There are several items you need to consider when setting up or starting a new fund, most importantly the following questions:
1. Do I need to be regulated?
In most cases the answer is yes, but not necessarily. There are several factor and considerations to determine whether or not to be regulated, such as where is the manager domiciled, the fund domiciled, and where and whom is the fund marketed to.
2. Which jurisdiction is suitable?
Again, there are several factors and considerations to be discussed before deciding on a jurisdiction. Domicile of the manager and investors, requirements and complexity of the regulation in each jurisdiction, and lastly the perception of a jurisdiction to your investors.
3. How do I apply for the fund license?
Many investment managers will approach a law firm, which is perfectly fine. However, the best approach would be to use a fund professional who can advise you on every aspect, start to finish, for the formation and operation of a fund. This typically saves you time and money.
4. Who do I need to set up the fund?
You would use several service providers apart from the investment manager including fund professional, law firm, directors prime broker, banker, auditor and administrator.
Things to Consider When Starting & Launching a New Fund
- Business Plan
- Fund Terms
- Primary Service Providers
- Audit & Tax
- Fund Administration
- Prime Broker
- Secondary Service Providers
- Office Space & Infrastructure
- Human Resources: Key Personnel
- Enterprise Risk Management
- Capital Raising
- Marketing Material
Develop a Business Plan
A business plan is the document that owners, business partners and financial sources want to see when you are starting your company. You should take the necessary time to work through your business model, estimate the gross revenues, general operating expenses, infrastructure needs and staffing.
A business plan is a road map for your business and should describe your business while answering fundamental questions about where you are going, how you plan to get there and whether you can succeed. The business plan may be amended as you move forward, and as you encounter new opportunities consider how those opportunities fit into your plan.
When structuring your Fund Offering Documents, there are a number of considerations to make when determining the Fund Terms. Some of those terms are described in more detail below:
This will be the minimum investment amount that you will accept from any new investor in the Fund (e.g. $1,000,000). Keep in mind, your fund’s Offering Memorandum or Private Placement Memorandum (PPM) will often contain language that allows investors to become a Limited Partner/Member in the fund for a lesser amount than the stated minimum at the “General Partner’s/Manager’s discretion”. As a new launch, you will often accept lesser initial investments from professional/accredited investors to gain their trust and build a track record in the hopes of receiving a larger allocation.
This determines how often you will accept new investors into the Fund. It is generally accepted that subscriptions will be accepted on a monthly or quarterly basis.
There are two (2) types of lockups that are generally used by Investment Managers, they are a Hard Lockup and a Soft Lockup.
This is an agreement between the Limited Partners and the General Partner that the Limited Partner(s) will not have the ability to withdraw partial or the full amount of their Capital Account prior to a minimum lockup. (e.g. 1 year)
This is an agreement between the Limited Partners and the General Partner that the Limited Partner(s) will have the ability to withdraw partial or the full amount of their Capital Account within the Initial Lockup Period (e.g. 1 year). If they do so, they will often have to pay a penalty on the amount of capital redeemed (e.g. 3%). Given the turmoil in the global capital markets in 2008, and the subsequent “gating” or “suspension of redemptions” of investor capital by many large hedge funds, investors have demanded that more favorable terms be provided by their hedge fund managers. Investors would rather pay a small penalty and know they can redeem their money versus being gated.
Redemption notice is a notice period which requires the Limited Partner to give written notice to the Investment Manager indicating their intent to redeem a partial or full amount of their Capital Account from the Fund. Traditionally, a redemption notice is 30, 45, 60, 90 days prior to a redemption period.
This is a period for which the Investment Manager is allowed to close out positions in an orderly fashion so as not to disadvantage the remaining Limited Partners to accommodate the redemption of a partial amount or full amount of a Limited Partner’s capital account. Traditionally, redemption provisions are often a monthly or quarterly time period. Coupled with the redemption notice, the redemption provision could read “Quarterly with sixty (60) days prior written notice”.
Redemption Provisions should be carefully crafted and based primarily on the average holding and disposition periods for securities in the investment strategy. Given the turmoil in the global capital markets in 2008, investors have demanded more favorable terms be provided by hedge fund managers.
This is a restriction placed on a hedge fund limiting the amount of withdrawals from the Fund during a particular redemption period. The “gate” is predetermined by the Investment Manager and is fully disclosed in the PPM. The purpose of the gate is to prevent a “run on the fund”, which could cripple its operations, as a large number of withdrawals from the Fund would force the manager to sell off a large number of positions. A gate is much less severe than a Suspension of Redemptions.
