For 40 minute voice presentation with this

presentation, please visit

www.hedgefundlawblog.com

Starting a Hedge Fund in 2009

Bart Mallon, Esq.

Mallon P.C.
bmallon@mallonpc.com
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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© www.hedgefundlawblog.com
Initial Items to Consider

• Who will be your investors?

• How will you get to where you want to go?

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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
1 Investors make investment in the Fund,
payment to the Fund’s bank account*
2 Manager wires money to the Fund’s
brokerage account*
Hedge Fund Investors Management Company 3 Fund is managed by the Management
Company
(Limited Partners) (LLC) 4 Fund makes investments
5 Fund pays Management Company a
management fee (or may be paid from
brokerage account)*
6 Fund allocates Management Company a
1. performance allocation
5. 6. 7 If Investors make withdrawals, the Fund
7. will make a distribution to investors*

Hedge Fund (LP) * Indicate where there would likely be wire

3.
fees
(Bank Account)

2. 7.

Hedge Fund (LP) Fees

(Brokerage Account)
Allocations

4. Management

Movement of money
Investments

Withdrawal
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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 sale

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Hedge Fund Investors

Section 3(c)(1) Funds Section 3(c)(7) Funds

• Limited to 99 investors • Limited to 499 investors
• Accredited Investor • Qualified Purchaser
• Qualified Client – Natural person with a liquid
– Natural person with a net net worth of $5,000,000
worth of $1,500,000
– Note: may be dependant on
state law

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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 $17,000 (boutique) to $35,000+ (BigLaw) for a basic domestic long-short fund;
registration extra
– My firm will be about $13,000 for a basic domestic long-short fund; registration from $3,500 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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 For Voice Presentation, please see:

www.hedgefundlawblog.com

Please send questions, comments or suggestions to

Bart Mallon at bmallon@mallonpc.com

© www.hedgefundlawblog.com