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Our partners in developing this guidebook:
executive summary ..................................................................................................................................................3 legal and tax Overview in establishing Your Fund.........................................................................................5
legal Overview............................................................................................................................................................................................. 7 tax Considerations.....................................................................................................................................................................................13
technology Considerations.................................................................................................................................. 17
infrastructure ...............................................................................................................................................................................................17 telecommunications..................................................................................................................................................................................17 data Protection ...........................................................................................................................................................................................18 Collocation ...................................................................................................................................................................................................19 Archiving......................................................................................................................................................................................................20 Common Mistakes and how to Avoid them ....................................................................................................................................20
selecting Your service Providers ........................................................................................................................23 human Resources Considerations .................................................................................................................... 25
selecting the Right staffing for Your Firm...........................................................................................................................................26 estimating the Cost of Your Firm’s staffing structure ..................................................................................................................... 27 Compensation Costs ................................................................................................................................................................................ 27 Retirement or 401(k) benefits ...............................................................................................................................................................28 Outsourcing Your human Resources Administration .....................................................................................................................29 equipment Costs .......................................................................................................................................................................................29 the Critical Factor—Firm Culture and Values ...................................................................................................................................30
insurance ................................................................................................................................................................... 31
employee Medical Coverage and insurance Plans ........................................................................................................................... 32
Operational infrastructure ....................................................................................................................................33
disaster Recovery and business Continuity Planning ..................................................................................................................... 33 Office location ...........................................................................................................................................................................................34 items for Consideration ...........................................................................................................................................................................39
Capital Raising ........................................................................................................................................................ 39
Factors to Consider When targeting investors ............................................................................................................................... 40 Allocation of Resources to Market ..................................................................................................................................................... 40 Marketing Your Fund ................................................................................................................................................................................41 Other issues to Consider..........................................................................................................................................................................41
A Final Word .......................................................................................................................................................... 42
A Guide tO es t Ablish in G A h ed G e Fun d
Owning and operating a successful hedge fund can be both personally and financially rewarding. However, launching a hedge fund can be a challenging and sometimes overwhelming experience. How should you structure your business? What service providers do you need? What do you need to do first? Fortunately, you need not face these decisions alone. Pershing Prime Services tapped into our wide network of industry experts, in-house expertise, and extensive experience working with businesses like yours, to offer you a framework of practical options, knowledge, and resources to help you make informed business decisions. This guidebook addresses the key areas that every hedge fund manager should consider: > Legal and tax considerations. A number of decisions must be made before a hedge fund can be successfully launched. First and foremost is your fund’s strategy. While this guidebook will not help you pick a strategy, it will give you the necessary framework of a hedge fund’s formation by providing relevant information on the key legal and tax information affecting hedge funds. Stark & Stark, Attorneys at Law, walks you through the legal landscape, and Sasserath & Zoraian LLP provides an overview of the tax environment and other necessary considerations. > Technology. In today’s financial services industry, technology plays a major role in defining a firm’s capabilities. If you previously worked in a larger, full service organization, you may have been constrained by the choices made by a separate information technology (IT) department. Now that you will make these decisions for yourself, you are free to build a technology environment that supports your own personal business vision. With that freedom, of course, comes the responsibility for every decision, including technology outsourcing, purchases, development, maintenance, and enhancements. EzeCastle Integration, Inc. discusses your firm’s technological building blocks: the systems, processes, and tools available and necessary for organizing the workflow within your firm. Technology experts weigh in on the decisionmaking process for selecting the most appropriate options. > Service providers. Third-party service providers will play a major role in your hedge fund’s success. This section provides you with information about the service providers typically used by hedge funds and offers a process that can be used in the selection process for your new fund. > Human resources. There are a number of human resources considerations to keep in mind as you prepare to launch and operate your new hedge fund. Generally, the single largest expense category for a fund relates to compensation for the individuals operating it. This section includes information on compensation and some of the associated costs, such as benefit packages and equipment allocated per staff member. > Insurance. Before beginning any work to establish your fund, it is necessary to address all the business insurance requirements that hedge your business risk. There are different types of business insurance and protection you will need to procure to minimize business risk and protect your personal and business assets, and this section walks you through some options you should consider. > Operational infrastructure. For a single-strategy fund with limited staff, the operations of the firm are relatively straightforward, as the manager is typically responsible for every task. A thoughtful approach to the structure of your operations will help you establish the most productive relationship with your service providers and maximize the time you have available for managing your fund. This section also covers the decisions involved in finding the right physical location for your new firm, common types of leasing arrangements available, ways to best estimate the amount of office space to meet your specific needs, and describes how to maximize the time you have available for managing the fund.
A G ui de t O e s t Ab l i s hi nG A he dG e F u n d
> Capital. The single largest component of success in the hedge fund industry is the ability to raise capital. It will take a plan that focuses on how capital will be raised and how performance will be recorded to successfully establish and grow your fund. Even with solid preparation, many managers find it difficult to survive the first few years of operation. Prudent managers will take steps to ensure that they will have the longevity to realize the results of their labor and investment. This section provides an outline for formulating your own capital-raising strategy. This guidebook is meant to help you understand many of the issues you will face as you strike out on your own. Not every issue presented in this guidebook will be applicable to your unique situation, and may not be as complex—or as simple—as discussed. Our goal is to share different considerations and provide a reference as you work through your hedge fund’s start-up phase, and to help you address key questions including: > What is my investment strategy? You have probably been thinking about this for some time; however, establishing your new fund’s investment strategy is the first step toward the ultimate launch. Your strategy will affect many of the other decisions you will face as you build your firm. > Do I have a marketing plan? In its most basic form, your marketing plan should identify who will be raising capital to invest in the fund and how it will be raised. This responsibility could fall on you or your partners, or you may seek outside assistance; however, capital, above all else, is what is needed for a fund to be successful. > Do I have sufficient resources to fund my new business during start-up? The process of establishing your hedge fund, creating the infrastructure of your own firm, and executing your first trade can take up to 16 weeks or more. Pershing Prime Services developed the Hedge Fund Start-Up Simulator to provide you with detailed information about the infrastructure and financial workings of a hedge fund—including how the allocation of resources and other initial planning decisions may affect the viability of your start-up hedge fund. During the start-up phase, you will be investing time and money in your new fund, so it is crucial to carefully assess if you have enough to sustain you through this period of growth and development. Answering these questions will lay the foundation for how you select the structure, staff, and systems for your hedge fund. It will frame the business decisions you make going forward, ensure that you remain on track to achieve efficient implementation, and create a firm that fulfills your hopes for personal and professional success. If you would like to explore any of the topics covered in this guidebook in greater depth, or for a copy of our Hedge Fund Start-Up Simulator, please contact Pershing Prime Services by emailing primeservices@pershing. com or by calling (866) 538-5046.
A Guide tO es t Ablish in G A h ed G e Fun d
The better prepared you are in understanding the process and managing expectations. Completing the first steps logically leads to the next decisions to be made. As the manager of a fund. define b. an administrator. and a prime broker—before an infrastructure can be built. capital raised. you will be prompted to consider the business issues. The first decisions that must be made are not about the legal structure of your firm or finding someone to ask for help.legal and tax Overview in establishing Your Fund The decision and commitment to establish a hedge fund puts you on a path on which your choices will largely determine your level of professional success. During the typical start-up period for a newly launched hedge fund. hedge Fund start-up timeline (Projected) Weeks Action Item 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 i. and the fund launched. You will need to identify and select numerous service providers—a lawyer. it is important to know that none of them will happen overnight. Throughout this guidebook. an accountant. select Office space location b. Office infrastructure a. discuss build-Out Options (e. you will be responsible for both the technical aspects of managing the fund. at least until the launch.. the process for starting the hedge fund is fairly linear in nature. establish Your Firm’s Presence a. which is approximately 16 weeks in the projected timeline. With the appropriate groundwork already having been laid. lawyer a. Architect) A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 5 . They are about making a decided commitment to the fund’s success. and creating a framework for how capital will be raised. significant time and money must be committed to getting the fund up and running. Fund Administrator ii. Create document 2. lease term and Price negotiations c. which are critically important to the success of your fund. Prime brokerage Firm 4. in addition to the technical aspects. Along with the freedom to pursue this level of success comes a host of decisions and responsibilities. as well as all of the business aspects of owning the management company. Accounting 3. While the actual time to complete each step may vary. the greater your chance of success. The start-up timeline on the following pages shows the general process and timing of key milestones in the launch of a hedge fund. It is important for you and any potential partners to be prepared to be expending both while not generating any revenue. developing a thoroughly vetted and articulated investment strategy. it is also likely that you will not be generating any significant revenue for the fund’s first year or two of operation.g. Choose Primary service Providers 1.
delivery c. establish and define business Continuity Plans e. select human Resources Provider (Professional employer Organization) b. installation iii. design network infrastructure 1. identify target investors c. Account integration c. Voice Circuit Order 3. delivery d. select it Consultant b. evaluate Middle. Prepare Marketing Plan b. Meet With Prime broker Capital introduction team and Marketing Firms d. Conduct Road show and investor Presentations vii. install and test v. select and Purchase Office Furniture 1. build Out space e. delivery 3. human Resources a.Weeks Action Item 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 d. Prime broker technology setup and training d. ix. Order 2. test Prime broker technology and data links viii. data Circuit Order 2. Obtain business liability insurance f. select Market data Vendor f. implement Order and Portfolio Management system(s) c. Capital Raising a. technology a. Operational insfrastructure a. evaluate and select Portfolio Management system(s) b. Prime brokerage Account integration training a. Account Funding First trade date 6 A Guide tO es t Ablish in G A h ed G e Fun d . Order Workstations and Peripherals 2. Prime broker legal documentation b.and back-Office solutions vi. define network Requirements 1. Recruit staff iv.
Delaware is most often chosen because of its favorable legal and judicial structure. Attorneys at Law. the incorporation process can take place. Full disclosure of the risks is necessary in order to comply with the antifraud provisions of securities laws and as a protection against litigation in the event the fund is unsuccessful. Once you have determined the type of vehicle. and summarizes the limited partnership agreement or operating agreement. the offering documents can also be prepared. operations. the offering of the fund is done through the preparation of a private placement memorandum and a subscription agreement. Formation The formation of a private equity fund requires a consideration of the nature of the business operations and investments in which the proposed fund intends to invest. the Offering Process The marketing of interests in the equity fund is considered a securities offering and is governed by the Securities Act of 1933 (the “1933 Act”). A general partnership is commonly known to be the better corporate structure. The operating agreement sets forth the operation and duties of the general partner. which is vitally important to the offering documents. Fortunately. Lastly. although the exemptions do not free you from the antifraud provisions of the 1933 Act. While an operating agreement will allow you to define the operation largely as you wish—to the extent an item is left undefined—statute will define it for you. so the fund is far more unlikely to have a solution imposed on it by statute. and counsel can form the entities in the preferred state. how it is marketed to potential investors.legal Overview There are a number of legal considerations that should be taken into account when deciding how to best structure a fund. The following overview of the hedge fund legal landscape has been prepared by Stark & Stark. Consultation with counsel concerning the precise nature of the fund. These include who can invest in the fund. and how compliance with applicable laws is maintained throughout the entire process. The limited partnership agreement defines what the partnership can and cannot do. with one LLC acting as the managing member of the other). A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 7 . preparation of the materials for the offering can begin in earnest. the strategy of the fund. the background of the individuals involved. and fees are defined by the limited partnership agreement. the admissions and withdrawals of members. Most private equity funds are set up as general partnerships with a limited liability company (an “LLC”) installed as the general partner (although some form two LLCs. The private placement memorandum describes the offering. The private placement memorandum also contains the description of the risks of the investment. Once the limited partnership agreement and operating agreement are prepared. Additionally. its investment strategy and fee structure. When the entities are formed. the Investment Advisers Act of 1940 (the “Advisers Act”) is implicated where there is a consideration of the kind of fees that may be charged. All the relevant control. and management of the fund are crucial at this early stage. At this time. the next step is to form the entities and have an operating agreement created for the LLC and a limited partnership agreement drafted for the investment vehicle. More effort is also needed to define the ownership status of the managing member. the Investment Company Act of 1940 (the “Company Act”) is also implicated because of an equity fund’s nature as a company to manage investments. both have registration exemptions. Typically. Partnership statutes define a considerably lesser number of items. the minimum investment amounts.
