Starting A Hedge Fund In 2009

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This presentation provides start up managers with an overview of the fund formation process and details many of the hedge fund laws and regulations. A full voice-over of this presentation can be found at www.hedgefundlawblog.com.

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Starting A Hedge Fund In 2009

  1. 1. For 40 minute voice presentation with this presentation, please visit www.hedgefundlawblog.com Starting a Hedge Fund in 2009 Bart Mallon, Esq. Mallon P.C. bmallon@mallonpc.com
  2. 2. Overview • Initial Considerations • Fund Characteristics • Basic Structure • Structural Issues • Laws • Regulation D • Investors • Registration • Service Providers • Timeline • Offering Documents • Costs • Raising Capital • Other Issues • Disclaimer 2 of 18 © www.hedgefundlawblog.com
  3. 3. Initial Items to Consider • Who will be your investors? • How will you get to where you want to go? 3 of 18
  4. 4. Hedge Fund Characteristics • Trading Strategies – Traditional – Non-Traditional – Other Pooled Investment Vehicles • Fees – 2 and 20 • Taxation – “pass-through” taxation – tax benefit of “allocation” of performance fees 4 of 18
  5. 5. Basic Fund Structure 1 Investors make investment in the Fund, payment to the Fund’s bank account* 2 Manager wires money to the Fund’s brokerage account* Hedge Fund Investors Management Company 3 Fund is managed by the Management Company (Limited Partners) (LLC) 4 Fund makes investments 5 Fund pays Management Company a management fee (or may be paid from brokerage account)* 6 Fund allocates Management Company a 1. performance allocation 5. 6. 7 If Investors make withdrawals, the Fund 7. will make a distribution to investors* Hedge Fund (LP) * Indicate where there would likely be wire 3. fees (Bank Account) 2. 7. Hedge Fund (LP) Fees (Brokerage Account) Allocations 4. Management Movement of money Investments Withdrawal 5 of 18
  6. 6. Structural Issues • Fund structure/ Investors • Minimum Investments – Initial, Subsequent, In-kind, Maximum • Withdrawal and Contribution Periods – Monthly, Quarterly, Yearly; Lock-up; Gate Provision; In-kind; Distributions • Fees – Management and Performance; High Watermark; Hurdle Rate • Management registration status • Reports to investors • Selling commissions • Expenses • Asset valuation practices 6 of 18
  7. 7. Hedge Fund Laws • Securities Act of 1933 – Interest in a fund are “securities” – Regulation D “safe harbor” • Securities Exchange Act of 1934 – Funds with 500 investors and $10 million in equity must register • Investment Company Act of 1940 – Hedge funds exempted under Section 3(c)(1) and Section 3(c)(7) • Investment Advisers Act of 1940 – Requires investment advisers to register with the SEC – Exemption under Section 203(b)(3) for advisers who have less than 15 clients over a 12 month period • Commodities Exchange Act – CPO and CTA Registration • Other Laws – Internal Revenue Code of 1986 – “Blue Sky” Laws 7 of 18
  8. 8. Regulation D • Rule 506 – No limit on amount of sales – Generally only sold to “accredited investors” – Can have up to 35 non- “accredited investors” • Definition of “accredited investor” – $1 Million Net Worth – $200,000 in income in last 2 years • No General Advertising – No newspaper ads – No radio shows • File Form D with SEC within 15 days of sale 8 of 18
  9. 9. Hedge Fund Investors Section 3(c)(1) Funds Section 3(c)(7) Funds • Limited to 99 investors • Limited to 499 investors • Accredited Investor • Qualified Purchaser • Qualified Client – Natural person with a liquid – Natural person with a net net worth of $5,000,000 worth of $1,500,000 – Note: may be dependant on state law 9 of 18
  10. 10. Registration • Investment Advisor Registration – State vs. Federal • Under $25 million – State only • $25 - $30 million – SEC or State • Over $30 million – SEC – SEC • Section 203(b)(3) exemption • Generally 2-4 weeks • Compliance manual – State • Exemption depends on state laws • Generally 2-8 weeks • Series 65 • Potential net capital requirements • Compliance procedures including potentially a compliance manual • CTA or CPO Registration – Registration with CFTC through the NFA – Potential CTA and CPO Exemptions (but potential state issues) – Series 3 – Various compliance requirements 10 of 18
