Hedge Fund Formation

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:

1. Domestic.

2. Offshore.

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 and pensions.

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.

A PIPE Fund has become a fairly well-known type of fund that invests mainly in microcap companies. It may grow in popularity as bank financing and funding from private lenders becomes harder to obtain.

Small brokerage firms and hedge funds are starting to pop-up now that the dust has settled from the Bear Stearns, Lehman Brothers and Madoff debacles. Wall Street and the rest of the financial services industry are starting to rebuild themselves and boutique firms that have good management teams and access to investors will be carving their niche.

During the next few years it will be interesting to see which new firms are successful and become well-known in the industry. Hedge Fund Formation is starting to pick-up steam once again and while there is talk of new or revised regulations, most people in the industry agree that it will do little to impede hedge fund formation and money management in general.