especially negative information. First. and implications of the Employee Retirement Income Security Act of 1974 (ERISA). Disclosure of more. A private placement memorandum should be prepared. using statements or offering documents that “include an untrue statement of a material fact or omits to state a material fact necessary to make the statements. the fund must not exceed 100 investors.S. rather than less. > The Securities Act of 1933: full and fair disclosure. or to leave out information that would make the offering documents misleading. therefore. Specifically. negative facts through risk factors should be disclosed. which makes it vital that. 8 A Guide tO es t Ablish in G A h ed G e Fun d . Because registration is costly and makes operation more expensive and difficult. full and fair disclosure of all material information is required. Securities and Exchange Commission (SEC) will likely take the position that the second fund was formed solely for the purpose of avoiding registration under the Company Act and “integrate” them. if multiple funds are being operated. > The Securities Act of 1933: antifraud provisions. in light of the circumstances under which they were made. Section 12(2) of the 1933 Act makes an offer absolutely. the investment strategy. . and. the fund is required to conform to the antifraud provisions of Section 12. full disclosure of the risks vital for adequate protection in the event the fund is not successful. as such disclosures provide significant protection from liability in the event the fund is not successful. or treat both entities as one. There is a registration exemption pursuant to Section 3 of the Company Act for all investment companies that have 100 or fewer investors. The private placement memorandum will describe the background of the individuals charged with fund operations. no more than 100 investors should be allowed into the fund. which carries severe civil and criminal penalties. Most offering memoranda have a significant number of “risk factors” listed for that reason. withdrawal provisions. the U. civilly liable for the offer or sale of a security. In that event. and its management. The fund will then be above the investor limit and you may be charged with the sale and operation of an unregistered investment company without an appropriate exemption. Therefore. Such a charge can lead to significant penalties.In order to avoid registration under the Company Act. a greater disclosure of investment risks is always preferred to ensure compliance with Section 12 of the 1933 Act and. not misleading . The provisions of the 1933 Act require that the documents offering the fund fully and fairly disclose all material information about the documents.” Risk factors are considered facts necessary to ensure that the more positive statements are not misleading. There are two considerations that relate to the 1933 Act. In general. the fee structure. most importantly. the funds’ investment strategies are not identical. even if it is offered pursuant to an exemption from registration. . Failure to disclose all material information. whether or not exempt. It is vitally important that the risks of loss be fully and completely described as part of these disclosures. registration is generally not preferred. in addition to a description of the positive aspects of the fund. Accordingly. is considered a violation of Section 12 of the 1933 Act. protect against potential liability. certain tax considerations. which details all the material disclosures required. its strategy. Accordingly. including the risks. Avoiding the limit of 100 investors cannot be done by closing the fund to new investors while simultaneously opening a new fund that is identical to the first and having new investors invest in the new fund. a description of the limited partnership agreement. information is usually advisable.
in general. not formed for the specific purpose of acquiring the securities offered.S. > (4) Any director. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958. with total assets in excess of $5 million. Offerings pursuant to Regulation D have relevant investor criteria designed to ensure that the investor is sophisticated enough to evaluate the investment or. or joint net worth with that person’s spouse. > (5) Any natural person whose individual net worth. > (2) Any private business development company as defined in Section 202(a)(22) of the Investment Advisers Act of 1940. > (6) Any natural person who had an individual income in excess of $200. Specifically. that the investor has assistance in such evaluation. at the time of his purchase exceeds $1 million. if a self-directed plan. with total assets in excess of $5 million.> The Securities Act of 1933: registration requirement. or general partner of a general partner of that issuer. which implicates the fund.000 in each of the two most recent years or joint income with that person’s spouse in excess of $300. Massachusetts or similar business trust. not formed for the specific purpose of acquiring the securities offered. The failure to register the fund or comply with the Regulation D exemption requirements can carry significant penalties. executive officer. (7) Any trust. any Small Business Investment Company licensed by the U. any insurance company registered under the Investment Company Act of 1940 or a business development company as defined in Section 2(a)(48) of that Act. for the benefits of its employees. or. The second aspect of the 1933 Act. Offerings to investors deemed to be sufficiently sophisticated or “accredited” have no limits on the number of investors.000 in each of those years and has a reasonable expectation of reaching the same income level in the current year. as defined in Section 3(21) of such Act. as defined in Rule 501. its political subdivisions. corporation. accredited investors are defined as follows: > (1) Any bank as defined in Section 3(a)(2) of the Act. must be registered. Accredited investors. whether acting in its individual or fiduciary capacity. if not. or if the employee benefit plan has total assets in excess of $5 million. whose purchase is directed by a sophisticated person as described in Rule 206(b)(2)(ii). any broker or dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934. any plan established and maintained by a state. or any director. any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974. with investment decisions made solely by persons that are accredited investors. are. wealthy individuals or financially sophisticated entities such as banks. which is either a bank. Regulation D provides an exemption from registration for “private placement offerings. insurance company. which is an exemption from the registration that is applicable to most private equity funds.” though this is subject to certain conditions. is the requirement that securities offerings. or any savings and loan association or other institution as defined in Section 3(a)(5)(A) of the Act. unless exempt. or general partner of the issuer of the securities being offered or sold. or partnership. if such plan has total assets in excess of $5 million. or registered investment adviser. and (8) Any entity in which all of the equity owners are accredited investors. if the investment decision is made by a plan fiduciary. executive officer. savings and loan association. > (3) Any organization described in Section 501(c)(3) of the Internal Revenue Code. The SEC has promulgated Registration D. though the Company Act limits still apply. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 9 .
) (A) Has a net worth (together. trustee. > (ii. or administrative functions with regard to the investment adviser) who. It is the fund’s obligation to demonstrate compliance with the requirements of Regulation D. within the state of residence of each investor. an investor questionnaire is generally provided to a prospective investor and. the Advisers Act requires that sales be made only to a “qualified client” or investor. Although each state has different requirements that should be researched prior to any actions. or > (iii.) A natural person who or a company that the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes. general partner. a special allocation fee. the investor attests that the information he or she is providing is truthful. depending upon the fee structure of the offering. As defined in Rule 205-3 of the SEC. Although Regulation D does not specifically mandate an investment advisor. as well as other documents and fees specified in “blue sky” statutes.000 under the management of the investment adviser. a Uniform Consent to Service of Process (or Form U-2). or > (ii. or > (iii.) A natural person who or a company that immediately after entering into the contract has at least $750. Accordingly. In other subscription documents.) (A) An executive officer. or person serving in a similar capacity.There is a limit of 35 “nonaccredited” investors—those who do not meet the above definition of accredited investor.5 million at the time the contract is entered into. in the case of a natural person. secretarial. or substantially similar functions or duties for or on behalf of another company for at least 12 months. the relevant department of the state government generally requires a filing of Form D. in connection with his or her regular functions or duties. It is advisable that such nonaccredited investors have an investment advisor. Within 15 days of the first sale.) (B) Is a qualified purchaser as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940 at the time the contract is entered into. where there is a performance fee. of the investment adviser. that he or she has read the offering materials and is not relying on anything other than those materials. which are usually also provided and required to be signed. generally. it contemplates one with an explicit description of what one is and its purpose. or meet the requirements of sophistication. The Advisers Act also identifies who can invest in the fund. However. immediately prior to entering into the contract. which must be complied with when selling to residents of that state. 10 A Guide tO es t Ablish in G A h ed G e Fun d . and signed by investors. > The Advisers Act: investor criteria. or a general fee tied to the performance of the fund. It is essential that such a document be provided. Each state has its own securities laws. director. participates in the investment activities of such investment adviser. and understands the risks of the offer. Where there is solely a management fee charged. the fund requires the investor to fill it out.) A natural person who immediately prior to entering into the contract is: > (iii. either: > (ii. Such advisors can go a long way toward meeting the burden of demonstrating that the Regulation D exemption is appropriate. with assets held jointly with a spouse) of more than $1. the fund must file the registration materials and a Form D with the SEC. including a demonstration that the investors are either accredited. a “qualified client” is: > (i. filled out. and a filing fee.) (B) An employee of the investment adviser (other than an employee performing solely clerical. have an advisor. the prescriptions of Regulation D are the only investor criteria that apply. provided that such employee has been performing such functions and duties for or on behalf of the investment adviser.
no matter the nature of the investor. most funds seek to avoid the strictures of ERISA and stay under the 25% threshold. if necessary. will suffice to comply with such laws. > If the client’s portfolio contains assets for which market quotations are not readily available.” Although. it is vital that you consider the nature of your investors. such as a driver’s license or passport. unless the intent of the fund is specifically tailored to the ERISA funds market and intends to operate under ERISA provisions under all circumstances. If the fund exceeds such amounts for more than 14 days. some form of government-issued identification. In general.” or move securities from one fund to another. the assets are valued by a person who is independent of the investment manager and who is appointed and. ERISA contains an exemption from its provisions for funds that have less than 25% of their assets as ERISA funds. to the extent that any sister entity is providing services to the fund. ERISA also restricts the ability of the fund to “cross-trade. Although the fund may be marketed to an (IRA’s) pension funds and other ERISA pension vehicles (“ERISA funds”). A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 11 . or engage in certain trading activities. Performance fees are allowed where: > The performance-based fee formula takes into account both realized and unrealized gains and losses during a pre-established measurement period. such as “block trades. when determining the fee structure. replaced only by the pension plan. the fund must follow the enhanced duties and restrictions required by ERISA and the Department of Labor (DOL). ERISA contains restrictions on the ability of the general partner to receive compensation. Small investors will restrict the fees charged and may make it impossible to offer the fund to a potential investor. > The decision to enter into the performance-based fee arrangement is made by an ERISA fiduciary who is independent of the investment manager. Similarly. the agency charged with enforcing ERISA. compensate sister entities. it has taken a more flexible approach over the past two decades. Under these statutes.eRisA Considerations Accordingly. they are considered under the statutes to be low-risk endeavors for money laundering activity. Because private equity funds investments are illiquid. there can be substantial issues with accepting more than a small amount of such investors. The DOL also reserves the right to inspect the operation of the fund to ensure compliance with ERISA. ERISA prohibits the general partner or its managing member firm from receiving any compensation from the activities of the fund. Anti-Money laundering Compliance You must also comply with anti-money laundering statutes. and > The arrangements involve sophisticated investors having aggregate assets of at least $50 million. Other funds are managed by the same investment manager to certain very limited circumstances and transactions and require no commissions or compensation to be paid in such cross-trades. the issuer is charged with having sufficient knowledge of the investor to ensure that the customer is not laundering money. > The fee arrangement complies with the securities laws governing performance-based compensation arrangements. the DOL at one time severely restricted the ability to charge performance fees. engage in transactions. Nonetheless. the issuer must take steps to ensure that the investor’s identity is verified. In general.
