starting a hedge fund in 2009 bart mallon, esq
TRANSCRIPT
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Starting a Hedge Fund in 2009
Bart Mallon, Esq.www.hedgefundlawblog.com
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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
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• Who will be your investors?
• How will you get to where you want to go?
Initial Items to Consider
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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
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Basic Fund Structure
Hedge Fund (LP)
(Bank Account)
Hedge Fund Investors
(Limited Partners)
Management Company
(LLC)
Hedge Fund (LP)
(Brokerage Account)
1 Investors make investment in the Fund, payment to the Fund’s bank account*
2 Manager wires money to the Fund’s brokerage account*
3 Fund is managed by the Management Company
4 Fund makes investments5 Fund pays Management Company a
management fee (or may be paid from brokerage account)*
6 Fund allocates Management Company a performance allocation
7 If Investors make withdrawals, the Fund will make a distribution to investors*
* Indicate where there would likely be wire fees
Investments
Fees
Allocations
Management
Movement of money
Withdrawal
1.
7.5. 6.
3.
2. 7.
4.
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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
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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
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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 sale8 of 18
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Hedge Fund Investors
Section 3(c)(1) Funds• Limited to 99 investors• Accredited Investor• Qualified Client
– Natural person with a net worth of $1,500,000
– Note: may be dependant on state law
Section 3(c)(7) Funds• Limited to 499 investors • Qualified Purchaser
– Natural person with a liquid net worth of $5,000,000
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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
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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
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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
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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
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Costs to Start a Fund
• Lawyer– Range from $15,000 (boutique) to $30,000 (BigLaw) for a basic domestic long-short fund; registration
extra– My firm will be about $10,000 for a basic domestic long-short fund; registration from $2,000 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.
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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
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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
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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.
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Please send questions, comments or suggestions to Bart Mallon at [email protected]
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