How to Start a Hedge Fund - Michael Coglianese CPA, P.C.

Starting a Hedge Fund – 2021

Before we discuss how to start a hedge fund, let’s define what it actually is: A hedge fund is a pool of investor money that uses various strategies to generate returns and/or manage risk for investors by taking positions in such securities as futures, options, and forward contracts.

And how do hedge fund managers make money? By charging fees typically based on a percentage of total funds committed and, assuming the fund does well, earn carry by retaining a portion of the increased value of the fund. However, setting up a hedge fund can be a daunting task.

Here are 6 steps you need to start a hedge fund

Retain Legal Counsel (first year estimated cost $10-50K)

The first thing you will need to do is to create the fund’s legal structure including preparation of such key documents as the limited partnership agreement, general partnership terms, private placement memorandum, subscription agreement, and investor questionnaire. The sale of hedge fund interests to investors constitutes an offering of securities that must be approved and registered with the United States Securities and Exchange Commission and certain state agencies unless the fund qualifies for an exemption. Legal counsel will have a keen understanding of the relevant legal considerations.

Legal counsel typically becomes involved early in the pre-launch phase of a new hedge fund when a sponsor needs formation and offering documents to be drafted. Counsel will begin by conducting a thorough intake process to discover the sponsor’s and the hedge fund’s needs, strategies, goals and objectives, investment criteria, asset classes, life expectancy, fees, locations, experience and qualifications of principals and management, number of anticipated investors and how much each will likely invest, assets under management, and other pertinent information that will help determine key points in drafting the offering materials.

Hire Back Office Fund Administrator (first year estimated cost $10-40K)

A hedge fund administrator must meet the needs of all interested parties including the fund manager, investors, and regulatory authorities as well as interact with other service providers such as auditors, legal counsel, bankers, brokers, and compliance advisors. Fund administration has continued to rapidly evolve with demands for more transparency and reporting along with the desire for a better digital experience and a seamless end-to-end onboarding process for investors.

A hedge fund administrator must have broad exposure and insights into many different strategies, asset classes, and hybrid structures to properly service your hedge fund as it operates today and may morph into in the future. Obviously, it should have an experienced professional team that you feel comfortable dealing with on a regular basis. Their technology platform needs to be state of the art to handle fund accounting, investor allocations, fee calculations, financial and investor statements, regulatory reporting, investor and fund manager web portals, and more all on an interconnected basis. Reporting should include robust analytics and be updated in real time. Another key consideration in selecting a fund administrator is an evaluation and independent verification of the administrator’s internal controls, processes and cyber security. Most administrators will annually engage an independent auditor to issue a SOC report detailing the procedures performed and providing an opinion of the administrator’s internal controls and security. The administrator should share this report with you.

Engage Compliance Advisor (first year estimated cost $5-20K)

Hedge funds are subject to extensive regulatory rules, burdensome reporting requirements, and constant oversight by government bodies such as the SEC, FINRA, NFA, and CFTC. A compliance expert can help you put together the necessary policies and keep them current as well as ensure your processes meet all of the compliance requirements. In addition, the compliance advisor will help you get through the regulatory audits that will inevitably occur.

Select Auditor and Tax Advisor (first year estimated cost $5-20K)

An annual third-party independent audit is required of all registered hedge funds. A reputable auditor who specializes in the alternative investment space can provide you with credibility and serve as a valuable partner in ensuring that all necessary procedures are followed, and that profit is maximized. Similarly, at tax time your tax advisor assures that returns are filed timely and correctly with all applicable federal and state agencies and that proper tax information is sent to investors.

Secure Proper Technology (first year estimated cost dependent upon size and type of fund)

Technology costs will vary depending upon the size and strategy of the firm. However, the core technology would include solid internet connectivity, professionally hosted and archived e-mail, a secure physical and electronic location for storing documentation and backups, and proper cyber security protocols. Additionally, if you manage an automated trading strategy, you will need redundancy, regular backups, and a documented recovery plan in the event of an outage or disaster. Hiring qualified staff and/or outside consultants is critical to the operation and security of your business. A system outage or security breach can have severe consequences.

Initiate Business Development (first year estimated cost $4-20K)

As a new hedge fund, you are competing with thousands of firms of varying sizes, styles, and industries. Having a professional image, a clear message on your hedge fund’s strategy, and a viable process for getting in front of potential investors is key. Professionally produced marketing materials including a logo, business cards, tear sheet, pitch book, and website help define your business, deliver your message, and create a favorable ongoing impression. A robust budget allocation is necessary to fund meetings with key contacts and service providers as well as to attend investor conferences frequented by potential customers and industry members.

In summary, now is an exciting time for fund managers to launch a hedge fund. Above are six core areas to consider when starting a hedge fund. Costs associated with each area will vary based on the size, risk level, operating complexity, and overall strategy of the fund. Furthermore, once the fund is established such ongoing operating costs as rent, equipment, staff, and other miscellaneous goods and services also need to be considered. With the help of experienced third-party advisors such as legal counsel, fund administrators, compliance advisors, auditor and tax advisor, technology experts, and business development individuals, fund managers will be well positioned for a strong start in the alternative investment space.

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