How To Start a Hedge Fund In the United States

The United States offers one of the best business environments in the world to start a hedge fund. In the first half of 2014 alone, 39 new hedge fund firms with at least $50 million dollars in assets under management were incorporated and managing in total more than $15.3 billion dollars. Given the growth and popularity of the hedge fund industry, here are the general steps for establishing a U.S.-based hedge fund. (Related 7 Hedge Fund Manager Startup Tips) 

What is a Hedge Fund?

The term hedge fund refers to any type of private investment company that is operating under certain exemptions from registration requirements under the Securities Act of 1933 and the Investment Company Act of 1940. (Ironically, hedge funds may use investment strategies that have nothing to do with hedging.) Given these exemptions, it is much easier to start a hedge fund firm rather than a firm that manages more highly regulated investment options such as mutual funds. The relaxed restrictions for hedge funds have helped bolster the growth of the hedge fund industry.

United States

File the Articles of Incorporation for the Hedge Fund Firm

Contact the secretary of state in the state where you intend to consolidate your firm for direction about fence investments business structures. Notwithstanding the physical area of the firm, many flexible investments consolidate in Delaware in light of its business-accommodating laws. Be that as it may, different states have acquainted business-accommodating arrangements with help make their states more aggressive with Delaware. Pick your best state for incorporation.In request to begin a fence stock investments in the United States, two business elements ordinarily should be shaped. The main element is made for the fence stock investments itself and the second substance is made for the multifaceted investments' venture supervisor. 

The fence investments is commonly set up as either a restricted association or constrained obligation enterprise. In correlation, the venture chief can be set up as a constrained obligation enterprise, or some other sort of business structure that addresses the issues of the speculation director. Much of the time, flexible investments are framed as restricted organizations, in which the venture counsel goes about as the essential accomplice, and a consolidated gathering of financial specialists goes about as the auxiliary accomplice.

Once the best possible business structure has been resolved for the fence investments firm, name the reserve and start utilizing the name to finish the important lawful printed material. Likewise, the new firm should apply for a Federal Employer Identification Number (FEIN) with the Internal Revenue Service. A FEIN number can be gotten for nothing by applying on the web through the IRS site, or by rounding out IRS Form SS-4. With this data, finish the state articles of joining. In the United States, organizations can be framed in a brief timeframe and with a negligible measure of cash.

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Write the Hedge Fund Firm’s Corporate Bylaws

In today’s more regulated hedge fund environment, representatives for the new hedge fund firm will likely want to complete a host of documents in order to move forward with incorporation, register with the U.S. Securities and Exchange Commission (SEC), and register with the regulatory bodies in the state of incorporation. The level of documentation and regulatory compliance will depend upon the type of hedge fund strategy the firm plans to use. At a minimum, the hedge fund firm’s bylaws should include a mission statement, a compliance manual, an ethical code of conduct, a manual for supervisory procedures, and an advisor portfolio management agreement.

Register the Company as an Investment Advisor

In order to establish a legal partnership, the company must register as an investment advisor. Do this by going to the Investment Advisor Registration Depository (IARD) website. This process is free and can be completed over the Internet. 

Register the Hedge Fund Firm’s Representatives as an Investment Advisor

If the hedge fund is going to operate as a going concern, some of its representatives will likely need to register as an investment advisor with the U.S. Securities and Exchange Commission. The SEC requires such registration if the hedge fund is going to have 15 or more investors. Representatives can register as an investment advisor by visiting the IARD website.  Representatives can also check with the secretary of state in the state of incorporation for more information.

In order to register as an investment advisor, the representatives will need to take the Financial Industry Regulatory Authority (FINRA) Series 65 regulatory exam, which will test the representatives’ knowledge of securities laws and practices, as well as their understanding of ethics. After passing the exam, the representatives will be a licensed investment advisor with the state. The fee to take the FINRA Series 65 exam is relatively inexpensive. 

Register the Hedge Fund Offering with the SEC

The hedge fund will also need to register the offering of the limited partnership with the SEC. Whereas corporations offer stock and LLCs offer memberships, limited partnerships offer interests. To register the hedge fund with the SEC, complete SEC Form D in each state in which the hedge fund will be offered.

Comply with Consumer Protection Provisions

As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, hedge fund managers are subject to registration and reporting requirements. However, if the manager has less than $25 million dollars in assets under management, the manager is not eligible for SEC registration and must look to the laws of the adviser’s home state to determine registration and licensing requirements. 

If the manager registers with the SEC as an investment advisor, the representative will need to complete SEC Form PF if the hedge fund has at least $150 million dollars in private fund assets under management. SEC Form PF is a comprehensive document that will take a fair amount of time to complete and requires a fee for filing.Advisers registered in their home state can avoid SEC registration until they reach $100 million dollars in assets under management. Once they reach this level, hedge fund managers will need to complete Form ADV, which contains basic information about the adviser’s owners and affiliates, certain business activities that may give rise to conflicts of interest with clients, information about the private funds the adviser manages, and disciplinary information about the firm and its employees.

Market the Hedge Fund to Potential Investors

The rules that govern the marketing activities for hedge funds have changed as a result of the Jumpstart Our Business Startups Act of 2012 (JOBS Act).(Related Can you invest in hedge funds?) As a result of these changes, hedge fund managers have greater flexibility in marketing their hedge fund to potential investors. In the United States, hedge funds can be legally marketed to investors that satisfy certain standards of sophistication (Rule 506(b), Securities Act of 1933).  In addition, hedge funds can be marketed to the general public, provided all purchasers are accredited investors and certain other conditions are met (Rule 506(c), Securities Act of 1933). However, except for a limited transition provision, the SEC has clarified that an issuer cannot rely on both Rule 506(b) and Rule 506(c) in the same offering. Hedge funds are also required to include a legend to the effect that the fund is not subject to the Investment Company Act, and if the general solicitation materials include performance data, the hedge fund is required to include additional legends and disclosures related to such data. (Source: http://www.mondaq.com/unitedstates/x/264860/Securities/SEC+Am)

Bottom Line

The complexity of starting a hedge fund firm is dependent upon the number of investors invested in the fund, the amount of assets under management, and the complexity of the hedge fund’s strategy for investors. There are a few hoops and hurdles to establishing a hedge fund firm in the United States, but these are easily understood. The greater challenge will be raising the necessary investment capital to operate the hedge fund firm as a going concern, and generating consistent hedge fund investment returns that outperform their representative benchmark proxy on a net-of-fee basis over time.