12 A Guide tO es t Ablish in G A h ed G e Fun d . it is not advisable to cross the 25% threshold. the offshore investment manager should be used in all transactions and not be ignored. In the event that the general partner wishes to change the fund’s investment strategy. These provisions should always be followed. Money laundering issues in the current environment have taken on a greater life. remain offshore. it is important to choose a location that has a sufficiently stable government and a regulatory structure that is rigorous enough to provide comfort to investors. Fees should only be paid in compliance with both the amount and timing procedures set forth in the limited partnership. as well as a year-end audited report. Typically.-based subadvisor to manage the fund’s assets. Offshore funds are primarily of interest to high-net-worth investors who have. but care must be taken to ensure that the fund’s activities. change the investor makeup to comply. The procedures set forth in the operating agreement should be followed. laws beyond Regulation S. if needed.S. It is also important that the location have an adequate amount of financial and legal service providers to implement the fund. corporate forms at all—for example. in turn. which provides a safe harbor provided that the securities “come to rest” outside the United States. Accordingly. partnership agreements require quarterly reporting of the fund’s profitability to the limited partner. Resale is similarly restricted with Regulation D as discussed earlier. and procedures should be in place to be able to discern the nature of the client. the British Virgin Islands. an offshore fund usually contracts with an investment manager located in its jurisdiction. Typical locations include the Cayman Islands.S. When setting up an offshore fund. Failure to follow proper procedures could create substantial issues for the fund and investor. The day-to-day administration of the activities is handled by the offshore investment manager. Therefore. Such individual account information should be included in the financial reports. who. and the offshore nature of the fund must be preserved in order to protect investors and the fund. so as not to trigger U. assets outside United States’ jurisdiction. beyond the offering. yet flexible enough to be able to operate on a day-to-day basis.S. The corporate structure of an offshore fund somewhat differs from a U. Care must also be taken to ensure that the fund remains below the 25% threshold previously described for ERISA funds. fund in that the location statutes generally favor other corporate forms or do not have the typical U. and Bermuda. Offshore funds may be marketed in the United States. ERISA allows a window of 14 days to correct an inadvertent crossing of the 25% threshold. Frequently. partnership agreements generally allow for such a change without approval. Each location also has its own anti-money laundering statutes that come into play for funds. Generally. Fund Operation The limited partnership agreement defines the fund’s operation and structure. or wish to have. However. investors must be informed of such a change in order to avoid a claim under the 1933 Act that the offering materials were false and misleading with regard to the description of the investment strategy. typically contracts with a U. most of which involve the “know your customer” types of rules. it is vital to monitor the percentage of ERISA funds under management to avoid the ERISA strictures and.S.Offshore Funds Funds are frequently created in certain offshore locations that have tax and privacy advantages. Ireland and the Netherlands Antilles are also used. The fund should have a reputable accountant or accounting firm calculate and maintain the capital accounts of each investor. Care must be taken to ensure that corporate structures are followed to maintain the fund’s offshore status. fund.S. Unlike a U. an exempted investment company issued in the Cayman Islands or an international business corporation in the British Virgin Islands. there are tax implications to those who invest in offshore funds.
and the taxability and deductibility of benefits. > Onshore fund. > Offshore fund. Investment advisors and brokers are generally aware of and comfortable with this duty. or a limited partnership. > – Side-by-side. as they owe the same or similar obligations to their clients. state and local tax implications. tax Considerations A number of tax issues relate to the formation of your hedge fund. In order to choose which entity will work best for your fund’s investment vehicle and which entity will work best for the management company(ies). a “C” corporation. Fund structure Your attorney will walk you through the choices that exist. an investor becomes a limited partner of the partnership. That duty generally requires the general partner to act in the best interests of the fund and its investors. and income allocation. The section below highlights some of the characteristics of each type of entity: > Limited Liability Company (LLC) > – Limited liability for all members > – Single level of taxation > – No limitation on number of owners > – No limitation as to type of owners (i. investors typically invest in a limited partnership organized in the United States and offshore investors invest in an offshore corporation. Offshore funds are typically organized in two ways: > – Master feeder.e. you must first understand the characteristics of each type of entity. U. An offshore fund is organized to facilitate investments of capital from investors residing outside the United States.. management compensation. a general partnership. entity or individual permitted) or citizenship of owners > – Income and loss allocation flexibility (i. This structure allows both investors residing in the United States and investors residing offshore to indirectly invest in the same offshore corporate entity commonly known as the “master fund. The following information regarding the tax considerations associated with launching your hedge fund has been authored by Sasserath & Zoraian LLP. Some of the general tax considerations are the selection of the type of entity to be used. entity selection The entities that are normally formed to start a hedge fund are the entity for the investment vehicle and the entity(ies) for the management company(ies). These entities may be organized as a limited liability company.S. tax basics. By purchasing an interest in the partnership.e. The prime broker typically allocates trade tickets between the domestic fund and the offshore fund.” Onshore and offshore feeders are used to invest assets in the master fund. For investors residing in the United States. however. In a side-by-side structure.The general partner has a fiduciary duty to the fund and its investors. an onshore fund is usually organized as a limited partnership. even if it is to its detriment.. an early decision you will make is who you are targeting as investors—people residing in the United States or residents of foreign countries? This decision will impact how your fund is organized. an “S” corporation. special allocations as defined below are permitted) A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 13 .
.S. special allocations as defined below are not permitted) > – Payroll taxes applicable to shareholders and employees that receive salaries > – Single class of stock requirement > – Taxable distribution of appreciated property at the corporate and individual levels > – Taxable liquidations > General Partnership > – Unlimited liability for all members > – Single level of taxation > – No limitation on number of owners > – No limitation as to type of owners (i.e.. which must be in proportion to each shareholder’s interest in the “S” corporation (i.> – Self-employment (payroll) tax on the distributive share of ordinary income applicable to active members > – No single class of membership requirement > – Tax-free distribution of appreciated property (subject to certain limitations) > – Tax-free liquidations (subject to certain limitations) > “C” Corporation > – Limited liability for all shareholders > – Two levels of taxation > – No limitation on number of owners > – No limitation as to type of owners (i. entity or individual permitted) or citizenship of owners > – No income or loss allocations to owners > – Payroll taxes applicable to shareholders and employees that receive salaries > – No single class of stock requirement > Taxable distribution of appreciated property at the corporate and individual levels > Taxable liquidations > “S” Corporation > – Limited liability for all shareholders > – Generally a single level of taxation > – 100-shareholder ownership limitation > – Ownership limit to U. special allocations as defined below are permitted) > – Self-employment (payroll) tax on the distributive share of ordinary income applicable to active members > – No single class of ownership requirement 14 A Guide tO es t Ablish in G A h ed G e Fun d ... or certain types of estates or trusts > – Limitations on income and loss allocations and distributions.e. entity or individual permitted) or citizenship of owners > – Income and loss allocation flexibility (i. citizens. resident aliens.e.e.
.e. except in New York City. in a percentage other than their ownership percentage. The only other permissible entity that could accommodate all of these characteristics is the LLC. Accordingly. state and local taxation rules follow federal taxation rules. and credit items flow through the owners of the entity either in their ownership percentage or. entity or individual permitted) or citizenship of owners > – Income and loss allocation flexibility (i. Investment vehicles are typically organized as limited partnerships for the single level of taxation. Accordingly. though it is not normally chosen. short-term capital gain.. there are separate planning ideas to minimize local entity taxes. and investment interest expense. and other benefit plans paid by the management company(ies) must comply with IRS and DOL rules and regulations. as long as the plan covers all employees of the management company(ies). Generally. if there is a long-term capital gain at the entity level. a deduction will be permitted at the entity level and the owner and employee will not have to pay taxes on benefits. The rule also applies to ordinary income. and permission of special allocations. limited liability for limited partners > – Single level of taxation > – No limitation on number of owners > – No limitation as to type of owners (i. All of the income. deduction.> – Tax-free distribution of appreciated property (subject to certain limitations) > – Tax-free liquidations (subject to certain limitations) > Limited Partnership > – Unlimited liability for general partners. which does not recognize flow-through entities. limited liability for the limited partners. These are discussed in more detail below. also known as a special allocation. flow-through income retains its character at the entity level. retirement plans. if the management of your hedge fund is located in New York City. such a gain will be reported to the owners as a long-term capital gain.e. Benefits paid by the management company(ies) to the owner and employee are treated similarly to the benefits paid by any company to their owners or employees. if permitted and agreed to within the entity operating agreement. health insurance plans. Accordingly. Entities with a single level of taxation generally have no tax liability at the entity level. Owners and employees may be limited in the benefits they are permitted to receive from a plan depending on the type of plan. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 15 . no limitation as to the type or citizenship of the partners. With a single level of taxation. loss. special allocations as defined below are permitted) > – Self-employment (payroll) tax on the distributive share of ordinary income applicable to general partners > – No single class of ownership requirement > – Tax-free distribution of appreciated property (subject to certain limitations) > – Tax-free liquidations (subject to certain limitations) Generally.
there are drawbacks to doing so.S. no limitation as to the type or citizenship of owners.In a situation in which there are one or more management companies. in the event that. your fund would most likely be a foreign corporate vehicle for offshore investors that require anonymity and freedom from making U. separate entities are typically set up to receive the management fee and the incentive reallocation. Other tax Considerations > IRC Section 475: election. if a “C” corporation was formed as the management company. Neither the Internal Revenue Code (IRC) nor its regulations mandate a specific method for hedge funds to allocate profits or losses to their investors. As mentioned above. However. The management fee is a fee paid to a management company. With offshore funds. typically 1%–2% of the assets calculated on a monthly or quarterly basis. This treatment is generally advantageous to both the investor and general partner. Funds that could benefit from this election are funds that do not expect to generate much in the way of long-term capital gains. The aforementioned are the tax considerations that all hedge funds face. Additionally. Accordingly. rather than capital losses that may or may not be able to be deducted by partners. However. For the most part. special allocations could be effected by adjusting the salaries of the shareholders and employees. Management companies are typically organized as LLCs for the single level of taxation. the liquidation of this entity is tax-free.S. deduction. and credit retain their character. limited liability to the members. For example. In this case. and no single class of membership requirement. Generally. because New York City generally does not recognize flow-through entities. once an approach is adopted. permission of special allocations. Below is a discussion of other considerations that your particular hedge fund may or may not need to address. However. 16 A Guide tO es t Ablish in G A h ed G e Fun d . manager compensation takes two forms: the management fee and the incentive reallocation. in the future. it is a reallocation of the profits from the investment vehicle. tax filings. the members of the company(ies) decide to change from this entity. as ordinary. This fee is used by the management company to cover normal operating expenses. though subject to certain limitations. Also. and gain or loss. It may be advantageous for certain hedge funds to make an election under IRC Section 475. loss. persons involved. there is a local tax benefit to having separate entities for management companies that are doing business in New York City. the items of income. volatile funds would generate ordinary losses in the years in which they created a loss. your fund should be consistent with the allocation methodology from year to year. the choice of entity question is more complex depending on whether there are taxable or tax-exempt U. federal or state tax benefits cannot be gained from forming separate companies for the management and incentive reallocations. Incentive reallocation is not a fee. While some of the attributes stated above may be effected by using other entities. > Offshore funds: entity choice. Such an election causes all gains and losses from securities and securities held at year-end to be marked to market. any reasonable approach that is consistent with the partnership rules is permitted. This incentive reallocation is typically 20% of the profits derived from the investment vehicle and is reallocated to the general partner of the investment vehicle. the IRS could deem such “salary adjustments” as “excessive” salaries.