This is an asset based fee expensed on a monthly or quarterly basis. Traditionally, Investment Managers have charged an annual management fee between one percent (1%) and two percent (2%) of Assets Under Management.
The Incentive Fee is a performance based fee that is a percentage of realized and unrealized gains of the Fund’s assets payable on an annual basis. Traditionally, Investment Managers charge a twenty percent (20%) incentive fee to investors in addition to the Management Fee.
Primary Service Providers
Before choosing any Primary Service Provider, you’ll want to make sure the representative firms have the following characteristics:
- Expertise in Investment Funds, Hedge Funds and Private Equity Funds – The firm should have a deep knowledge and experience of all aspects related to investment funds and private equity funds on a global scale.
- Partner – The partner(s) you work with at each representative firm should have a deep knowledge of their respective area as it relates to investment funds, hedge funds and private equity funds. The service providers you choose during your pre-launch stage will often be your service providers for many years to come, so you’ll want to choose service providers that have the expertise and with whom you feel comfortable partnering with.
- Startup Expertise and Ongoing Support – Select service providers that are “right sized”, to not have the expertise in launching new funds, but who are also transitional in growing with your fund to provide ongoing support.
The key determinant used in establishing the correct structure for a hedge fund or private equity fund is determined by the geographic location(s) of the Fund’s initial investors. For example, a Fund that will be structured to accommodate US-only investors will be set up differently than a Fund structured to accommodate Non-US investors.
There are generally four (4) types of Fund Structures that are used by Investment Managers:
This can be structured as a Limited Partnership (LP) or a Limited Liability Company (LLC) and is created to accommodate investors that reside in the United States.
This can be structured as a Corporation or a Partnership and is created to accommodate investors that reside outside of the United States and US-Tax Exempt investors. The Fund is often organized in a tax haven jurisdiction which may include, but not be limited to: Cayman Islands, British Virgin Islands, Bermuda, etc.
Master Feeder Structure
This allows for US-Only, US-Tax Exempt and Non-US investors to invest in the same fund structure. Traditionally, the US-Only investors enter the Fund through the Domestic Feeder and the US-Tax Exempt and Non-US investors enter the Fund through the Offshore Feeder. This structure creates efficiency to the Investment Manager by allowing them to manage only one (1) pool of capital versus multiple pools.
Parallel/Side by Side Structure
This structure allows US-Only, US-Tax Exempt and Non-US investors to invest with the Investment Manager separately. The Domestic Fund and the Offshore Fund are run as “parallel” or “side-by-side” with each other and attempt to allocate trades on a pari passu basis. Given the separation of the two (2) funds, there is often slippage between the Funds given their different size and representative fund expenses.
In addition to formation of the hedge fund or private equity fund structure, you will be required to organize the General Partner (GP) and Investment Manager (IM) entities. Often organized as Limited Liability Companies (LLC), the GP engages the Investment Manager through an Investment Management Agreement (IMA) to manage the Fund. The IM is paid the asset based Management Fee (e.g. 1%-2%) and the General Partner is allocated the Incentive Fee. (e.g. 20%) Each entity will need to have an Operating Agreement drafted and negotiated amongst the Founding Partners.
Audit & Tax
During the pre-launch stages, you will work closely with your Audit & Tax Firm along with your Legal Counsel to review and assist in the formation of the Fund’s partnership agreement and private placement memorandum.
Among others, the following services will be provided by your Audit & Tax Firm:
- Estate Planning at launch is recommended while the business has little or no value versus in the future where there may be considerable tax consequences to alter the ownership structure while the business is worth considerably more.
- Year-end audit of financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) or International Financial Reporting Standards (IFRS)
- Tax Preparation for the General Partner and Management Company entities along with initial consultation with Legal Counsel to determine the best corporate structure for tax efficiency across the entire fund structure.