  11. 11. Hedge Fund Service Providers • Lawyer – drafts offering documents; entity formation; registration; strategic and legal advice • Administrator – provides fund NAV calculation; fee calculations; investor reporting; etc. • Auditor/ Accountant – provides yearly fund audit; prepares tax forms for the manager and investors • Prime Broker – provides execution and/or clearing services for trades; custodian of assets • Consultant – provides consulting services to management company re: fund raising, marketing, operational guidance etc 11 of 18
  12. 12. Hedge Fund Timeline • Week 1 – discuss fund structure in depth, organize legal entities (management company, fund), begin talking with outside service providers • Week 2 – receive draft of offering documents, begin thinking about operational issues which may arise – are your computers ready, is office space secured? • Week 3 – discussion and revision of offering documents with attorney, begin finalizing outside service provider contracts, establish bank account, establish brokerage account • Week 4 – tie up loose ends, finalize offering documents, begin to get ready for trading or selling interests in your fund • IA registration and CTA/ CPO registration will affect this timeline – usually add about 2-4 weeks to the schedule assuming that the principals have all required regulatory exams and also provided that there are no prior regulatory actions 12 of 18
  13. 13. Offering Documents • Private Placement Memorandum (PPM) – Similar to mutual fund prospectus – Discussion of important structural terms – Discussion of investment program – Information on management company and managers • Limited Partnership Agreement (LPA) – Governing legal document • Subscription Documents – Subscription agreement – Investor suitability questions 13 of 18
  14. 14. Costs to Start a Fund • Lawyer – Range from $17,000 (boutique) to $35,000+ (BigLaw) for a basic domestic long-short fund; registration extra – My firm will be about $13,000 for a basic domestic long-short fund; registration from $3,500 if necessary • Administration – Range from $750 - $1,500 per month; Initial one time set-up fees range from $500 - $1,500 – Larger funds may also pay a fee (x bps) on AUM • Audit – Audit: $5,000 – 15,000 depending on a number of factors including Audit firm – Tax Prep: $4,000 - $10,000 depending on a number of factors including number of investors and the Audit firm • Prime Broker – Varies depending on strategy, investments, trading volume • Business Expenses – office rent, compliance costs, telephones, computers and IT, office equipment, staff salary, etc. 14 of 18
  15. 15. Raising Capital • Must be done pursuant to Regulation D • Who – Friends and Family – Institutional Investors • Marketing Materials – Powerpoint Pitchbooks – One Page Tearsheets – Appropriate Disclosures/ Disclaimers • Outside Marketing – Hedge Fund Databases – Hedge Fund Industry Events – Capital Introduction Services – Third Party Marketers 15 of 18
  16. 16. Other Issues • “Incubator” hedge funds • Offshore hedge funds • Taxation • ERISA and IRA investments • “New Issues” Rule • Soft Dollars • Side Letters • Due Diligence • Blue Sky Filings 16 of 18
  17. 17. Disclaimer • This presentation was made for informational purposes only. • I am not providing legal advice to any user. • I am not providing tax advice. Presentation is subject to the Circular 230 Notice on the disclaimer portion of my blog. • This presentation does not establish an attorney-client relationship between myself and the user. • Any discussion herein is not a substitute for seeking actual legal advice from a licensed attorney with knowledge of the rules and regulations governing the industry. • I make no representations, guarantees, or warranties as to the accuracy, completeness, currency, or suitability of the information provided via this presentation. • This may be considered to be “attorney advertising” in some jurisdictions. 17 of 18
  18. 18. For Voice Presentation, please see: www.hedgefundlawblog.com Please send questions, comments or suggestions to Bart Mallon at bmallon@mallonpc.com © www.hedgefundlawblog.com

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