How many investors can invest in a U.S. hedge fund? A Section 3(c)(1) fund is limited to 100 accredited investors (35 of which can be non accredited investors). An Accredited Investor (if an individual) must have either (i) a minimum $1 million net worth or (ii) $200,000 annual income/$300,000 if combined with spouse, or (if an entity or trust) a minimum $5 million net worth. Most startup hedge funds are structured as 3(c)(1) funds because of the lower investor suitability requirements. Learn More About Accredited Investors A Section 3(c)(7) fund is only open to “qualified purchasers.” A qualified purchaser (if an individual) must have a minimum of $5 million in net investments, or (if an entity or trust) a minimum of $25 million in net investments. In our experience the 3(c)(7) exemption primarily is used by fund sponsors backed by institutional investors. Learn More About Hedge Fund Regulations and Contact Hedge Fund Attorney Hannah Terhune for a Consultation
Fund FormationTo start a U.S. hedge fund, you need two business entities: the hedge fund and its investment manager/management company. A U.S. hedge fund is set up as either a Delaware Limited Partnership (LP) or Limited Liability Company (LLC). Both LPs and LLCs offer pass-through tax treatment (meaning that unlike a corporation, they are not subject to company-level tax). Investors in an LP or LLC are taxed on their pro rata share of the income, gains and losses of the LP or LLC, irrespective whether they receive any distributions from the LP or LLC. Learn More About Company Formations
Some clients make the mistake of forming entities before consulting speaking with us. The legal structure for your fund is dependent on a number of tax, regulatory, and financial considerations. For example, you have to consider whether your fund should be closed-end (i.e., preferable for real estate and venture capital funds) or open-end fund; whether to rely on Section 3(c)(1) or 3(c)(7) as an exemption from the Investment Company Act (i.e. real estate funds typically rely on Section 3(c)(5)); and whether to set up an offshore fund or a U.S. fund. Contact Us for Assistance
Delaware Hedge Funds U.S. hedge funds are established in Delaware because Delaware has the best company law in the United States. Contact Us For Help Hedge fund sponsors based outside the United States can set up both a hedge fund and its management company in the United States. Learn More About U.S. Company Formations
Management Company The fund manager can be set up as a LLC (most common) or as a limited limited liability partnership (not common) or as some other type of business entity in your home state, home country or offshore. Many fund sponsors based in other parts of the world choose to set up a U.S. investment management company to avoid home country licensing issues and to make the fund more attractive to investors. We have seen U.S. and foreign fund managers set up the management company in Florida as a LLC for tax and regulatory reasons and then insert a Delaware LLC on top of the Florida LLC to ensure personal privacy.
Setting up the management company requires not only the formation of a company but also preparation of the company's operating agreement (OA). The OA specifies how ownership is divided among the principals, how voting is decided (i.e., voting and non voting interests), how the company will wind up operations, among other important matters. The management company OA is not disclosed to investors or to the government. In sum, the OA set forth the rights and responsibilities among the individuals sponsoring the fund. We not only incorporate fund management companies but also prepare customized OA's for fund sponsors with complex arrangements. Contact Us for Assistance
Performance & Management Fees Hedge fund managers typically charge a management fee based on assets under management (AUM), and a performance fee (also called an incentive allocation, carried interest, performance share, etc.) based on the hedge fund's success. Learn More About Hedge Fund Performance and Management Fees Management fees can be charged to anyone. If you are not SEC registered you most likely can charge performance fees to all of your investors. In some U.S. states, performance fees can be paid to a licensed RIA only when the profits of the fund exceed a hurdle rate or on an annual basis. We can advise you as to the permissible fee arrangements for your fund.