- Examination report of investment performance statistics to assist investment managers in marketing and packaging their track record
In choosing a Fund Administrator, you will want to choose a firm that has a breadth of experience in working with all types of investment strategies and can service different asset classes on a global basis. Advanced Fund Administration provides a comprehensive and cost effective, turnkey solution for new launch managers including, but not limited to:
- New Client On-boarding
- Fund Accounting and record keeping of the fund
- Performance Calculations
- Portfolio Reporting and Investment Manager Reporting
- Investor Services and Investor Reporting
- Anti-Money Laundering due diligence
- Cash Management of subscriptions/redemptions, capital calls, payment of fund expenses
- Online Web-Based Reporting Portal
- Year-end financial statement preparation and liaise with Auditors during Annual Audit
A new hedge fund manager should consider the following characteristics of a prime brokerage firm:
Multiple Custodian Choices
Many new launches are often constrained by working with the large prime brokers due to smaller asset base, so many new launches obtain high quality prime brokerage through an introducing broker (IB) relationship. The IB introduces hedge fund managers to the custodian(s) and provides the middle/back office roles on behalf of the custodian. The hedge fund’s securities remain at the custodian where they provide custody, clearing and execution of trades. Because the IB aggregates accounts on behalf of the Custodian, the large minimum levels often required by the large prime brokers do not come into play. Often a hedge fund manager can become “multi-primed” at a small asset level to adhere to “best practices” often required by institutional investors.
Depending upon your investment strategy, you may require your prime broker to provide securities lending across many different asset classes and geographies.
Depending upon your investment strategy, you may require various types of financing to achieve your objectives. You will want to choose a prime broker that has knowledge and experience in these areas and is capable of providing the type of financing you require.
The prime broker should have an online portal where all of your trade data is captured and provides robust portfolio analytics and reporting. Ideally, the portal should have the ability to gather trade files from all prime broker/custodial relationships so aggregated reports can be produced to calculate performance and risk analytics.
Your prime broker, through their online portal and/or real-time technology, should be able to provide Profit & Loss, Performance Attribution and Risk Analytics.
Depending upon your investment strategy, you may require an Electronic Trading model or a full-service Outsourced Trading desk. It is important that your prime broker has a robust offering of both Electronic and Outsourced Trading across multiple asset classes.
Your prime broker should be able to provide multiple Execution Management systems (EMS) that encompasses trading across multiple asset classes on a global basis. There is not a “one size fits all” and having options to choose from should provide the right solution.
Business Consulting Services
Your prime broker should be staffed with professionals that understand your business and can implement solutions across all of the key areas of your business. Solutions should not only address current issues, but also be scalable if your successful in executing your business plan and grow to a larger size.
Your prime broker should be “right sized’ to meet your needs as a new launch and as you grow and become a large hedge fund with multiple custodial relationships.
Secondary Service Providers
Once the Primary Service Providers have been chosen, you will then move on to the Secondary Service Providers that, in many cases, will provide equally important services as your primaries.
Engaging a high quality outsource compliance firm can assist in developing and maintaining a compliance program for your firm that is in line with “Best Practices” for the hedge fund industry. Even if you are not required to register with the SEC or State Regulatory Body, it is a generally accepted best practice to manage your business with a “Culture of Compliance” and have many of the components in place as if you were registered. Some of the key benefits you receive from working with an Outsourced Compliance Consultant are outlined below:
- Annual reviews
- Compliance controls testing
- Specialized compliance reviews
- Employee trading review
- Regulatory compliance reviews
- Mock examinations
- Policy & procedure development
- On-site SEC examination support
- Insider trading reviews & training
- Set-up of appropriate compliance infrastructure
- Management & Advisory
Outsourced Risk Management
Identifying a high quality outsourced risk management firm will help you protect and grow assets, obtain a higher level of trust from investors, and manage risk for your fund. Some of the key areas that an outsourced risk management firm would provide would be:
- Exposure Reporting
- Stress testing/scenario analysis/VaR
- Risk budget/volatility sizing
- Limit exception monitoring
- P&L time series & attribution analysis
An insurance broker can provide a variety of insurance products, which may include, but not be limited to:
- Business Owners Policy (BOP)
- Errors & Omissions (E&O)
- Directors & Officers (D&O)
- Employment Practices Liability
- Fiduciary Liability
- General Liability
- Workers Compensation
- Umbrella Liability
- Travel Accident
- Key Man Life
- Fidelity Bond
Outsourced Human Resources
Engaging a high quality outsourced Human Resource Department or Professional Employer Organization (“PEO”) allows you to focus on your core competencies and provides administrative relief from many employer-related responsibilities, so you can concentrate on your Investment Strategy, which is what provides you with your competitive advantage.