When selecting an Internet service provider. If outsourcing IT. and archiving.Checklist – legal and tax Overview Evaluate whether you have enough capital to sustain you through the fund’s start-up phase. available. Managers should also inquire about the frequency of system and application monitoring to ensure that nothing goes wrong with the security in place. data protection. many funds lease space in collocation data centers. Cable modems and DSL offer high speeds and are relatively inexpensive. Most firms view the Internet as a critical means of collecting and distributing market data. technology Considerations Establishing a reliable. voice services. and multiple network providers. telecommunications Telecommunications has three key categories to consider: Internet service. multi-day fuel supply onsite. An N+1 infrastructure should be developed through multi-entry fiber paths and power grids. cameras. and 24/7 monitoring. and how it operates. Create a timeline of events leading up to the launch of the fund. Have your accountant review the documents prepared by your attorney. A business continuity plan and a corresponding disaster recovery system have become essential in today’s marketplace. infrastructure Security is fundamental when considering a fund’s technology setup and network infrastructure. cages. A voice communications system must be created to support the valuable communication that takes place within the fund. or a T-1 line. which host their hardware and software in an offsite facility. and market data services. DSL. There are a few basic technology requirements that all funds must consider when starting up: infrastructure. you should look for a A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 17 . as well as communicating through the use of email. especially when compared with a T-1 line. A multitiered security approach is essential to protecting the critical information that passes through the system every day. A solid network infrastructure must be created in order to carry the valuable information that a fund uses on a daily basis. as well as technical security. phone and voicemail. The specific technology required for a firm varies depending on the applications used. but their reliability is low. Having transactions archived will make it possible to refer back to what specifically took place and answer any questions that might arise. To meet this need. email and instant message archiving to guard against loss of information are both required from a legal standpoint. Finally. providing necessary bandwidth and increased protection. what the fund does. Have an attorney draft your legal documents. Three Internet options are typically available: cable modems. Internet T-1s are generally considered high in reliability and offer efficient speeds. Identify your strategy and target investors. the manager should verify that the provider is considering the security of its data center and hosting environment. The data center needs sufficient redundancy and availability. The site should maintain physical security. and digital monitoring. and secure technology core is essential for a hedge fund to become successful. with investors looking for funds to demonstrate how they will be able to maintain operations regardless of external events.
or PBX. A business continuity plan makes use of the infrastructure addressed in the disaster recovery plan. as well as having more users.. A disaster recovery plan encompasses the steps taken to implement and support the infrastructure (hardware. They expect firms to have comprehensive. and Dow Jones®. Reuters®.g. Ideally. yet unique. accounting). an auto-attendant. voicemail to email setup. The cost of services is determined by the offering mix. It asks the questions whose answers are crucial to business functionality: what are the mission-critical processes. pre-investment due diligence audits. small. and the real-time pricing requirements. speed.000 to $40. and call recording system. as they deliver complementary. a firm typically purchases a phone switch. a firm should consider having two providers and a router to establish automatic failover if one of the providers goes down. as well as caller ID. For example. When reviewing your options. reliability. these systems should be carefully selected and tested. and client service. tested plans and procedures in place and often request to see them documented during routine. capabilities to a fund. call accounting system. and integration with trading systems. The steps to access up-to-date information and applications are established with a disaster recovery plan.000 for a solution that includes centralized call processes and solutions. trading. A PBX provides many options for routing calls and storing voicemails. may increase the costs into the range of $30. and integration with ring-down lines to various brokers. file.to medium-size firms with less than 40 people can expect to pay roughly $20. as poor call quality is not uncommon with this technology. such as voicemail and administration. These features.000 to $80. email. how are they going to be notified of an emergency. Many hedge funds require and expect more advanced features from their voice solution. voice. For phone and voicemail services. However. as well as on additional functions you may require. which is installed in the data center. who are the key personnel. software. the remote access method. To help ensure superior reliability. as well as cost.company that bundles proactive monitoring and security features to achieve high levels of availability. and where or how will they continue to operate? 18 A Guide tO es t Ablish in G A h ed G e Fun d . data Protection Investors are becoming increasingly stringent in vetting a firm’s business and IT practices. but focuses on business operations. the number of users. VoIP services can be a relatively inexpensive option for firms lacking upfront capital for the back office.000. Selecting a market data vendor is based on the market and product coverage a firm requires. Key market data providers include Bloomberg®. It is important to understand the difference between a business continuity plan and a disaster recovery plan. Bear in mind that your final costs will be dependent both on the number of end users on the system. it is important to consider the number of users and required functionality of the system. Some firms may also consider implementing a Voice over Internet Protocol (VoIP) system. branch office. advanced mobility capabilities. your IT service provider will have strategic partnerships in place with trusted telecommunications companies and will help you select the appropriate system for your fund. including redundancy. including modular messaging. Thomson®. and sites) necessary to make possible the recovery of mission-critical services and applications (e.
and > Addresses documenting. Firms must determine the acceptable level of downtime for an application and then design the disaster recovery system to achieve that level of availability. Finally. Some of these ineffective methods include relying solely on physical tapes for backup or hosting a disaster recovery site at an employee’s home. Collocation can be the solution. Also. primarily in-house facility limitations. they often decide to host their equipment offsite. in fact. a firm’s systems will work and its employees will know how to get the business back up and running. if not in near-real time.Developing both a business continuity plan and a disaster recovery plan that will be effective takes approximately two to three months and: > Supplies an understanding of what processes and personnel are essential. rooms) can be difficult. it is important to keep in mind that some practices may seem appropriate to a fund manager. If this technology grows at a rate faster than the businesses can accommodate. firms are relying on collocation data centers to host their hardware and software in an offsite facility. firms must regularly test and update plans and systems to ensure that all personnel know their roles and that the technology is sufficient. Communication rooms (comm. as equipment is stored away from the production environment at locations built from the ground up. a certain level of power is needed and it can often be difficult to generate onsite. Another ineffective method is hosting a disaster recovery site in the same geographic region as the firm’s primary office. which can seriously affect the performance of most hardware. with multiple levels of redundancy. which provides necessary bandwidth and increased protection. When dealing with business continuity and disaster recovery plans. Firms should also back up all essential documents and data offsite in an electronic format at least daily. so does the supporting technology. and diesel generators make running a disaster recovery server out of a home impractical. planning. such as redundant power. Establishing a means to access critical information and applications in a remote manner will prove useful when an outage occurs by reducing downtime and enabling a business to remain running near its full capacity. This will guarantee that when the time comes. fire suppression systems. This approach does not protect the data from regional outages. The many requirements. motivate firms to rely on collocation services for storage and support. HVAC systems. A number of factors. Firms must also take into consideration their ability to control heat and humidity levels. and infrastructure to ensure that these mission-critical processes and people can continue to operate or quickly return to operations after an unexpected outage. lessening the likelihood of failure. ineffective. disaster recovery and business continuity planning are increasingly being sought out by businesses that understand the realistic need to prepare for a potential outage. and maintaining the policies. to expand. The need for redundancy is another reason why firms are becoming more reliant on collocation data centers for hosting. testing. Collocation More and more. As smallor medium-size businesses begin to grow. but are. which would likely affect both locations. as well as expensive. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 19 . Effective practices include having actions based on business and application availability. As with general size and space limitations. an onsite facility might not be able to accommodate the levels of redundancy that a firm requires to operate sufficiently. Based on a firm’s size. implementing. procedures. such as flooding or power outages.
The best way to store data is on its own offsite server. it is easy to become overwhelmed and end up with a less than optimal technology choice. a full cabinet. Next. Data should be stored in WORM (Write Once. Funds can expect to spend roughly $1. Additionally.Another significant advantage to using collocation services is the security they provide. accessible via the Internet. the lifespan of the hardware will ultimately be shortened. or multiple cabinets in which to store their data. First. without having to worry about spending thousands of dollars expanding your own facilities. If your business ever needs to move operations to a new production environment. Email and IM data should be saved for the amount of time prescribed by law. are compatible with running out of a collocation center. consider application compatibility. If you choose to host your firm’s hardware in a data center. whereas a data center could potentially offer you additional storage in hours. There is never a cause for concern over space at a data center. costing the firm even more money. A final driving factor for the use of collocation is the flexibility a data center offers its tenants. The Federal Rules of Civil Procedure relating to electronically stored information requires hedge funds to be able to supply things such as emails. The exact cost will depend upon a few factors. as well as those of any future applications you may be interested in. you simply rent out the space you need. When confronted with the vast number of choices for your own firm. Bloomberg Mail and IMs. If a launching or relocating firm attempts to store equipment in house and the accommodations are not suitable. At a data center. Your IT service provider will assess your needs and provide guidance on how much space is necessary for your fund. be sure that the functions of your current applications. Remember that every 60 miles you are from your data center equals a millisecond of response time for your applications. including the city in which the data center is located and how much closet space a fund needs to house its equipment. latency will quickly become an issue. room on your own will most likely take weeks. particularly if you have become accustomed to the standards and methods of analyzing and processing your work through proprietary technology systems as an employee of a large firm. IMs. construction and moving operations are never a concern.500 per month on collocation space. Building or expanding a comm. Archiving Email and instant message (IM) archiving is essential to proving compliance with the many rules and regulations to which hedge funds are subjected.800 to $3. If you do not have enough bandwidth. 20 A Guide tO es t Ablish in G A h ed G e Fun d . and. With a data center you “pay for what you get”. spreadsheets. and PDFs if requested. your security comes with the package. Funds can reserve space within a cabinet. you will not need to worry about transporting all of your hardware. Below are five common mistakes that managers make and what you can do to avoid them. The data center you choose must be able to install redundant connections. you must understand the necessary bandwidth you need in order to process information from your work and production environment to your data center. Common Mistakes and how to Avoid them It may seem challenging to run your own business. you rent more. documents. a half-cabinet. They often provide surveillance and monitoring—services you could potentially get on your own but most likely at a higher cost. Read Many) format so that nothing can be changed or deleted. if your equipment expands or increases. Records need to be indexed in searchable files to aid in providing only the information that is requested. with most data centers secured and manned 24/7.
you should consider hiring support or administrative personnel that is skilled with technology. Think about the work you currently do today and write down some notes on what systems you use to complete that work (email. More than likely. Now. the idea that there may be one or more solutions that can meet 100% of your technology requirements can be an appealing thought. if not all. understanding what your firm will look like in the future is important as well.). you will need most. etc. Unless you spend most of your free time building servers and managing networks. will you have the necessary technological systems to support that larger business? > Failing to understand how much you rely on technology today. They can help you develop the correct workflow to maximize your investment. if you go with a single vendor. you will likely need to negotiate. Avoid rushing the installation in order to make a set deadline and ignore subsequent issues that may arise. Often. the vendor’s professional services arms know all the quirks of the software package so well that many important details are glossed over during the sales process. Realistically. these can be invaluable resources for getting up and running quicker and with less frustration.> Looking for the perfect solution. Use this list as a shopping guide when building out your technology platform. reports. by relying on it to be around in the years ahead. the more sophisticated your business. think about the work that will need to be done in your new hedge fund and what systems you will require to complete it. Without envisioning how your practice will look over the longer term—in three or five years—you may be setting yourself up for some short-sighted solutions. unless your business is narrowly focused. vendors provide some sort of onsite or web-based training. Many. For ongoing interaction and maintenance of technology. During the planning phase of your new fund. the chances that a single vendor will meet every aspect of your needs are very slim. For project-related work (“one-and-done” jobs). Also. you will most likely want to take advantage of it. > Overestimating your capacity to manage technology. purchase. However. There is an immense amount of advice and information regarding how technology can be applied in a hedge fund. Some vendors are attempting to develop a turnkey platform to deliver on this promise. Often. quote feeds. Once you have all of your new systems lined up. > Insufficient planning for the future. Using the framework outlined above. the more vendors you will need. and deploy systems from multiple vendors and service providers. if not all. of the same systems. however. Despite your intense focus on completing the immediate tasks of launching your fund. Many of the vendor firms offering an all-inclusive solution are rather small and new and. you can contract with a third party. including additional ones. > Shortchanging the training options and resources. Managing technology is a profession unto itself. as well as get you past some of the inevitable challenges. you can use consultants and contractors. If it is reasonably priced. phones. you need to learn how to use them. you may be assuming more business risk than you are willing to accept. you will need help in managing technology at your new firm. ask the vendor if there are any established users groups for their software and systems. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 21 . If your fund grows significantly. you should feel confident in your ability to ultimately select the most useful and effective technology solutions for your unique business. Generally.
