarity. In an SMA, none of that applies.

The agreement should clearly define which expenses are chargeable to the account and which are borne by the sponsor. This typically includes legal and accounting fees, third-party consultants, diligence costs, broken deal expenses, travel, data subscriptions, valuation costs, and other expenses incurred in sourcing, evaluating, executing, and managing investments. If internal costs or overhead are to be allocated, that should be addressed explicitly.

This analysis should also extend to the cost of putting the SMA in place. It is common for the agreement itself to be treated as an account expense, with the client bearing the legal fees associated with negotiating and documenting the arrangement, rather than those costs being absorbed by the sponsor. If that is the expectation, it should be stated clearly.

Vague standards such as “reasonable expenses” invite disagreement and retrospective scrutiny. Clear drafting at the outset aligns expectations and reduces the likelihood of disputes later, when leverage has shifted..

Standard of Care

The standard of care provision sets the framework for how the sponsor’s conduct will be evaluated. Sponsors should be cautious about importing fiduciary duty language into SMA agreements without fully appreciating its scope.

A fiduciary duty of an investment adviser incorporates a broad and evolving body of law, including regulatory rules, interpretive guidance, and enforcement positions that were not designed for bespoke, negotiated arrangements. Many of these obligations are difficult to define ex-ante and even harder to apply in hindsight, particularly when performance outcomes drive second-guessing.

A more workable approach in most SMAs is a commercial standard of care, typically framed around how a reasonably prudent investment professional in the same field would operate under similar circumstances. This standard is more predictable, easier to defend, and more closely aligned with how sophisticated parties generally expect risk to be allocated.

That said, some large institutional investors, including certain state pension plans, will insist on an express fiduciary standard as a matter of policy. While this remains more the exception than the norm, it is a reality sponsors may need to accept depending on the size and strategic importance of the mandate. In those cases, sponsors should be careful to ensure that adopting a fiduciary standard does not quietly undermine the indemnification and exculpation framework elsewhere in the agreement. Accepting a higher standard of care should not, by default, eliminate contractual protections that are intended to allocate risk in a commercially reasonable way.

Liability, Exculpation and Indemnification

Liability provisions define the sponsor’s downside exposure and should reflect the economics of the relationship. If the sponsor is earning a fixed management fee and limited ancillary compensation, it is not commercially reasonable for the sponsor to bear unlimited liability.

Most SMAs include exculpation and indemnification in favor of the sponsor, subject to carve-outs for serious misconduct. Market practice generally excludes gross negligence, fraud, and willful misconduct, and in some cases material breach of the agreement. Sponsors should be mindful of how these carve-outs interact with any fiduciary standard included elsewhere in the agreement, as an expansive standard of care can effectively narrow or undermine the intended protections. This risk is heightened where the SMA also carves out breaches of the agreement, which can transform routine contractual disputes into uncapped liability exposure.

As a general matter, indemnification in an SMA is typically one-sided in favor of the sponsor, reflecting the fact that the sponsor is performing the investment, execution, and management functions. Some clients will insist on mutual indemnification as a matter of policy. Where that occurs, sponsors should be careful to avoid open-ended exposure. One common approach is to cap any indemnification obligations owed by the sponsor at an amount tied to fees actually received under the SMA. Caps based on arbitrary dollar amounts or unrelated metrics distort the risk profile and undermine the economic rationale for the arrangement.

Termination Rights

Termination provisions often appear straightforward but can have significant economic consequences. Sponsors should focus not only on whether the client can terminate, but on how termination occurs and which obligations survive.

Notice periods are particularly important where the SMA represents a meaningful portion of the sponsor’s business. In some cases, a post-termination fee runway may be appropriate to allow for an orderly transition. This is especially relevant where the sponsor has hired dedicated personnel or incurred incremental costs to service the mandate, such as additional data subscriptions, market terminals or other infrastructure needed to execute the investment strategy. The agreement should address how those costs are treated if the SMA is terminated early.

Accrued but unpaid fees should survive termination, as should confidentiality and indemnification obligations. These are foundational protections and should not fall away simply because the relationship ends.

Equally important is the treatment of transactions that are in process at the time of termination. Without a clear sunset provision, a client may be able to terminate the SMA and complete a transaction that was sourced, diligenced,and negotiated by the sponsor without further obligation. That risk is real and should be addressed explicitly in the agreement.

Discretionary vs Non-Discretionary Authority

The distinction between discretionary and non-discretionary authority has practical implications that go well beyond labeling. In a discretionary SMA, the sponsor has authority to make investment decisions within agreed parameters. In a non-discretionary SMA, that authority is withheld and client approval is required.

