How to Start a Hedge Fund Business
A hedge fund is an unregulated investment company that takes long and short positions in stocks, bonds, commodities and other investment products. Short positions (in which the investor attempts to make money when the value of a security decreases) can result in unlimited losses; hence, hedge funds are riskier than traditional investment funds such as mutual funds. Consequently, hedge funds are typically available to sophisticated investors with large sums of capital, such as university endowments, pension funds or extremely wealthy individuals.
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Things You'll Need
- Operating agreement
- Private placement memorandum
- Certificate of incorporation
- Prime brokerage account
Instructions
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1
Draft the operating agreement for your hedge fund company in consultation with your lawyer. The operating agreement will define the hedge fund's business and establish the financial and managerial rights and duties of the hedge fund members. If you are starting the hedge fund with partners, you should all discuss and agree upon the duties and financial commitments of each partner prior to drafting the agreement.
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2
Draft the fund's private placement memorandum (PPM), which will be the document you use to raise money from investors. The PPM should contain information such as the investment strategy and objectives of the fund, whether or not the fund will invest in illiquid or hard to value securities, and the backgrounds of the fund's employees. Highlight any previous investment experience (including amount of money managed and the returns earned) of the fund's employees.
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3
Determine the appropriate corporate structure for your hedge fund. Most hedge funds are structured as limited liability companies (LLCs), which provide the benefits of traditional corporations (artificial personality and limited liability for corporate managers) with the tax benefits of a partnership (there is no corporate tax on the hedge fund's profits). Consult with your lawyer to determine the optimal corporate structure for your hedge fund.
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Incorporate your hedge fund in the appropriate jurisdiction. The hedge fund does not need to be incorporated in the state in which it actually operates; many U.S. hedge funds incorporate offshore, such as in the Cayman Islands. Fill out an Article of Incorporation with the Office of the Secretary of State for your chosen jurisdiction. You will need to list your corporate structure on the article, and you will have to pay a fee ranging from $25 to $125.
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5
Solicit money from accredited investors by creating a list of investors legally able to invest in hedge funds and distributing your PPM to them. Your lawyer will help you identify accredited investors. Most potential investors will want to meet with you after they have reviewed your PPM. Be prepared to talk about the background of your partners, your fund's strategy and how your fund differs from other funds in the market.
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Establish a prime brokerage account with a major investment bank. The prime broker will help you purchase or short blocks of shares and will help you invest in more complex securities, such as derivatives.
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Tips & Warnings
The legal documents and regulatory requirements to staring a hedge fund change often. Check with your lawyer to ensure that you have fulfilled the most up to date requirements before raising money from investors.
If your fund has more than $30 million in assets under management, you will need to register the fund with the Securities and Exchange Commission (SEC). Even if you have less than $30 million under management, you may need to register with the state in which you are incorporated, though you will not have to register with the SEC.