Website: Determine website and email host. fax.Checklist – technology Considerations Office space requirements for both current needs and future growth: Visit and secure space. monitors. order equipment. Arrange for software installation. Determine wireless and LAN capabilities. Order servers. Register website domain name. leased. maintenance. and upgrades. Install telecommunication lines. Determine phone numbers for main office and individual lines. Select a contractor for build-out. 22 A Guide tO es t Ablish in G A h ed G e Fun d . Verify that email addresses are working. Perform due diligence and select trading and order management software. Arrange for technology equipment room. Telecommunications: Determine telecommunication needs (dial-up. and schedule delivery and installation. Computer hardware: Order desktop computers. Schedule move-in date. Note existing wiring and cable configurations and determine any additional requirements. Determine electrical needs. Software: Perform due diligence and select an operating system. Create and review a disaster recovery plan. Order printers. Install an accounting system and provide training. Perform due diligence and select accounting software. and laptops. Internet connectivity). Design office configuration with an architect and a designer. Email: Create email addresses.
and frequently these service providers can recommend others who may fit well with your new business. Perform due diligence and select a research vendor(s). your accountants can help you review the initial documents drafted by your lawyer before they are finalized. but may not be limited to. In this review. Perform due diligence and select an analytic tool vendor(s). > Lawyer. the first step to formulating a new hedge fund is selecting your service providers. establish installation time frame. your accountant will be assessing the controls in place to ensure that accurate accounting. prime broker. In addition to providing you with audit services and K-1 preparation for the fund’s partners once the fund is launched. Install market data. Legal counsel will inform you about the various regulatory aspects of operating a hedge fund and the registration requirements and will help you determine the appropriate fund structure. A lawyer will also prepare the legal documents necessary to form. Generally. research.2 Additionally. As part of this process. please review the section on the legal landscape provided by Stark & Stark. and market your hedge fund. During the audit. and analytic tool systems. In their review.Market data and research: Perform due diligence and select a market data vendor. they can offer advice on the tax implications associated with entity selection and manager compensation. A section on the tax considerations associated with launching your fund has been authored by Sasserath & Zoraian LLP. Attorneys at Law. 1 For more information on each of these documents. which will be performed by your accountant. selecting Your service Providers With initial plans determined. 2 A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 23 . the accountant should also be able to coordinate with your administrator. the following: > – Limited partnership agreement > – Operating agreement > – Subscription agreement > – Private placement memorandum > – Offering memoranda > Accountant. the first outside party involved is a lawyer. and trading procedures are followed. which can be found on page 5. and their accuracy is critical to your success. Many individuals contemplating a hedge fund launch have pre-existing relationships with one or more of the four main service providers previously mentioned. as well as conduct a review of the partnership agreement to determine the partnership percentages. These documents1 include. You will be heavily relying on these third parties to meet the needs of your business and partner with you as your hedge fund grows. your accountant will review your financial statements and the capital accounts of the investors (partners) of the fund. The numbers your firm generates are extremely important. and internal accountant. operations. your accountant will provide a statement of account to each of the investors. Test trading system and research vendor information and accounting system. which begins on page 7. > Of particular significance and importance is the annual audit. if you choose an accountant with hedge fund experience. operate.
however. Many providers have additional services specifically targeted to start-up funds to help them plan. While these functions can certainly be done internally. trust. Questions about how problems and other issues are resolved and how long resolutions typically take are good ways to assess the responsiveness of the support provided. as well as of the smallest. The suite of services offered by prime brokers has greatly expanded in recent years beyond the core services they offer. In evaluating potential service providers. and administrator. or other bad business practices that often result in lawsuits—all of which can lead to poor service (or no service at all if the company fails). performance fee calculations. and successfully launch their fund. As a start-up fund. you have specific needs. prepare. responsiveness. > Administrator. technology and support services. record keeping of investors. Additionally. It will be necessary for you and your operations personnel to coordinate the operating functions among your accountant. 24 A Guide tO es t Ablish in G A h ed G e Fun d . your reputation can be helped or hindered by the providers listed above.> Prime broker. As much or as little support as a manager needs is generally available with the goal of allowing you to focus on the core concerns of your business. because you will be interfacing with some of your service providers on a daily basis. Here are some things to consider when selecting your providers: > Counterparty risk. and management fee calculations are the services typically used. may keep you from outgrowing the services and support they can provide. Your prime broker provides the fundamental services of custody of assets and access to financing and securities lending. > Ability to serve you as both a start-up hedge fund and a large. operational support. Support services may be particularly important during the initial phase of launching your fund. A third-party administrator is not required to successfully operate a hedge fund. you will need them to be responsive when problems arise. your needs may become more complex over time and selecting providers that can support you now. This is the risk that your service provider will not be able to live up to its obligations. and does the service provider have a reputation of being an innovator? The hedge fund industry is always in a state of evolution and having providers who see emerging trends and plan for your future needs can be an extra benefit for you. In every instance. > Support provided. Start-up assistance. Monthly accounting and net asset value (NAV) calculations. and even office space are some of the areas where prime brokers can assist you. they can relieve a significant amount of the burden from the manager and improve the consistency with which certain tasks are handled. Given the recent turmoil at financial institutions of the largest. > Additional capabilities. counterparty risk has never been a more relevant consideration. capital introduction. Other services that are central to the offering of a prime broker include executing orders and portfolio reporting. you need to be able to ascertain the reliability of the ongoing service they can provide. While many of the processes and procedures will remain the same as the fund grows. Additionally. scale. Many managers use administrators to serve their investors and effectively act as their outsourced accounting department. and expense should all be considered when evaluating your providers. Technical skill. prime broker. A provider’s failure to perform can be a result of poor management or assuming too much credit risk. and cost is not always an accurate indicator of the quality of service and support you will receive. Are any additional services or capabilities currently in development. well-established one. fraud. as it is an extension of the service you provide to your own clients. it can be time consuming for the manager to do them and costly if staff is hired to perform them—particularly in the early days of a fund. the level of interaction will likely increase. as well as in the future.
and proceed with the others from there. and > Operations support and administrative staff who have the primary function of supporting the various operational aspects of the business. but many have spent at least a part of their careers working for a large. such as screening and routing telephone calls. you will no longer be provided with resources like compliance. and implementing the firm’s strategies in terms of business and investment management. and technology software and systems—you must find them on your own or perform tasks yourself. There are two types of staff discussed in this guidebook: > Front-office employees who design and implement the investment and business management strategies of the firm. If you do not have an existing relationship with any service providers. and gain additional perspective on your needs. When you start your own firm.It is always important to evaluate multiple service providers to get an understanding of the capabilities they have. administrative assistants. Receptionists. One of the biggest challenges for some new managers is to determine staffing. such as chief investment officers. designing. Dedicated front-office employees are the individuals with responsibility for developing. portfolio mangers. Evaluate and select your service providers. operations support staff members also coordinate the compliance. along with the firm management: chief executives. evaluate pricing. Depending on your approach to the business. your firm will require a combination of different staff. research. The ability to tailor your in-house capabilities is one of the most significant attractions to owning your own firm. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 25 . analysts. and office managers provide administrative support by performing secretarial and clerical duties. Having worked with many hedge funds. the idea of building a network of both processes and people may seem daunting. cashiering. When selecting any provider—whether it is your lawyer or one of the other providers discussed in this guidebook—ask them for recommendations on your other providers. full service firm. it is likely that they will be able to give you valuable advice and potentially shorten your search. and traders. asking for referrals from providers you select. and trading functions to ensure that the transactions are settled in a timely and appropriate manner. To the extent necessary. and typing correspondence. Operations support and administrative staff include any individual who supports the front-office employees or the business itself. marketing materials and support. As a business owner. The senior investment professionals. but can also seem overwhelming to create and implement. you should begin your search by evaluating and selecting an attorney. Checklist – selecting Your service Providers Create a list of the service providers you will need. but this is an opportunity to design your own staffing model to fit the needs of your business. and operating officers. financial. scheduling appointments. operations. are included in this classification. compliance. human Resources Considerations Hedge fund managers have varying backgrounds.
You may fill this role as you set up your firm. However. bonuses. and marketing functions were at one time easily performed by a single individual. or hire an individual to work exclusively as the chief compliance officer and assume the title for SEC purposes. a firm’s growth increases the scale of each job to a point where another individual may be needed to spread the workload. but this does not eliminate the need for a chief compliance officer at your own firm. Any expenses will lower the performance of your fund and will likely have to come out of your own pocket. and then compensating them in salary. Certain positions are mandatory. you will likely need a more robust organizational structure to ensure that you can deliver what you promise. enforces adherence to federal. Where the research. you may need either to have an outside professional assist you with the responsibilities of the role (in which case you would still be the designated chief compliance officer). compliance. If. and benefits. if you will have multiple people working in your firm from day one.selecting the Right staffing for Your Firm How complex should the staffing structure be in your new firm? What positions do you need to fill and how many individuals will occupy those positions? To a large degree. and self-regulatory organization securities regulations. trading. state. For example. With the management and financial responsibility of first finding and hiring all levels of staff.). and be effective at? Which aspects of your job would you want to delegate to others? > Do you enjoy working independently or would you rather work in a team-oriented environment? > What are the essential functions at your firm? What would be complementary but not strictly necessary? > What are the values and culture that you want for your firm? Most new funds are operated by the managers alone.) > Which functions do you think you will enjoy. the answers to those questions depend on the initial size of your firm. Many technology service providers have created compliance packages and solutions to assist you with developing and implementing a compliance system at your own firm. This is the common mentality of most hedge fund managers. regardless of the size and scale of the fund. you may be inclined to add staff from the beginning as an investment expense. and creates and supervises the firm’s code of ethics. management. so does the scale of the functions being performed. Many managers who are just starting out do it alone without any staff. etc. any hedge fund that is not exempt from the Advisers Act is required by the SEC to have a designated chief compliance officer. It is particularly common among start-up managers who often do not draw a salary in the months that immediately follow the launch of their fund. polices. Conversely. managers are required to perform every function within the firm (research. your firm will start as a more complex organization with a large number of staff. In these cases. it is helpful to answer the following questions: > How many investors and how much capital will your fund have when it is launched? (If you will be serving a large number of clients at the time of launch. The chief compliance officer ensures the safety of client data. and procedures. want to do. however. But as a firm grows in size and scale. 26 A Guide tO es t Ablish in G A h ed G e Fun d . general office management. which will ensure sufficient capacity for future growth. it may be wise to begin with a lean organizational structure to minimize compensation expenses.
