As a result of state and federal regulatory issues, Hedge Fund Formation has become
more complex over the years. Going back just 10 years, most of the investing public
knew very little about hedge funds.
Now, with the internet, as well as heightened interest on the subject, anyone can find
large amounts of information on these once secretive investment vehicles.
Forming a hedge fund takes careful planning, as well as a strong understanding of the
regulatory issues involved both at the state and federal level. With good legal advice
in combination with a knowledgeable CPA in the hedge fund field a hedge fund can
be formed to suit the specific needs of the hedge fund manager or management team.
When looking for a Hedge Fund Attorney to advise you, keep in mind that you need
to specify what services you are looking for, which will affect the involved and the fee
you will be charged. Also, just like most things, whether it be a fee charged for
accounting work, carpentry work or consulting work, legal fees are not all the same.
Make sure that whatever attorney you use, he or she is experienced and has formed
several hedge funds and advised them as clients. Also, you should get a retainer
agreement in writing form the attorney. That retainer agreement should specify the
legal work that will be performed and even the legal work that will not be performed.
Hedge Fund Attorneys should be knowledgeable on all aspects of hedge fund
formation including such issues as state and federal law exemptions for the
investment manager, filing of Form D and state blue sky filings, broker-dealer
exemptions relative to capital raising efforts, preparation of the offering memorandum,
SEC view on proper hedge fund website setup, and advising the client on the choice
of a prime broker, administrator and auditor.
Hedge funds can be broken down into two categories:
There is a great difference between the domestic and offshore fund and it is important
to fully understand both structures and the reasons for each. It is not simply the
domestic fund takes in US investors and the offshore takes in non-US investors.
Be wary of any businesses or consulting firms that make it sound easy and for a low
flat fee are willing to provide you with an offering memorandum (also known as a
PPM) and all the tools you need to set up an offshore fund or domestic fund.
Domestic hedge fund formation is almost always in the form of a limited partnership.
The investors purchase limited partnership interests rather than shares of stock. By
purchasing limited partnership interests the investors are protected from loss in the
event of a lawsuit against the hedge fund, however, they are only limited to loss of
their limited partnership interest.
There is also a benefit in taxation when an investor is a limited partner. In the United
States, investors face double taxation if the fund is set up as a corporate entity, since
there would be tax at the corporate level and tax at the individual level.
As you probably already know, Hedge Fund Regulation is just around the corner. The
SEC is looking at several proposals by Congress. Some of the main issues being
discussed are the following: - Mandatory registration of managers (with assets over
$50MM); - Mandatory record keeping; - Mandatory audits; and - Oversight of
derivatives and leverage used by hedge funds.
Offshore hedge fund formation is almost always in the form of a corporate entity. The
choice of jurisdiction is important since the fund manager will want to choose a tax
free jurisdiction so the investors will benefit from such a structure, however, they may
not be U.S. persons since that would defeat the purpose of the tax free jurisdiction.
The Cayman Islands and the Netherlands Antilles seem to be two of the more popular
choices for offshore formation.
It is not uncommon for newspapers, even small local papers, to carry at least one
article that mentions something about a hedge fund. Large amounts of capital fund
these investment vehicles. Investors include wealthy individuals, trusts, institutions
It is estimated that over one trillion dollars is now managed by hedge funds. Although
the current economic crisis may reduce that number it is very likely that once the
economy settles down again, assets will again flow into hedge funds in large amounts
and hedge fund formation will again pick up.