Becoming the manager of your very own hedge fund will give you the opportunity to invest other people’s money for them, which can be profitable for you and your investors. If you’re an experienced financial advisor, it may be advantageous for you to step out from under the umbrella of the banking industry and strike your own path. To start a hedge fund, you’ll need to create and register a fund and start an investment company to be the fund’s general partner. In this endeavor, the investors will act as limited partners in a corporation. See Step 1 for more information.
Creating an Entity
Decide what kind of entity you want to create. The fund entity type that you are able or required to create will depend on your state regulatory laws. Limited partnerships, limited liability companies, and trusts are the typical entities used to create a hedge fund, but you’ll need to research local laws regarding the formation of business entities to learn more. Contact the commerce department in your state.
For the most part, hedge funds are typically formed as limited partnerships, in which an incorporated group of investors acts as the second partner, and an investment advisor acts as the primary partner.
Assemble an investment team of trusted advisors. If you’re spinning off from a bank, it’s typical to try and bring some coworkers with you to your new venture. A good team is essential to success. Try to hire at least two junior analysts, a junior trader, and a chief financial officer to get started. It’s hard to sell yourself to investors without an established, successful track record. Choosing workers with great employment histories and a killer instincts for stocks will help in the long run, seeding your company with human capital and enabling you to hit the ground running.
Put a name on it. Your fund needs to have a name in order to fill out the proper paperwork legally. It should be something that sounds memorable, stable and reputable. Avoid overly aggressive names like the The Viking Fund or The Valhalla Fund, which can reinforce consumer stereotypes of the hedge fund business. Use the name to soften your image, not to hypermasculinize it.
Apply for a tax ID number. Your fund entity will need to get a Federal Employer Identification Number (FEIN) from the Internal Revenue Service (IRS). This can be done by calling or going to the IRS website and filling out the necessary forms.
It’s free to get your ID number, the process only takes a few minutes, and can be completed online.
Register an an investment advisor. You will need to register with the Securities Exchange Commission (SEC) as an investment advisor if you have 15 or more investors associated with your fund. If you have less than 15, you don’t have to register with the SEC, but you still may have to register in some states. Check with the commerce secretary for more information. To register, you’ll also need to take the Series 65 regulatory exam. This 3-hour exam tests your basic knowledge of securities laws and practices as well as your understanding of ethics. When you pass the exam you will be a licensed investment advisor with your state.
Fill out a form U-10 with your state to register for the examination, then pay the small exam fee and schedule your exam. It typically costs around $30 or so.
Consider creating a corporate partner. Each investment advisor has two basic choices in structuring the fund: you can either run your hedge fund as the sole proprietor, or you can create a corporation to partner with you and limit your own liability. It’s most common to protect yourself from liability by creating a corporation to act as the general partner of your fund entity. This will be your investment advisory company.
Fill out the articles of incorporation in your state and get an FEIN for your new advisory company from the IRS.
Write your corporate bylaws. Your new investment advisory firm will need to complete its in-house rulebook to move forward with incorporation and register with the SEC and the regulatory bodies in your state. The bylaws will depend largely on you, but might commonly include:
A compliance manual
An ethical code of conduct
A manual for supervisory procedures
An advisor portfolio management agreement
Lawyer up. It’s usually best, when you’re in the middle of incorporation, to hire a law firm to guide you through the process. It’s not especially difficult to do yourself, but it’s usually advisable to establish contact with a group of lawyers experienced in financial law who’ll be able to help you down the road. Not the time for a silly paperwork slip up that could cost you. Consult the experts.
Register your company as the Registered Investment Advisor (RIA). Do this on the website of the Investment Advisor Registration Depository (IARD) to make the partnership legal. The process is completely free, but will take probably a few hours to negotiate. You may want to speak to your legal team before moving forward with the process of registry.
Register yourself as the Investment Advisor Representative (IAR). At the same time, you’ll also want to register yourself as the Investment advisor for the fund, which you can do online at the same website. To complete the process, you’ll need to complete and submit a Form U-4 and pay the fee to the IARD.
Register the fund offering with the SEC. Hedge funds don’t technically register with the SEC, but register the “offering” of the limited partnership. As corporations offer stock and LLCs offer memberships, limited partnerships offer interests.
To register, fill out Form D with the SEC. You’ll also need to fill out Form D in each state in which you intend to offer your fund.
Expanding and Growing
Seek anchor capital to seed your fund. Getting the cash to get your fund off the ground can be the most difficult part of starting a hedge fund. You need assets under management, which you’ll have to get from investors unless you’re independently wealthy and want to seed the fund yourself. The best way to make your case to investors is to have an established track record of success and as air-tight of an operation as possible.
Don’t let investment companies push you around and lock into sizable chunks of your business. Stick it out and hold onto your company, and try not to sell off too much of it before you’ve even built it up.
Hire brokers. After you get started, it’s a good idea to start attracting talented brokers to expand your operation and start performing more transactions. You can’t grow your hedge fund without dedicated employees who want to make money in a fast-paced and competitive environment. Get the word out that you’re looking for the best.
Hire excellent public relations help. Thanks to people like Bernie Madoff, increasingly, the world of hedge funds needs more and more help in the PR department. It’s an excellent idea to hire a team of specialists to help market your doings to the public and advise you in the marketing of your fund to the public.
Create a space in which you can work. As soon as you can afford it, move into a space appropriate for your business. Start small, but build a corporate office that will display the professionalism and spirit of your hedge fund operation.
Hiring a law firm to help you through the fund setup process can makethings easier, but the costs will be substantial.
How to Start an Investment Club
How to Invest
How to Hedge in Investments
How to Hedge Currency
How to Choose a Hedge Fund Manager
Sources and Citations
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