000 $27.000 $29. it support internal Accountant.000.000 $55.000 $75.000 $175. Total Compensation Levels (Base and Incentive Pay) Dedicated Front-Office Employees Portfolio Manager. you might estimate those expenses as the cost of labor—salary and benefits.000 $500.000 *Pershing Prime services estimates only. as well as a fee for managing the assets within the fund.estimating the Cost of Your Firm’s staffing structure Each position has an associated cost. with perhaps some bonus or incentive—and end the financial consideration there. Other staff members.000 $150. The table on the next page provides examples of total compensation levels (base and incentive pay).000 $300.000 $50. As a hedge fund manager. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 27 . In this section.000 Example Compensation* $140. bear in mind that adjustments are always needed to make any compensation figure (such as the examples provided by Pershing Prime Services in the table below) relevant to your geographic location and its cost of living. a number of affiliated costs accompany each staff position.000 $100. you may receive several forms of compensation. Chief investment Officer (CiO) Chief Financial Officer (CFO) Chief Operating Officer (COO) Chief Compliance Officer (CCO) trader Analyst Operations Support and Administrative Staff Operations and Middle-Office Personnel trade support sales and Marketing Assistants Office Manager. we separately examine each of the costs. Office Administrator network Administrator. Typical manager compensation structures often include pay for investment performance on an annual basis. Initially. Cash compensation is composed of an individual’s salary and bonus (incentive pay). Generally. Please seek appropriate resources and information when benchmarking compensation for any position. When seeking candidates qualified for these positions.000 $50. will likely have base and incentive compensation components. bookkeeper Administrative Assistant Receptionist Example Compensation* $1. the portion you retain is the net of these fees and the expenses of the fund. meaning that part of their pay is for performing their job and the incentive (or variable pay) rewards for individual or firm performance. However. Compensation Costs Calculating the financial expense of compensation is fairly straightforward.000 $500. however.
these compensation figures may change dramatically downward in many cases. Research the tax advantages and employer duties associated with each type of plan and then adopt a written plan. like an employer contribution? This is very much your own business decision. which is applicable for firms with fewer than 100 employees. It is part of the plan document that is distributed to all participating employees. your selection of who the plan trustee will be is one of the most critical decisions in the process. and Savings Incentive Match Plan for Employees (SIMPLE). a 401(k) plan is becoming a standard part of the benefits package and the compensation scheme. the employees and owners of newly launched funds typically earn less. > Should I offer any additional perks. Many small businesses select the SIMPLE 401(k) plan. some key preliminary determinations must be made. Retirement or 401(k) benefits Increasingly. or insurance company. 28 A Guide tO es t Ablish in G A h ed G e Fun d . > Who will be the plan trustee? The next step is to arrange the trust fund for the plan’s assets. it may not be financially feasible to promise employer contributions. > How do I develop a record-keeping system? A third-party administrator usually handles the accounting and record keeping of the plan assets.While these examples may provide you with a starting place from which to evaluate the compensation your employees will receive. During your firm’s start-up phase. it is easier to enhance a plan at a later date when the business can clearly afford it. > Should I self-manage or outsource? Your firm can establish its own 401(k) plan with administrative procedures. resting on both your willingness and financial capacity to make the 401(k) contributions. guidelines. Given the lower levels of return that were observed in 2008. From a management perspective. and access to funds. providing benefits to both staff and owners. > How do I roll out the plan to employees? Most plans have a summary plan description (SPD). a compensation consulting firm will be able to assist you with establishing a compensation structure and levels that will meet your needs. When you consider establishing a 401(k) benefits plan. These compensation figures are for established funds. Additionally. bank. It is perceived as a valuable option for firms considering a retirement plan. Remember that the financial record is a key part of the annual report that must be filed with the federal government. which educates the participants and beneficiaries regarding the characteristics and mechanics of the plan. or you can use a third-party institution. Because the financial integrity of the plan and its assets are paramount. Should you be struggling to determine an appropriate compensation package. If you choose to use an insurance company for your plan administrator. safe harbor. > What kind of plan? You need to select a type of 401(k) plan. the performance of the fund is likely to be a significant component of compensation for many positions. The three types of 401(k) plans are Traditional. rather than revoke a plan contribution in light of a tight financial situation. typically you will not require a trustee. they are only estimates and need to be thoroughly evaluated and should be used in conjunction with other industry benchmarks and ranges. like a mutual fund firm.
but you should also consider the same criteria you used in evaluating your other service providers: > Counterparty risk > Ability to serve you as both a start-up hedge fund or a large. a place to sit. and even termination. as well as the legal requirements you assume when you employ staff. From hiring to employment.Outsourcing Your human Resources Administration In large organizations. as the manager of a start-up hedge fund. a business may not have the funds. Often times. these businesses can provide experience and support in dealing with human resources-related issues. or expertise to manage the human resources functions that must exist within it. However. the following: > Employment administration > Benefits management > Retirement services > Government compliance > Employer liability management > Recruiting and selection These businesses essentially assume the role of your human resources department. staff. identify what positions will require certain infrastructural components. time. cost may be a significant factor. and can assist you with meeting all of your legal requirements and maintaining the appropriate paperwork. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 29 . well-established one > Support provided > Additional capabilities equipment Costs Each person who joins your firm will need. these companies can provide you with significant levels of support. a computer workstation. you will need to become familiar with many of the functions that fall within this arena. among other things. In these cases. You may want to consider outsourcing much of the oversight as you launch your fund. In other cases. the human resources function is departmentalized within the administrative area of the business. but not limited to. and telephone and Internet connections. Professional employer organizations (PEOs) provide many human resources-related functions including. As you plan your staffing structure. outsourcing probably is not your best option. outsourcing can be a cost-effective solution to building an human resources capability within the firm. If you are considering outsourcing your human resources functions. such as employment laws. However. if you are not comfortable with an outsider handling your human resources functions or if the costs outweigh the perceived benefits.
500—$4. bookshelf executive desk. telephone.800—$2. culture becomes an important consideration for how you recruit. standard chair (2). retain. telephone and internet connections. computer workstation. it support internal Accountant. bookshelf Type of Equipment desk. develop. telephone and internet connections desk.300 the Critical Factor—Firm Culture and Values No organizational and staffing plan can be successful unless it has incorporated the firm’s culture and values. premium executive desk. one of the most compelling reasons for setting up your own business is the opportunity to define its identity. telephone and internet connections.300 $1. telephone and internet connections. telephone and internet connections Cost $3. computer workstation. computer workstation. bookshelf Office. executive chair. computer workstation. telephone and internet connections. As soon as other individuals are added to the team.300 $1.300 $1.800—$2. bookkeeper Administrative Assistant Receptionist $3. computer workstation. the definition of culture and values should also consider the following: 30 A Guide tO es t Ablish in G A h ed G e Fun d . premium executive desk. When you think of your business’ culture and values. premium executive desk.500—$4. internet connection desk.300 $1. but is at least straightforward. you will likely identify the importance of the client relationship or adherence to standards of professional excellence as your business’ cultural principles. standard chair (2).500 Cost $1. If the total number of staff working in the fund only consists of you and your partners. computer workstation.800—$2. and values may be challenging. The management of your own time. bookshelf executive desk. computer workstation. executive chair. telephone and internet connections desk. Chief investment Officer Chief Financial Officer Type of Equipment Office. computer workstation.500—$3.800—$2. standard chair (2). telephone and internet connections desk.800—$2.000 $3.500—$3. then establishing a culture for the firm will be of lesser importance. standard chair (2).300 $1.300 $1. bookshelf desk.800—$2.500—$3. bookshelf Office. computer workstation.500—$4.800—$2.500 $2. however. computer workstation. schedule.300 $1. telephone and internet connections. and compensate. bookshelf desk. executive chair. computer workstation. Office Administrator network Administrator. telephone and internet connections.800—$2.000 Chief Operating Officer Chief Compliance Officer Analyst trader Support Staff Operations and Middle-Office Personnel trade support sales and Marketing Assistants Office Manager. telephone and internet connections. executive chair. computer workstation. However. bookshelf executive desk. standard chair (2).000 $2.500 $2. standard chair (2). computer workstation. executive chair. computer workstation. telephone and internet connections. telephone and internet connections desk.dedicated Front-Office employees Portfolio Manager. Indeed. executive chair. Every individual who is part of your business will impact your ability to adhere to and exemplify those values.
By doing this. you also have the responsibility of managing the associated risks. insurance Launching your own hedge fund means that you are in total control of your business. Align the positions to the business’ internal workflow. Before beginning any work to establish your fund. exciting. Your business’ staff represents one of the most significant investments you can make for the future success of your business. the risk of beginning a business is just as important a consideration as the potential return. The checklist that follows outlines key points as you build your staffing structure. and alignment with the culture will define the ability of your business to consistently deliver its service to an ever-growing number of clients. Define your business’ technical needs and cultural values. While this can be empowering. Develop a budget and timeline for making your decisions and prioritize key hires for your business. As you contemplate the ownership of your firm. it is necessary to address all of the business insurance requirements that can help to mitigate your business risk. you can look beyond the list of technical accomplishments on a résumé and delve into how that person will work at your firm. Just as you explain the risk and reward relationship of an investment to your clients. As a successful hedge fund manager. while allowing you the opportunity to realize the economic and personal fulfillment of a leveraged and productive organization.> What kind of behavior do you expect from your staff? > What are the performance expectations for the staff? > What kind of professional environment do you want to foster? > What are the critical elements of the firm’s success and how do you articulate that in the cultural value statement of the firm? Each candidate for a position at your firm should be gauged against your firm’s cultural statement and values. Define the job positions and compensation structures. personality. Create any employment contracts. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 31 . technical skill. and have an attorney review the documents if necessary. Determine whether you will outsource your human resources administration to a third-party organization and select a provider. with roles and responsibilities for each position. you have to effectively plan for your assumption of business risk so that you can more fully enjoy your business rewards. Checklist – human Resources Considerations Identify your business’ operating and staffing model. Selecting the right “fit” in terms of experience. you know that every strategy is accompanied by both risk and reward. and rewarding. such as noncompete agreements.
> Employment practices liability. group life insurance is an attractive benefit to offer to prospective employees. and hospital expenses. your employees require separate types of insurance. you may require additional. > Group life. The term “health insurance” refers to a range of insurance policies. It covers those losses incurred as a result of fraudulent activity by a firm’s employees. Depending on what kind of clients with whom you work. home. if you plan on working with ERISA plans. which is designed to address the net capital and net worth minimums in each state. such as travel protection or coverage for dependants and families. and other workplace liabilities. the following types of insurance are usually offered: > Health. The numerous considerations regarding liability and insurance may seem overwhelming. Commonly referred to as “errors and omissions” (E&O) insurance. from your commercial insurance agent to your attorney. and some weather damage. flood. including dental and vision coverage. > Commercial property and liability. such as fire. theft. > Directors and officers liability. In firms that have staff other than managers. alternatively. Managing your firm’s business risk is just as important as creating and implementing a strategy for its growth. Generally speaking. health insurance is designed to cover doctor bills. This includes specialized forms of insurance. Obtained through a commercial insurance agent or firm. employee Medical Coverage and insurance Plans While the previous categories of insurance cover you and your business. This type of insurance provides indemnification claims brought against the firm’s officers and directors for breach of fiduciary duty. The firm usually pays for the premiums. surgery. but there are a number of resources. such as those that cover the costs of doctors and hospitals and those that meet a specific need. this type of insurance plan protects your firm and your personal assets against legal liability resulting from any errors or omissions relating to your client service deliverable or process. with the cost charged to the employee. it is typically required to hold ERISA bonds. For example. A casualty insurance policy covers losses that are directly caused by unforeseen events. This type of insurance protects the firm from losses related to employee dishonesty. offers protection against most risks to property. or prime broker that can help you perform the research necessary to make informed decisions regarding these matters.There are five common types of business insurance that you may need for your firm: > Professional liability. banker. Generally. This insurance coverage is designed to protect the firm and you as the owner from charges such as discrimination in hiring. such as fire. wrongful termination. Individual states may also mandate surety bonds or a surety affidavit. you will want to protect yourself and other firm directors and officers. As the officer or director of your firm. earthquake. also known as “property and casualty” (P&C) insurance. > Fidelity bonds. such as natural disasters. an insurance company may mandate a certain percentage of employees to participate in the plan. A group life insurance plan may be enhanced through coverage of additional items. specific types of insurance. the amount of life insurance coverage offered is equal to the employee’s annual salary. 32 A Guide tO es t Ablish in G A h ed G e Fun d . or boiler insurance. For many firms. this type of insurance.