IT Managed Services
Information Technology (IT) will play a major role during prelaunch and throughout the lifecycle of your business. IT Managed Services should be designed specifically to enable financial firms to manage their security requirements and regulatory compliance, and to securely provide their financial products to their clients and investors. Some of the services may include:
Network services should provide redundant, firewall protected, high speed, managed communications services to leading Market Data providers and the Internet
Hosted Systems Services
Hosted Systems should include a “highly available” encrypted e-mail platform (with spam filtering), multiple file sharing servers, server and workstation monitoring and maintenance, and an IT Help Desk that is available whenever you need them
Your telecommunication services should include hosted VoIP phone service, allowing managers to work from anywhere with an Internet connection
Disaster Recovery/Business Continuity Plan
Your Disaster Recovery/Business Continuity Plan plans are tested periodically for accuracy and allow managers to “check the box” on their due diligence questionnaires (‘DDQs’).
Cloud computing provides a library of pre-installed applications designed specifically for the financial industry, connectivity to 3rd party providers, and virtually unlimited computing power that can scale on-demand. Cloud computing is a virtual and outsourced modular platform that allows financial clients the ability to adopt state-of-the-art technology with the confidence of industry best security and compliance. Applications and data are available anywhere, anytime and from any computer or device that can access the Internet.
Office Space & Infrastructure
Looking for office space can be a time consuming process, and you will have to determine whether you require a physical office or virtual office presence. To determine your space needs, you’ll want to consider (a) how many employees you’ll have at launch and also one (1) year from launch if you execute your business plan; and (b) the configuration of the office (trading desk, private offices, conference room, communications closet/room, kitchenette, reception, etc.).
Human Resources: Key Personnel
Chief Financial Officer (“CFO”) – Will have responsibility of overseeing the financial functions for the general partner entities, management company, and fund(s). In addition to being responsible for the financial matters of the operating companies, the CFO will be responsible for the daily cash/position reconciliation of the fund(s). Depending upon the size of the firm, the CFO might execute this function themselves, delegate to an internal Controller with Fund Accounting expertise or outsource this function to a third party like a Fund Administrator. The CFO will collaborate with the COO to execute the overall business plan of the firm as determined by the Founding Partner(s).
Chief Operating Officer (“COO”) – Will have the responsibility of overseeing the operations for the general partner entities, management company and fund(s). This will include working with the primary and secondary service providers along with daily fund operations (e.g. trade reconciliations), marketing, and investor relations along with collaborating with the CFO to execute the overall business plan of the firm as determined by the Founding Partner(s).
Enterprise Risk Management
An Enterprise Risk Management (ERM) review will include the review of a firm’s enterprise-wide infrastructure, reporting and governance, and recommend customized ways to enhance and align business efficiency and reporting capabilities.
Enterprise Risk Management Solutions
- Analyze an investment management firm’s complex system of interrelated business units
- Implement system-wide solutions encompassing analytics, operational infrastructure, and compliance policies and procedures
Operational Risk Assessment
ERM Solutions create compliance policies and procedures to fit a firm’s organizational structure and business goals, and meet all external regulatory requirements.
Through the course of its analysis, the ERM team will:
- Identify internal divisions of labor and responsibilities to optimize policies and procedures
- Create a code of ethics and personal trading, including governance and policy guidelines
- Review data capture and maintenance procedures, including the handling of material nonpublic information
- Coordinate the information flow among front, middle and back offices, and third parties, and devise customized reporting procedures
- Review procedures for documenting valuation to ensure standards are clear, adequately disclosed and supported, and appropriately documented
- Review the overall allocation of expenses, including disclosures in PPM, LPA, and Financials
ERM Solutions develop tools, training material, and annual audits that fit a firm’s technology, infrastructure, and reporting requirements. The ERM team works with internal and third-party staff to oversee implementation and operation.
Implementation of technological tools:
- Customized data warehouse
- IT hosting
Annual internal audit reviews:
- Compliance manual updates
- Systems and procedure checks
- Disclosure reviews
- Trading reviews
Document Review and Preparation
ERM’s Document Preparation services enable firms to review and enhance external reporting processes and outputs.
- Review and enhance external reporting
- Assist in creating risk management slides for marketing presentations
- Assist in filling out the appropriate sections of Due Diligence Questionnaires, Private Placement
- Memorandums, and Investor correspondence
Preparation and maintenance of all required reports and reconciliations:
- Daily profit and loss (P&L) reporting
- Trade capture and reconciliation, real-time (“flash”) P&L, performance measurement, confirmation of over-the-counter (OTC) trades, and management of corporate actions data
- Post trade but pre-settlement activities including trade processing/support (confirmation and allocation), position and trade reconciliation
- Development of reporting systems for internal and external distribution, including Shadow Books and Records
Having a well-thought out and organized marketing strategy is a key component prior to beginning the process of raising capital. A number of factors will affect how the strategy is determined including the type of investors that a firm will target.
