Hedge Fund Articles

The Process of Creating a Hedge Fund

gizapyramids1.jpgYou’ve done your research. You’ve studied the market relentlessly. You feel you have a strategy devised that will make your investors and yourself a lot of money. In today’s high-tech industry, it is easier than ever to start a hedge fund. Most of the consulting work can now be done via the internet or the telephone. It’s basically a matter of finding the right people to set up your fund properly. So, now that you’re ready to go, keep in mind these essential components to launching your hedge fund.

1) Find the Right Attorney

With all of the special licensing requirements associated with hedge funds, it’s important to find an attorney that specializes in the industry. The first thing you will do with your lawyer is devise the master plan. The location of the fund, investment adviser registrations, and any areas that need further planning will be addressed. Once the plan is charted, the attorney will construct several documents. The first is the Offering memorandum, also referred to as the Private Placement Memorandum. This 60-70 page document is essentially the heart of your hedge fund. The offering memorandum lists all of the fees associated with the fund, outlines the fund’s strategy, lists the services providers, and is the basic operating manual for your hedge fund. These documents must be written in a clear, concise manner, and all terminology must be defined so that the auditor can refer back to the Offering Memorandum to better gauge the overall success or failure of the fund. The second set of forms that your attorney will produce is the Subscription Documents, usually about 20-30 pages. Since there are many requirements for an individual to invest in a hedge fund, the investor must sign these documents asserting that he/she meets the prerequisites.

Many times securities regulations will vary from state-to-state, so the attorney will file a U-2 form in each investor’s home state. These state regulations are referred to as Blue Sky Laws. The U-2 form is a commitment to comply with the state laws concerning the registration and sale of securities. States sometimes charge a fee, however most states don’t require you file a U-2 if there are 6 or fewer investors in the fund from that state. All in all, legal fees will usually run you anywhere from $15,000-$25,000+ a year.

2) Construction of the Business

General Partnership

Also called the Investment management firm, this entity is set up to form and advise the hedge fund. The general partners will control the investment strategy. The partners conducting business have unlimited liability, so their personal assets are at stake if the company goes under. However, being a part of the General Partnership also has its rewards. These partners get to collect all the fees and bonuses associated with the hedge fund. Usually an incentive fee of 2% is collected, along with a performance fee which ranges anywhere from 20-40%. If certain managers do well, many times they will be invited to become a general partner.

Limited Partnership

These are the people who actually invest in the fund and they take stake in the fund as a business. Usually, a limited partnership is set up so that the investors are only liable for the amount of money they have in the fund. Limited partners may include individual investors, pension funds or endowments, brokerage firms or investment companies, or other corporations formed to manage investments in hedge funds.

3) Hire Service Providers

The Prime Broker

Since the broker is the person who executes the actual buying and selling of the securities, it’s important you find someone who is highly accessible. Having a prime broker with a stellar reputation also increases the attractiveness of your fund. Goldman Sachs, Bear Stearns, and Morgan Stanley are among some of the big players in the Prime Brokerage industry. In addition to dealing with the day-to-day operations of the fund, brokerages also may try to find qualified investors for the fund. They also may run a risk-analysis of the fund, or provide consulting services since they do have a vested interested in the success of the hedge fund.

Independent Auditor

Typically speaking, an audit should be done on an annual basis in order to review the fund and its strategies. Sometimes, these audits are done on a quarterly basis so the investors can better gauge the progress of the fund, and see how well the fund manager is handling their assets. The costs of auditors usually varies depending on the amount of assets they are handling.

The Administrator

The administrator is responsible for the day-to-day administrative duties. This may include fund accounting, linking investors to a specific fund, and maintaining the books and records. The SEC imposes strict requirements for record-keeping, and a good administrator will be quite familiar with them. These records include typical business accounting records as well as most forms of written communication such as emails, any advice given or received, the disbursement of funds, or the execution of the buying and selling of the securities. Hedge managers can either hire an in-house administrator, or they may outsource in order to cut costs. For more about administrators, click here. Usually administrators will cost you anywhere from $500-$3000 a month.

Website Design Firm

Since the SEC has strict limitations regarding the advertising and marketing of your hedge fund, you have to be a bit creative when it comes to putting your funds out there. Attracting the right audience is key. Most investors are inherently cautious about handing over millions to any fund, let alone a new one. That’s why the utmost professionalism and attractiveness must be purveyed in a way that makes people want to learn more about your investment strategies. Most of the time, a website design firm will even assist you in providing documentation, data analysis and statistics, to make the management aspect of your website one less thing to worry about.

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