and fires have affected many businesses. floods. like the death of a key individual. certain functions need to be kept in house. Others believe in outsourcing those functions so that the systems and people in house are minimized and structured to support the external providers. Whichever approach you choose. Throughout the entire process. At this point. you will need to assess and refine your operations. The cost structure of the firm is one thing that is under the immediate control of the manager. Some managers believe that. As you transition from start-up to ongoing management. The approach employed by most hedge fund managers is to minimize the costs and resources associated with maintaining their operations. However. Consult with insurance companies and other third-party resources. terrorist attacks. To create a procedures manual. As your business is formed and launched. natural disasters like hurricanes. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 33 . and from document management to reporting performance. this means outsourcing. a documented plan for how processes are performed will allow you to focus on your investment strategies.Checklist – insurance Document the different kinds of insurance you will require for the business and for yourself. you will make numerous decisions about your physical office space. disaster Recovery and business Continuity Planning There are many unforeseen events that can significantly impact your ability to continue operations. Have this list compiled into a single document and logically group procedures together under common headers or sections. start by documenting all of the tasks you perform as you complete them and have your colleagues do the same. as well as the roles and responsibilities of the people working within your business. Operational infrastructure Coordinating the various functional aspects of your internal operations and third-party service providers is a necessary. all have the potential to disrupt your normal operations. but probably are not necessary. and leaner is better—in most cases. Explore the capabilities of your service providers and leverage their resources as much as possible. Align insurance coverage activation with the formation of your fund. with scale. Other unexpected events. After further refinement. but time-consuming task. While the unexpected will always be just that—unexpected—you can be well-prepared to overcome such events should they occur. This also helps reduce dependency on key individuals who possess the only working knowledge of the tasks they perform. or something as simple as a leaky pipe in your office location. Develop a budget and timeline for making your decisions. earthquakes. you will have a working procedures manual that can be shared with others in the firm. In recent years. it is important that you approach your operations as a business owner and are able to differentiate between mission-critical capabilities and those that are nice to have. you can evaluate procedures as they currently exist and identify possible areas for improvement. The operating agreement you have will govern many of your firm’s high-level activities. you will need fully developed and documented policies and procedures for all aspects of your internal operations: from how you communicate with current and potential investors to how you work with your service providers.
One step that is often overlooked is testing the plan with a dry or trial run—simulating an emergency and testing the procedures. protecting the firm’s books and records. As a new business. and allowing clients access to their funds within the normal time frame. promptly resuming operations. you have a bewildering array of choices for where to house your firm. you will likely save time and effort in developing your business continuity and disaster recovery plans. By starting from scratch. Overall. A business continuity plan is somewhat broader in nature and deals with sustaining normal business operations during periods of change or disruption—whether catastrophic or more business-specific. its accessibility for your clients. or urban) and region (Northeast or Southwest United States). Disaster recovery and business continuity planning essentially are means of systematically assessing the potential impacts resulting from various unexpected events or incidences and determining the organization’s preparedness to deal with such events. the following steps should be taken: > Assess the business risk and impact of potential emergencies > Prepare for possible emergencies > Document a disaster recovery plan > Outline the business recovery phase > Train staff for the business recovery phase > Test the plan with a realistic dry run > Keep the plan timely Much of the work performed in a hedge fund is done using technology.Disaster recovery and business continuity plans both deal with sustaining operations during times of change. and the economic expense of carrying a long-term lease on your financial statements. sublease a portion of space from another business. Office location As a new business owner. which will likely be one of the larger components in the plan. In this planning scenario. 34 A Guide tO es t Ablish in G A h ed G e Fun d . like the departure of a key individual or problems within the business’ building. the plan should be designed to help prepare for securing employees’ safety and firm property. You could work from a home-based office. or lease an impressive office space in a prestigious business location. Because gaps in the plan are often identified through the testing process. By developing your normal and emergency procedures concurrently. The planning process should seek to ensure little to no business and project interruption during either a planned or an unexpected event. it is improved as a result. suburban. Rent expenses can be significant and vary depending on such factors as the location of the market (rural. you will be in a unique position to develop your backup procedures at the same time as you develop your normal procedures. it will be necessary for you to first document your procedures before you can begin to understand your needs in terms of disaster recovery and business continuity. Backup systems and alternate locations of operation are also significant components. The selection of office space involves a consideration of the projected capacity of your business’ growth. A disaster recovery plan deals with how a business will resume normal operations in the event of a catastrophe.
It is also appealing for managers who appreciate the “packaged” approach to running an office.to twelve-month period after its inception. many executive suites are located in high-cost real estate areas. Use of the facilities and services are usually charged separately. Terms of the leasing agreement can be month-to-month.Step 1: Explore Your Options Securing your office is not only one of the largest initial expenses you can incur as a business owner. there are some drawbacks. six months. Cost is another consideration. Rates may also be adjusted according to a predetermined and nonnegotiable schedule.to five-year term. depending on its location. As appealing as this option may appear to be. There may also be a number of hidden costs and fees written into the leasing contract. Leasing arrangements and contracts will be standardized. as the table below shows. Moreover.200 per month. Managers typically have three standard choices to consider: > Select an “executive suite” service > Join an existing business as a sublessee > Set up their own office by renting commercial office space A. three months. trained administrative support. Common advantages of this approach include no capital investment for either purchasing or leasing office equipment. This “plug-and-play” option provides the ability to keep both budgets and lease terms predictable and to a minimum. Executive Suite The executive suite option is well-suited for managers who would prefer to observe how their business is growing over a six. offering an individual manager affordable access to a prime location in which to do business. the availability of comprehensive technology packages. such as downtown office complexes. as well. rather than commit to a long-term commercial lease with a three. particularly in the event of a premature breach of the lease agreement. leaving little room for significant customization. but it also signifies a long-term financial commitment. Included Furnished Reception Room Kitchen and lounge Area listing of Your Firm in lobby directory utilities and Maintenance Janitorial service dedicated Receptionists Mailroom Processing Phone Answering service Facilities Management Separately Charged Per Usage Club Office or Conference Room (set number of hours per month) Video Conferencing broadband services Videoconferencing Room and service Multiline digital telephones Administrative services PC and network support Copying and Fax transmissions Courier and Overnight services A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 35 . An executive suite for one professional and one administrative staff member can cost between $800 and $1. or up to two years. with standardized services and office support for a set fee. and a degree of flexibility in customizing the services you wish to use.
The critical differences. estimates will vary greatly. phone. such as the reception and meeting rooms. such as relocated corporate executives or family trusts. allowing you to observe and adapt your layout and infrastructure needs as you adjust how you and your staff work in your new business model. B. collegial atmosphere of working in a larger office or with a team of other investment analysts. This is known as “clustering” or positioning your new office by other businesses attracting a similar type of client. this option mirrors the executive suite alternative previously presented. However. leasing commercial space may be the best option. It can serve as an incubator space for your business. or Internet services > Shared common areas like meeting rooms. 36 A Guide tO es t Ablish in G A h ed G e Fun d . Other new managers have extensive professional networks that present opportunities to share office space. but also requires that you thoroughly prepare and understand the terms and conditions of the leasing arrangement. This presents the chance to craft your own leasing contract language. may choose to share office space with a real estate office or concierge service provider. Choosing to sublease from an existing business should not be a solely financial decision. Some find success in exchanging referrals between their firm and the professional services firm with whom they share offices. it also commits you to a lease term. this approach has significant advantages. Leasing Commercial Office Space If you want the greatest freedom in designing and planning your own office space. most managers should expect to pay the price per-square-foot estimate of the entire office space. In many ways. Subleasing from an Existing Business Some new managers find the packaged approach attractive. It is important to understand and clarify all of the costs and potential risks and reserve enough flexibility if your business expands at a faster (or slower) rate than originally anticipated. though. Consequently. with either a pro rata charge for use of common spaces. leasing commercial office space can be the most expensive of the three options. and reception areas Because costs are typically negotiated between individuals. largely resulting from avoiding start-up and installation expenses for items like utilities. are that the leasing arrangement is fully customized and you will be directly negotiating with another small-business owner. but are reluctant to relinquish the professional. kitchens. a manager with a specific target market of clients. C. which typically is between three and five years in most commercial office buildings. However. While this affords the best opportunity for customization. New managers can sublet office space from an accounting firm or a small law firm and leverage off of the business manager experience and technical expertise of these enterprises.An executive suite option is a viable and prudent solution for many new managers who are used to working as an employee of a large corporation. Pursuing this approach can also be an opportunity to align with another business that offers complementary services to your client service offering. Alternatively. By physically sharing space with an existing business. Benefits of this approach include the following: > Ability to utilize administrative and support staff from the other business > Reduced overhead expenses. or a fixed-fee arrangement. you are also implicitly acknowledging certain common characteristics between your business and the business from which you rent space.
it allows you to be flexible in how you use your office space. at the termination of the lease. or you can undertake the search and selection yourself. the work letter may include information about whether you or the landlord bears the cost of the improvements. upgrades. particularly if you end up leasing a larger office space. Also. If you plan on updating the space. predetermined price. As a new manager. this means that the landlord would present you with the terms of the deal being offered to a third party and you would have the opportunity to match the deal. > Personal lease guarantees. consider including a separate clause for minor alterations or improvements that are nonstructural in nature. you may be able to defer rent escalations for the first two years. This clause sets forth the permitted uses of the leased space.” a document that accompanies commercial leases and describes standard fixtures. Regardless of how you choose your office space. so long as the consent is not unreasonably delayed or withheld. If the landlord agrees to a broad range of uses. If you are planning any customization of the office space. such as painting. your leasing contract can be highly customizable. As you contemplate your business’ growth past the initial three-year time period. carefully examine the “work letter. > Repairs. such as reduced parking lot fees or upgrades in exchange for the longer lease term. > Lease term. > Tenant improvements. Generally. Many businesses ask for a clause that permits them to make alterations or improvements with the landlord’s consent. If you want to remain in the office space for a longer period of time. > Renewal options. even if the tenant is a corporation or another type of business entity. Most standard commercial leases prohibit you from making alterations or improvements without the landlord’s consent. Frequently. It is rare for a landlord to maintain a fixed-rent rate. Also. and replacements. without having to secure the landlord’s consent. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 37 . It bears repeating that it is essential that you read and understand all of the terms in your lease. a conservative estimate of your business’ growth and need for the office space would result in a shorter-term lease with renewal options. it is imperative to understand all the commonly used lease terms in order to secure the most favorable lease arrangement for your new business. commercial landlords will usually offer either discounts or some concessions. This clause is your opportunity to renew your rent at a fixed. make sure to spend some time discussing this clause with the landlord. > Rent escalations. so lease agreements contain percentage increases usually determined by the Consumer Price Index or another real estate index. and repairs for which your landlord is willing to pay. Some landlords may want to include a clause in the lease agreement that makes the business owner personally liable for any damages or overdue rent. you can also negotiate a cap on the amount of annual rent increase.You can either work with a commercial real estate advisor to find office space and negotiate the lease agreement. > Permitted use of the premises. > Right of first refusal or first offer for additional space. you may want to secure the right (but not the obligation) to rent any office space that becomes available before the landlord offers it to any other third parties. the premises must be returned in their original condition. If you are considering a lease period of three years or longer. improvements. rather than “fair market” value. One of the most appealing aspects of leasing from a commercial landlord is adapting the office space to your vision of the firm. Usually. It may also be possible to negotiate for the landlord to pay for the moving and renovation costs associated with a relocation move. commercial landlords protect themselves by inserting a clause into the lease agreement stating that. When you directly contract with the commercial landlord.
fax machine n/a Conference Room Kitchen Other Areas supplies and Mailroom Closet hallway Room with door Room with door. also keep in mind how you would like work to flow within your office and how you would like clients to perceive your office space. microwave Items in Area Cabinets. then you may need to select a layout that is conducive to client meetings and frequent visits. water cooler. 1–2 chairs. at first. the building’s location within the area. 38 A Guide tO es t Ablish in G A h ed G e Fun d . you may not require significant meeting space. office space includes all areas that function for your business. or the total “usable space. bookshelf Open desk. On the other hand. However. only consider your “professional” office space. if your clients are used to coming to your office. sink. If. counter space. receptionist desk Medium to large meeting table. end table. 4–6 chairs. step 2: determine Your spacing needs When you consider office space.The cost of commercial office space depends on your regional location. coffee machine. The table below offers guidelines for both the amount and type of office space necessary for your business’ different uses. for instance. be sure to have the paperwork reviewed by an attorney or real estate specialist. step 3: Review Your lease Before you sign any lease agreement. and cabinets Type of Space Room with door. and bookshelf or credenza Refrigerator. or those areas used for client meetings. coffee table.” from the hallways to the kitchen and supply rooms. shelves. Staff Professional support Administrative Common Areas Reception Area Type of Space Office with door Cubicle. 2–3 chairs. This last step ensures that you are aware of the implications and meanings of all the terms and conditions of the lease. and the location of the office space within the building itself. and cabinets Open When calculating office space. and 1 file cabinet or shelf Items in Area sofa or chairs. counter space. bookshelf desk. partitioned open space Open space Type of Space Open Square Feet 150–200 100–120 80–110 Square Feet 125–200 (2–4 people) 200–300 (6–8 people) includes receptionist desk 200–250 50–75 Square Feet 40–70 20%–30% usable area Items in Area desk. you conduct all your client meetings at their residences or places of business. copy machine. you may. 1 chair.