Investment Adviser Registration (RIA) Only funds that invest in "securities" require a manager to evaluate investment adviser registration. The definition of a "security" is broad and covers investment instruments, schemes and structures. Funds that invest only in commodities, futures, currencies, real estate investments, or certain private equity investments may be subject to other rules. Fund managers that advise venture capital funds are generally exempt from state or SEC RIA registration. A securities hedge fund manager that manages over $150 million is required to become a SEC RIA. Learn More About SEC RIAs In most U.S. states, a fund manage that invests in securities and has less than $150 million under management must register as a state RIA. Some states offer an Exempt Reporting Adviser (we call it a "partial RIA license" due to its limitations) to advisers on private hedge funds. Learn More About State RIA Formation and Contact Us For Help
A reason for a foreign fund manager to consider becoming a U.S. RIA is to satisfy a brokerage and/or bank’s requirement that a hedge fund’s manager be licensed somewhere. If your home country’s licensing requirements put investment manager registration out of reach, consider getting licensed in the United States. Any foreign based investment manager is eligible to register with the U.S. Securities and Exchange Commission (SEC) without regard to the amount of assets under management. The SEC registration process is very simple and relatively streamlined. Learn More About U.S. SEC Registration
Investment Management Agreement (IMA)The investment management agreement is an agreement between the fund and the management company (often the same entity as the general partner). It defines the services that a fund manager will provide. It also delegates to the fund manager authority over the fund's assets, and gives the fund manager the broad discretionary authority to manage such investor funds and securities in a manner that the fund manager believes is consistent with the investment strategy of the fund. We prepare IMAs for U.S. and offshore funds. Contact Us For Help
Timing a Fund LaunchIn general, a U.S. hedge fund takes about four (4) weeks to organize including the time needed to prepare offering documents, file SEC Form D in the EDGAR System and to arrange for the hedge fund's bank and brokerage accounts.
Fund Offering Documents(PPM) The offering documents are the documents that are provided to a prospective investor prior to investing in your fund. These documents include: (i) a private placement memorandum; (ii) a limited partnership agreement or operating agreement (depending on whether the fund is formed as a limited partnership or LLC; and (iii) a subscription agreement, which includes a purchaser questionnaire to determine investor qualification. A private placement memorandum (PPM) is a document that discloses material information about your fund. A thoroughly prepared PPM should protect you from investor claims of lack of disclosure. Learn More About Hedge Fund Offering Documents and Contact Us For Assistance
Limited Partnership Agreement (LPA)The LPA (or in the case of an LLC-based fund, an operating agreement) is the legal governing document of your fund. It outlines the terms of the fund and the rights of an investor. Among the terms of the limited partnership agreement are: the powers of the general partner; management, performance or other potential fees (i.e., legal startup costs, brokerage, administration, and audit expenses; allocations and distributions of profits to all partners, including how profits are calculated and the timing of distributions; withdrawal provisions, including minimum and maximum withdrawal amounts, lock-up periods, gates, and distribution dates; and a designation of power of attorney, which authorizes the fund manager to act on the limited partner’s behalf for such purposes as voting the fund’s securities, buying and selling fund securities, admissions of new limited partners, and amendments to fund formation documents and other documents necessary for continued fund activity. We have a handy checklist that covers what you must consider when structuring the terms of the fund. We can send it to you for a small fee. Contact Us For Help
Subscription Agreement A subscription agreement (SA) provides your investors with a description of the steps necessary to invest in your fund. It is the investor’s contract with the fund, which specifies the subscription amount and outlines the terms under which the investment is being made. It requires investors to attest that they meet certain eligibility standards, such as being an “accredited investor” or “qualified client” as required by SEC and state law. If your fund is an advertised fund under Regulation D Rule 506(c), it contains an "Accredited Investor Certification Form." Contact Us For Help
Fund Administration Unlike most countries, there is no legal requirement in the United States to use a hedge fund administrator. However, using one is a good idea as it can reduce: (1) the cost of an outside audit for the fund at year end and (2) the costs associated with the preparation of a U.S. fund's income tax return (i.e., Form 1065 and K-1s). Hedge fund administrators provide detailed net asset value statements (NAVS), performance reports, brokerage statement reconciliation, tear sheets, and much more. Investors and regulators see value in the appointment of a third-party administrator. Learn More About Hedge Fund Administration and Costs We offer low cost hedge fund administration services through Capital Management Administrative Services, LLC. Please see our Sample Performance Report and Contact Us for Assistance