For non-discretionary accounts, approval mechanics must be precise. The agreement should specify who provides approval, how approval is communicated, whether silence constitutes consent, and how timing issues are handled. Informal or ambiguous processes create risk, particularly in fast-moving markets, and can leave sponsors exposed either to missing an opportunity or, worse, closing a transaction without having proper authority to do so.

Power of Attorney

Execution authority is often overlooked, but it has real and immediate consequences in practice. Without a power of attorney, the sponsor may be unable to sign even routine documents, requiring client signatures for each action. That slows transactions, introduces unnecessary friction and can materially complicate interactions with counterparties.

From a market perspective, the absence of clear execution authority creates confusion about who actually has the ability to act. Counterparties may question whether they are negotiating with the right party, which can weaken the sponsor’s negotiating position, undermine credibility and dilute the sponsor’s brand. In those situations, the sponsor risks being viewed as a broker or intermediary rather than as the principal driving the transaction.

Even in non-discretionary SMAs, a limited power of attorney for execution and administrative matters is practically important. The core feature of a non-discretionary arrangement is that the sponsor must obtain client approval before making an investment decision. It does not mean that the sponsor lacks authority to execute documents once that approval has been granted. Without a power of attorney, the sponsor cannot sign anything, and transactions can stall at precisely the moment when speed and clarity matter most.

Allocation of Investment Opportunities

Where a sponsor manages more than one vehicle, including other SMAs, commingled funds, co-investment vehicles, or successor strategies, the allocation of investment opportunities becomes a central issue. This is particularly acute for emerging managers who may begin with one or more SMAs and later expand their product set. In that context, the sponsor needs to think not only about current allocations, but also about how the SMA’s terms may affect future fundraising, new funds and relationships with other investors.

The SMA should clearly articulate the investment strategy in precise and operational terms. Overly broad or vague mandates create room for second-guessing later, particularly where an attractive investment could reasonably fit within multiple accounts or funds. Clear strategy definitions help reduce disputes and provide a defensible framework for allocation decisions.

Equally important is the allocation methodology itself. The SMA should specify how investment opportunities are allocated among eligible vehicles, whether on a pro rata basis, through a round-robin mechanism, or based on suitability, portfolio construction, or other articulated considerations. The agreement should also include a defined set of factors used to determine whether a particular investment falls within the SMA’s mandate or is better suited for another vehicle. Without this framework, allocation decisions become harder to justify, especially when performance diverges across vehicles.

This issue does not exist in isolation. Allocation provisions in the SMA should align with the sponsor’s Form ADV disclosures and the firm’s written allocation policy. Inconsistencies between contractual terms, regulatory disclosures, and internal policies create unnecessary risk and can undermine the sponsor’s ability to defend allocation decisions to investors or regulators.

Confidentiality and Use of Information

Confidentiality provisions should protect both parties. While it is appropriate to safeguard the client’s information, sponsors should also ensure that their proprietary information is adequately protected.

This includes deal flow, investment ideas, pricing intelligence, valuation methodologies and other intellectual capital developed through the sponsor’s efforts and experiece. Without clear protections, an SMA can effectively function as unpaid consulting arrangement, allowing the client to terminate the relationship while retaining the benefit of the sponsor’s work.

This risk is not theoretical. In practice, some clients, particularly in non-discretionary SMA arrangements, engage emerging managers primarily for access to deal flow, market intelligence, or sourcing capabilities without ever executing a transaction. This is especially common where the client is exploring a new market or strategy and lacks internal capabilities. Clear confidentiality and use-of-information provisions help limit that risk by defining how the sponsor’s proprietary information may be used during and after the relationship.

Regulatory

Finally, sponsors need to confront the regulatory implications of managing an SMA directly. In most cases, advising an SMA requires full registration as an investment adviser with the SEC. Exempt Reporting Adviser status or reliance on the venture capital adviser exemption generally do not apply, as those exemptions are tied to advising private funds rather than separate accounts.

This issue frequently arises when sponsors attempt to structure a “fund-of-one” as a substitute for an SMA. Regulators focus on substance over form. If a vehicle is formed with the intent that it will have a single investor and operate pursuant to that investor’s mandate, it will typically be treated as an SMA regardless of the legal wrapper. Creating a vehicle to avoid registration does not change that analysis and can introduce unnecessary regulatory risk.

Conclusion

The broader point is straightforward. SMAs concentrate risk. They can be powerful tools, particularly for emerging managers, but they are unforgiving structures. Early compromises tend to persist long after capital is deployed and problems that seem theoretical at launch often become very real once performance diverges or relationships change.