List any specific requests.versus long-term commitment. Have every individual document the tasks and workflows they perform. Combine operational documentation into a procedures manual. make sure it meets realistic financial considerations and offers some degree of flexibility. Determine your preference for a short. Finally. Office Location: Define the goals for the office space. Identify the common facilities. As a fund manager. Compile job descriptions for each individual. Capital Raising A hedge fund’s success is greatly dependent on a manager’s ability to raise capital. you need sufficient assets to manage to successfully employ your investment strategy. Have your auditor review your procedures manual. including upgrades or changes to the office space. After rigorously developing and testing a strategy. such as lobby and parking space availability. leasing office space represents one of the largest capital outlays during the start-up phase of a new hedge fund. be certain that the office space you select is one in which you can envision yourself working and meeting with your clients.items for Consideration For the vast majority of new managers. such as client and colleague interactions. Research your different options and narrow down your choices. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 39 . In your evaluation of office space. be aware of the long-term commitment and cash requirements. There are many important factors to consider when developing a plan to attract capital investment. and personal expectations for workspace. you must raise money from potential investors. Finalize the lease contract. Create business continuity and disaster recovery plans. Develop a budget and timeline for making your decision and occupying the new office space. Read carefully through your leasing contract and consult an attorney if necessary. and important regulatory and legal requirements. Checklist – Operational infrastructure Processes and Procedures: Document the systems in use. location. As you determine which office space fits your business’ requirements. the materials needed to present your fund. including the types of investors to target. accessibility.
As institutional investors have the potential to invest large sums of money. and they tend to look for funds that will provide diversification in their portfolio and have the potential to generate significant returns. A fund-of-funds will often diversify its investments and invest in both start-up and existing funds with different strategies. you should develop a strategy using the best approach to successfully market the fund. > High-net-worth individuals. 40 A Guide tO es t Ablish in G A h ed G e Fun d . they usually are more conservative when making investment decisions—they seek returns. as well as the longevity of the fund. However. High-net-worth investors often invest on an individual basis or structure. usually have fiduciary responsibility and are more likely to scrutinize a hedge fund’s size and track record. including start-up. since these investors often provide some of the initial capital to help launch a fund.Factors to Consider When targeting investors One of the first critical steps when developing a plan to raise capital is to determine what types of investors to approach. and banks. > Funds-of-funds. they might look for certain privileges. your staff may not have the necessary expertise or network to adequately market the firm. Potential investors evaluate several factors when deciding whether or not to invest in a hedge fund. as you will not have to pay outside vendors for marketing support and can personally control the process. Institutional investors. such as partnership rights or reduced fees associated with making an investment. Based on these parameters. endowments. They often look for larger funds that have sizeable assets under management and have had a strong performance record for several consecutive years. Seed and incubator investors can be either high-net-worth individuals or institutional investors. Startup hedge funds will generally target investors who are different from those that are targeted by funds with an established track record. Allocation of Resources to Market After you have determined what types of investors to target. foundations. > Institutional investors. you should determine what types of investors would be most appropriate and detail a plan to attract those specific groups accordingly. Family offices consist of high-net-worth investors who have created partnerships and an institutionalized structure by which to invest. Institutional investors include pensions. > Seed and incubator investors. or as part of a family office. This approach can be beneficial. including the manager’s pedigree and previous track record. Third-party marketers are outsource firms that specialize in marketing start-up hedge funds to different types of investors. Your hedge fund can choose to either hire internal staff or retain third-party vendors to promote the fund. However. Family offices will generally invest in both start-up funds and established firms. Institutional investors are more likely to invest in funds with fewer assets under management. such as prime brokers. If conducted in house. funds-of-funds. but tend to be more averse to risk than their high-net-worth counterparts. to find potential investors. consultants. A fund-of-funds is a pool of money from multiple investors that invests in multiple hedge funds. your marketing team will generally leverage its network of friends and family and possibly third-party resources. However. as well as a potential share of both your management and performance fees. Seed investors usually invest during the early stages of a hedge fund’s development. You may choose to outsource the responsibility to experts who focus on this service so you do not have to hire and manage an internal staff. especially those that manage money for other individuals. hiring a third-party marketing firm can be costly and often entails some type of retainer.
e.net. Thus. or a combination of both—to use to market your start-up hedge fund. including allocation of economic and personnel investment Other issues to Consider It is imperative that as a hedge fund manager you consider regulatory and legal requirements when preparing marketing materials for your firm. it is important to consult with legal counsel when preparing marketing materials for your fund. In addition. such as MarHedge. the fund’s strategy. You can also leverage third-party capital introductions resources. which vehicles you can use to promote your fund. your marketing plan should include the following: > A discussion about your strategy and why it is superior to other hedge funds currently launching > A list of your marketing objectives – Types of investors you will target – The amount of capital you are seeking to raise – Other objectives unique to your fund’s strategy > A detailed marketing plan – An outline of the specific itemized steps and timeline to be followed – Marketing materials to be created – All regulatory and legal requirements – An internal person who is appointed to be responsible for making sure the marketing plan is implemented – The hiring of any appropriate third parties to assist you in the capital raising and public relations efforts > Budget. an investor presentation. third party. hedge funds can only market to accredited investors). as a possible platform to get exposure to an investor community. Your hedge fund should also explore inclusion in third-party databases. and Hedgefund. Marketing Your Fund After you have decided which resource—in house. your team should research speaking opportunities. you may also elect to hire a public relations firm to help your fund generate more publicity with the goal of gaining additional credibility in the marketplace and attracting more investment capital. you and the individuals you have chosen to share in the responsibility for marketing the fund should prepare the sales presentation to potential investors whom you have identified. There are specific regulations about who a fund can and cannot approach (i. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 41 .. At a minimum. including a fund profile. Once the materials have been finalized. as a result.In addition to marketing your hedge fund. and an offering memorandum. a due diligence questionnaire. Barron’s. the next step is to prepare marketing materials. Your fund will need to create several pieces of information. such as third-party industry conferences and prime brokerage events. among other documents. including websites that bring investors and managers together. and any historical returns the fund has generated. The materials should highlight the biographies of your principals. and.
contact us by emailing email@example.com. 42 A Guide tO es t Ablish in G A h ed G e Fun d . Consider all regulatory and legal requirements. It is only an introduction to the exciting world of hedge funds.com or by calling (866) 538-5046. Plan a budget allocation. Draft a pitchbook to guide your conversations with potential investors. You may also visit us on the web at www. If you would like to learn about other services from Pershing Prime Services that can help make the launch of your hedge fund a success. More help—from business consulting to technology outsourcing to innovative trading solutions—is available if and when you need it. but it can serve as a road map to help you determine and organize your next steps. A Final Word We hope that you have found this guidebook to be a useful tool for getting your new hedge fund off to a strong start. Determine internal and external resource requirements.com.Checklist – Capital Raising Develop a profile of your target investors. Outline a marketing plan.
Pershing is a subsidiary of The Bank of New York Mellon Corporation. A G ui de t O e s t Ab l i s hi nG A he dG e F u n d 43 . visit us on the web at www. personalized consulting. member FINRA. it represents Pershing Prime services’ unique approach to practice management support—going beyond high-level guidance to offer actionable information.this guide is part of a program designed to help hedge fund managers and financial services firms identify trends. to learn more about Pershing Prime services. For professional use only. NYSE. SIPC. and ready-to-execute programs.com.pershingprimeservices. Pershing Prime Services is a service of Pershing LLC. enhance operations. Trademark(s) belong to their respective owners. and grow revenue.
and venture funds. including extensive access to securities lending. worldwide execution and order management capabilities. offers customized accounting and professional management services for hedge funds. corporations and high-net-worth individuals. storage. (800) 243-4936 About eze Castle integration eze Castle integration (www. Managing director. (609) 895-7255 50104 Gb-PPs-ehF-4-09 . more than $1.bnymellon. thomas d. California. and stamford. Founded in 1913 and headquartered in seattle. issuer services. hedge Fund Client Management (212) 635-8843 About Moss Adams llP Moss Adams llP provides accounting. Arizona. Jeremy todd. Gregory Zoraian CPA.1 trillion in assets under management and services $11 trillion in outstanding debt. Giachetti. and new Mexico. the company is a leading provider of financial services for institutions. © 2008 ezeCastle integration.eci. in order to meet the unique needs of their clients. Moss Adams has 19 offices in Washington. llP sasserath & Zoraian. director of hedge Fund Administration services. a new York-based CPA firm. Marina lewin.. inc. a broad array of cash management products. they work with numerous funds of all sizes. london. With offices in Princeton.eci. Additional information is available at www. With a special emphasis on providing timely tax reporting. llP. tax. our dedicated hedge fund group is committed to working with managers to help funds succeed and grow. relationship-driven services for all types of funds. director. eze Castle integration is headquartered in boston and has offices in Chicago.com. Alternative investment services (212) 815-6973 Jim Whitaker.900 includes more than 250 partners. dedicated client service. los Angeles. Washington. we are a regional law firm with a national client base. providing superior asset management and wealth management. Marlton. (800) 752-1382 About sasserath & Zoraian. comprised of more than 110 attorneys and a support staff in excess of 200. the company’s service areas include start-up and relocation. private equity funds.About Pershing Prime services Pershing Prime services delivers an unconflicted.com) is the leading provider of technology and it services to the investment industry. private equity and pension funds. robust technology and reporting tools. Minneapolis. asset servicing. new York. and consulting services to public and private middle-market enterprises in many different industries. it has more than $23 trillion in assets under custody and administration. archiving. operating in 34 countries and serving more than 100 markets. www. in order to streamline the administration and back office functions. and the integrated platform of the bank of new York Mellon. the Moss Adams hedge fund team offers professional. funds-of-funds. including hedge funds. from startup to more mature funds. Pershing Prime services is a service of Pershing llC. its staff of over 1. Pershing Prime services (201) 413-4617 the bank of new York Mellon Corporation is a global financial services company focused on helping clients manage and service their financial assets. securities Group Chairperson. professional services. new York. and internet service. Managing director. master-feeder funds. and the largest headquartered in the West. Philadelphia. business Consulting Group. mutual funds. comprehensive suite of global prime brokerage solutions.com. Attorneys At law. Oregon. telecommunications. (631) 368-3110 About stark & stark stark & stark is one of the largest law firms in new Jersey. and newtown. Moss Adams is the 11th largest accounting and consulting firm in the united states. stark & stark. clearing services and treasury services through a worldwide client-focused team. disaster recovery and business continuity planning. outsourced technology support. san Francisco.
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