Regulatory Licenses & Filings Regulatory filings are documents that need to be filed with the federal and state regulators jurisdictions to satisfy securities laws and registration exemptions. Among these filings are: SEC and state blue sky filings which are required whenever there is a US investor in a fund (see below); investment advisor registration (see below); and registration with the Commodities Futures Trading Commission (CFTC) when funds trade in commodities, futures, swaps, currencies and similar instruments (see below). Learn More About Starting a Forex, Futures or Commodity Pool
File SEC Form D & State Blue Sky Filings Form D is a notice of an exempt securities offering under Regulation D that is filed with the SEC. Form D discloses information about the fund and the managers. Form D is not subject to a review or approval by the SEC and must be filed within 15 days of the first sale to investors and if the offering is ongoing, the Form D must be filed annually. Contact Us For Help Filing Form D & State Blue Sky In addition to the SEC Form D requirements, each state requires Form D notification filings. Most but not all states require the state notice filing be made within 15 days after a resident of the state invests in your fund. Learn More About Hedge Fund Law and Learn More About SEC Form D & State Blue Sky Hedge Fund Filings
Hedge Fund Banking & Brokerage Services For either banking or brokerage services, you cannot use your personal account as the hedge fund’s account. Need help with international banking and brokerage arrangements? Contact Us for Assistance Dealing With Non-Accredited Investors If you allow non-accredited investors to invest in a U.S. fund, you need to have an initial financial statement prepared (i.e., an initial audit). Learn More About Hedge Fund Audits In addition, your non-accredited investors must (alone or together with a purchaser representative) be sophisticated in that they must have sufficient knowledge and experience in financial matters to evaluate the merits and risks of investing in your hedge fund. You will need to use a Purchaser Questionnaire in addition to the standard Subscription Agreement if you allow non-accredited investors in your fund. Moreover, you must prepare your hedge fund offering documents to a higher standard (i.e., as if you were offering the securities publicly). We have a Purchaser Questionnaire that you can use with non accredited investors. We can send it to you for a small fee. Contact Us For Assistance and Learn More About Hedge Fund Offering Documents
Consulting with and advising you on tax (i.e., S or C corporation elections), regulatory (i.e., state or SEC investment adviser registration & NFA registration and exemptions), US & International legal and business matters (i.e., operative agreements among multiple hedge fund organizers, contractor agreements, algorithm licensing agreements, etc.) that apply to you, your intellectual property, the fund and your investment management company;
Structuring hedge fund performance and management fees (plain vanilla & graduated rate fees) that are lawful;
Answering your fund and management company related questions;
Preparing the Private Placement Memorandum (PPM, Prospectus, etc.) in plain English while accurately and lawfully disclosing the fund’s investment terms, trading approach, and other relevant data from a legal and marketing standpoint;
Preparing the Limited Partnership Agreement or LLC Operating Agreement governing the fund;
Preparing the hedge fund Subscription Agreement;
Preparing the investment management agreement between the fund and the investment management company;
Forming the hedge fund and its management company;
Preparing and filing the hedge fund’s SEC Form D in the EDGAR System;
Preparing and filing state Blue Sky filings;
Advising you on fund marketing, branding and operational issues;
Coordinating and arranging for the fund administrator, auditor, prime broker and other service providers; and
Advising you on capital raising issues, database listings, and resources related to finding investors for your hedge fund, and
Numerous other advisory services (i.e., capital introductions).
Use of Investment Adviser Sub-Contracts Many hedge fund sponsors opt to set up a hedge fund management company outside of their home country or home state, whether for tax, commercial, or regulatory reasons. If you (as the hedge fund sponsor) set up the hedge fund management company outside of your home country or home state, you should have a sub-agreement for "consultancy" or "advisory" services between yourself and the offshore (or out of state) hedge fund management company. In the United States, an investment adviser is an investment manager. However, there is legal distinction between “investment manager” and “investment adviser” in most other countries. If you live in a country where a such a distinction exists and if you set up the hedge fund's manager in such a country, you should position yourself through contracts as a consultant to the offshore investment manager. Such "advisory" or "consultancy" services (i.e., an independent research analyst) is not a regulated business activity. To do this, you need an agreement between the offshore investment manager and a sub-agreement between the investment manager and the investment adviser. The goal of the agreements is to allow you to offer research services to the offshore investment manager for a fee. There are other approaches to consider as well. When the investment advisory agreement is drafted properly and timely executed, you will be able to control the timing, tax character and amount of taxable income reportable in your home country. In addition, if the investment management agreement between the fund and the investment manager are drafted correctly and timely executed, further income deferral is possible. A hedge fund manager seeking to defer substantial amounts of management and performance fees should use third-party (i.e., “outside”) directors to ensure that the deferral mechanisms are respected for home country tax purposes. Contact Us for Assistance
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