Creating a Hedge Fund is like setting up a small business. In fact, a Hedge Fund is a small business. The term ‘Hedge Fund’ has been used in the Financial Industry for years. The term has been used to describe an investment company that uses alternative investment styles, which earns a profit for its shareholders (or limited partners). Unlike other investment companies, such as Merrill Lynch, Morgan Stanley, etc., Hedge Funds are designed like a corporation (sometimes LLC’s or Limited Partnerships). They sell shares to investors who then become actual shareholders in the company. The shareholders then partake in the profits based on their ownership percentage.
Typical Hedge Fund Legal Structures
Hedge Funds can be setup as a corporation, LLC or Limited Partnership. In a Limited Partnership, the Fund’s managers form a separate LLC and that LLC is the General Partner, while the investors are Limited Partners. In an LLC, it’s typically designed like a limited partnership, with the ownership percentage represented by Membership Units. The LLC style can also be structured like a corporation with stock shares representing the ownership percentages. The legal structure typically depends on the best tax situation and optimal liability mitigation.
Investment Structures
After choosing the right legal structure, Hedge Funds setup their investment structure for external investors. This involves creating the investment memorandum, also called a Private Placement Memorandum, or PPM. The PPM details the investment strategy, discloses required information, explains the securities being offered and payout goals, and provides the investment method (how to make an investment), etc. Most Hedge Funds rely on Regulation D for exemptions from securities registration. By using this exemption the Fund can file a simple Form D with the SEC’s EDGAR website (see our section on EDGAR), and then filing the same form in the NASAA uniform filing system, which covers most state filings.
General Business Setup
Along with the above formal tasks, the general business tasks also need to be included, e.g., accounting system, checking/savings accounts, investment accounts, method of investing, office space, employees, etc.. Hedge Funds can invest in just about anything, real estate, stocks, bonds, options, private offerings, and much more. However, unless the principals are licensed by FINRA it would be wise to refrain from offering any type of investment advise regarding the investments of the Fund, or any of its presumed payout plans.
