At the first glance, starting a hedge fund seems to be an easy task even if you’ve just graduated from college. Small hedge funds are almost not regulated, and this is an absolute advantage for starting up.
Christina Qi, a Founding Partner at Domeyard LP, started the hedge fund 8 years ago with $1000 in savings. Now Domeyard trades up to $1 billion USD per day.
In simple words, establishing a hedge fund means setting up a limited partnership and a bank account to place the fund’s initial assets. Some documents are normally used including a partnership agreement and a form that designates the investor as an accredited investor.
Finally, you start a management company (an LLC in the U.S.) that will manage the money in the fund.
The real challenge starts when your small hedge fund starts raising money. You will compete with other small hedge funds like yours and also the brand-name funds for clients. In order to win in the competition, you should prove your fund is better than others in a few criteria.
Join Our Small Business Community
Get the latest news, resources and tips to help you and your small business succeed.
Of course, this cannot be a proven track of fund performance or even the presence of well-known investors among your clients.
The competition for raising money for small or medium-sized hedge funds requires these funds to be at some level of uniqueness, where every little thing matters.
Having a well-thought-out structure, tools, and knowledge from the very first day of the fund can give you a competitive advantage later. So, let’s take a closer look at each step required to set up a hedge fund to see what can be potentially improved for a benefit.
1. Legal Registration
To create a hedge fund in the United States, it is generally necessary to create two businesses. The first entity is created for the hedge fund itself, and the second is for the hedge fund investment manager.
A hedge fund is usually created as a limited liability partnership (LP) or as a limited liability corporation (LLC). By comparison, a general investment manager can create any type of business structure that meets the needs of an investment manager.
In most cases, hedge funds are formed as limited partnerships in which the investment advisor acts as the primary partner and the combined group of investors acts as the secondary partner.
Check with the secretary of state of the state where you plan to register your firm for advice on hedge fund business structures. Regardless of the firm’s physical location, many hedge funds are incorporated in Delaware due to its business-friendly laws.
However, other states have introduced business-friendly provisions to help their states become more competitive with Delaware. Choose the best state to register
2. Building the Internal Team and Acquiring Third-Parties
The fund’s attorney plays a crucial role in forming the necessary legal entities and drafting the fund’s offering documents. Consider this specialist to be the first for hiring as an outsourced consultant.
After that, start building the team and partners relations by weighting the costs you can take internally or externally:
- Prime broker/custodian
- Fund administrator
- Regulatory consultant
- Independent valuation consultant
- Independent directors
- Information Technology (IT) consultant and support
- 3rd party marketers/fundraisers
Prime Brokers generally provide a bundled package of brokerage services including clearing, custody, leverage/ securities lending and financing, back-office support, and technology management enabling complex reporting and analysis.
An unaudited fund will be a significant red flag for potential fraud. At a minimum, it is fair to say that no institutional investor will invest in an un-audited or self-administered fund. Auditing costs can be expensive, ranging upwards from $10,000 per year.
3. Setting up the IT support
One of the main components in the ability to scale a hedge fund business is technology. Bob Shaw, at Eze Castle Integration, says:
“People should decide which way they want to learn in terms of technology – should they start simple but secure with fewer bells and whistles or something more complex with advanced security features.
Clients are often concerned about cost and scalability, but scalability doesn’t always come with a high cost. While protecting your sensitive data is key, you need to focus on building a secure foundation that can be scaled upon.
You can build a technology platform, typically fully managed in the cloud, which is secure with the flexibility to grow.
To meet this challenge, managers can balance the price against what they need to get done now and what can be done later. All while keeping their company secure.”
The rise of hedge fund management & reporting services made the fund managers able to stick with the core values and tactics while using dedicated software.
Tools such as MetaTrader 5 for hedge funds are used by fund managers to have all the settings in place: trading tools, data analysis service, and fund management capacity.
The potential cost of having service providers who can’t meet a growing fund’s needs could lead to considerable pain at a later date. At the same time, having proper software for fund scalability and automation can tickle an advantage for the fund when showing the benefits to potential investors.
4. Wrapping up the Fund
Efforts to raise funds for a hedge fund may be limited by regulations prohibiting them from publicly advertising their services. However, you can create an informative website that explains your investment strategies and benefits.
Fund managers often seek out a wider audience by offering specific trading ideas on these websites.
Mediaboom made a collection of the ten most expressive hedge fund websites, which can surely be taken for inspiration. “Hedge funds must be able to adapt to meet their clients where they are – and that starts with their website. As more and more prospective clients go digital, so too must your Hedge Fund.”
Once you are ready with the registration, team acquisition, and general vision for your fund, you may need to consider finding a suitable place to set up all the offline office equipment.
Using special listings like HedgeFundSpaces, you’ll be able to find an appropriate office space for your firm. Things you should consider include:
- The projected capacity of your business’ growth;
- The space’s accessibility for your clients; and
- The economic expense of carrying a long-term lease on your financial statements. Rent expenses can be significant and vary depending on the location of your desired office.
Launching your hedge fund will be a major commitment on your part. However, with the right planning, preparation, and assistance, it can be a painless and rewarding experience. The key is to start early and absorb as much information as possible as soon as possible.
According to Hedgethink, the average U.S. hedge fund creation takes about 4-5 weeks, considering the time to organize and prepare legal documents, setting up the brokerage accounts, and formation of the management team.
However, before you start, it’s crucial to dive into each aspect of fund formation – not only to be prepared but to get the ideas for better improvement and competitive differentiation.