How to Launch a Hedge Fund

2017-08-25 - Wilton

Startinga hedge fund, or any fund for that matter, is the ultimate dream of many talented investors around the world. For those people that haven't worked in a fund before, the internal workings of hedge funds can seem pretty opaque and complicated. In reality, starting the fund is pretty straightforward - once you have an investment strategy and committed seed capital for the fund.This article describes the steps that come after those two.

  1. Earn a Winning Track Record - Before anybody gives you money to manage, they will want to see your performance for the previous three years. This means you will need awinning and differentiated investment strategy, long before it's hedge fund time. Besides beating your benchmark, your strategy will need to be significantly different than what other funds offer, or else you won't be able to command standard 2/20 hedge fund fees. Long-only equity strategies are common and will not get anybody excited.

  2. Hire an Attorney - Next, you need to find an attorney who specializes in fund creation that can set up the funds legalstructure. I will leave the intricacies of fund legal structure for another post, but the important thing to know is that you'll need two legal entities: the management company and the fund itself. The management company isthe company that you and your partners will own. You'll probably want a limited liability corporation (LLC) structure that provides you the flexibility to divide the ownership amongst yourselves in the appropriate manner. You and your partners will own 100% of the management company. Thefund is a separate legal entity - a partnership - in which your management company is the general partner, and the investors are the limited partners. When the investors put money into the fund, they are buying equity shares of the partnership. They own the hedge fund, and the fund is managed by you, via your management company.

  3. Select a Prime Broker - Your prime broker will handle all your trades. Obviously, if you've been investing for a while, you are already working with a broker.

  4. Hire a Third-Party Administrator - Besides finding an attorney to set up the legal structure, you will need to figure out how you are going to handle the back-office fund operations. Back-office activities include receiving investment, sending monthly reports, fund accounting, distributing funds, handling redemptions, generating tax documents, and making all required filings with the SEC. You can try to do all of this yourself, but the reality is that there are third-party administrators that do this much better than you can. And, in a post Bernie Madoff world, many investors prefer the idea of an independent third-party handling the back-office, as it reduces the opportunity for fraud.

  5. Hire an Auditor - The final piece of the puzzle is the auditor. Your auditor is going to review your investments and the fund accounting on an annual basis and provide your investors with the reporting they need to feel comfortable with your stated performance. In reality, you might want to hire an auditor long before you launch your hedge fund. Your auditor can review the returns from your trading account and provide assurances to your potential investors that your claimedperformance is accurate.

One your attorney has formed the legal structure and made the filings to form the corporations, there are two other documents that you'll need before you can accept funds from your investors, the private placement memorandum (PPM), and the investor packet. The PPM is a disclosure document that describes in detail everything the investor needs to know about the investments you'll be making. The investor packet includes documents that the investor must review and sign that ensure he or she is an accredited investor and understands the investment risk.

Launching a hedge fund is a well understood process that has been performed successfully thousands and thousands of times. However, it is not something that anybody should without proper help from experts.