We will provide a specific set of deliverables to managers of early stage hedge funds and private equity funds, as well as established fund managers who seek to increase Fund assets under management through development of an institutional grade product. We partner with its advisory clients to prepare the necessary marketing collateral and develop a detailed road-map to navigate the various stages of fund raising. Areas of focus include:
Investment Strategy/Style Description
What is your background?
- The education of the founding partner(s)
- The professional experience of the founding partner(s)
- The founding partner(s) experience managing money in this strategy
What is your investment strategy?
- What securities will you invest in? (Equity, Options, Fixed Income, Futures, Commodities, Forex)
- What geographic locations will you invest? (US, EUR, Global)
- Is your strategy Sector/Industry specific? (Tech, Healthcare, Financial, Energy, etc..)
- What is your bias? (Long/Short, Market Neutral, Long biased, Short biased, etc..)
- What is your target annual return net of your estimated fees?
- What is your target annualized volatility? (e.g. Standard Deviation)
Types of Investors
- They know the founding partner(s), trust them and believe in them
- Suitability and Accredited Investor Status remains in place
High Net Worth Individuals
- Often a Quicker Sales Process (< 6 months usually)
- Often a “stickier” investor than a fund of funds (FOF) or institution
- Not as onerous on due diligence, no reliance on a committee, etc.
Family Offices (ultra-high net worth individuals)
- One of the larger groups that invest in hedge funds globally
- Often a “stickier” investor than a FOF or institution
- Often use the “10% Rule” like a FOF
- Larger FO’s have more Rigorous DD (6-12 months)
- Larger FO’s (> $500mm) behave like Fund of Funds with Due Diligence and Investor Committee
Strategic “Seed Investors” and/or Incubators
- Equity in GP or Revenue Sharing for initial trading capital contribution
- Seed amounts are generally $20mm – $100mm
- Rigorous Due Diligence (3-12 months)
Fund of Funds
- They control one of the largest pools of hedge fund investment capital
- 10% Rule (e.g. they often will not allocate larger than 10% of AUM)
- Rigorous Due Diligence (3-12 months) with Investor Committee.
Institutional Investors (Pension Plans, Private Banks, Insurance Co.’s)
- They also control one of the largest pools of hedge fund investment capital
- 10% Rule (e.g. they often will not allocate larger than 10% of AUM)
- Rigorous Due Diligence (3-12 months) with Investor Committee
- Often will use a third party Consultant to assist with Manager Selection
A summary of the firm’s qualitative and quantitative characteristics which will include firm history, organizational chart, team member biographies, description of the investment strategy, current fund performance, prior track record of principals (if applicable), case studies (long and short), description of fund terms, service providers and risk disclosures.
A monthly summary of key characteristics of the Fund including a description of the investment strategy, monthly net performance, risk/reward analysis, peer group analysis, benchmark analysis, current AUM, service providers and contact information.
Due Diligence Questionnaire
A large percentage of sophisticated allocators will request that a manager complete a Due Diligence Questionnaire (DDQ). The most widely accepted DDQ has been produced by the Alternative Investment Manager Association, known as AIMA (www.aima.org). Given the amount of information required and the necessary time to complete a DDQ, it is recommended to complete the DDQ in advance of your launch and make updates on a quarterly basis.
An investor newsletter provides investors and prospective investors an opportunity to further understand the manager’s investment process, current views on the global economy, analysis of the most recent fund performance, attribution of returns (long or short) and fund exposures. (gross exposure, net exposure, sector/industry exposure, asset allocation)
Website Design and Hosting
Marketingafund.com provides full service web design and hosting. Proprietary to Marketingafund.com, this product is designed specifically to address the operational challenges of running a Hedge Fund or Private Equity firm and to help attract and maintain institutional investors. Some of the features are:
- Website development using the latest standards: HTML5 + CSS3
- Issuance of a standard SSL certificate to establish a secure connection between browser and server
- Use of industry-standard client side frameworks like jQuery and Normalize
- Use of client’s logo and color palette throughout the website, with a choice of standard fonts in either serif or sans-serif types
- Enhanced grid-based site layout ensures symmetrical look and feel
- Google Analytics tracking to provide various metrics on ‘anonymous’ users, identifying how they access your website and length of time spent on website.
- Basic Search Engine Optimization (SEO)
- Hosting fees include content changes (such as changes in wording or Bio information)