Examples of Hedge Fund Structures: Appendix

JWBT709-bapp02 JWBT709-Strachman Printer: Courier Westford April 14, 2012 2:38 Trim: 6in 9in
The Fundamentals of Hedge Fund Management, Second Edition

By Daniel A. Strachman
Copyright © 2012 by Daniel A. Strachman
APPENDIX B
Examples of Hedge
Fund Structures
he purpose of this appendix is to provide you with examples of various

T structures used by hedge fund managers to operate their funds. The
examples that follow include structures that are created by both onshore
and offshore lawyers for managers around the world. The key element to
the creation of a hedge fund structure is understanding where your investors
are coming from. Once you understand this, your attorney can create a
structure that meets the needs of your investors.
189
190 APPENDIX B: EXAMPLES OF HEDGE FUND STRUCTURES
Domestic
Entity
Domestic
20% Incentive General Entity
Allocation Partner
Investment
Manager
2% Management
Fee
Domestic
Limited Liability
Company
LP 1 LP 2
U.S. U.S.
Person Person
FIGURE B.1 Simple Onshore Structure

This figure illustrates a classic stand-alone fund structure that
simply replaces the limited partnership with a limited liability
company. For reasons best known to the drafters of the fund
documents, they prefer the limited liability company. The
general partner can, in certain situations, suffer more adverse
income tax consequences from this structure.
Source: Created and reprinted by permission of Maury Cartine,
JD, CPa.
Appendix B: Examples of Hedge Fund Structures 191
Domes c
En ty
Domes c
En ty
20% Incen ve General
Alloca on Partner
2% Management
Fee
Investment
Manager
Domes c LP 3
Limited O shore
Partnership Corpora on
S1 S2
LP 1 LP 2 Foreign U.S. Tax-
U.S. U.S. Person exempt org.
Person Person
FIGURE B.2 Classic Master-Feeder Structure. In some cases, an investment

manager may prefer a somewhat simpler version of the classic master-feeder
structure illustrated in Figure 3.2. In this simpler version, the offshore partnership
is eliminated and so is one audit. The auditors will only have to audit the domestic
fund and the offshore feeder corporation. However, the general partner of the
domestic fund will be required to collect and remit income tax withholding for
dividends and other income subject to withholding that is reported on the Schedule
K-1 provided to the offshore feeder corporation.
Source: Created and reprinted by permission of Maury Cartine, JD, CPa
Domes c Domes c
En ty En ty
2% Management
20% Incen ve General Fee
Alloca on Partner
Investment
Manager
O shore Sole O shore
Limited Limited Corpora on
Partner
Partnership
S1 S2
Ac vi es Foreign U.S. Tax-
Person exempt org.
Inves ng in Trading in
Securi es Securi es
FIGURE B.3 Modified Master-Feeder Structure

This is the hedge fund industry’s answer to the loss of the deferral opportunity that
previously existed with respect to management fees and incentive fees paid by an
offshore fund to the investment manager. Since investment managers could no
longer defer the fees paid to them from offshore funds, they preferred to replace a
totally fee-paying structure with a classic stand-alone fund structure. This new
structure provides the general partner with the income tax benefits of an incentive
allocation that is described in Figure 3.1. The only difference in the structures is the
replacement of the domestic limited partnership with an offshore limited
partnership. This simple extra step eliminates the investment manager’s potential
responsibilities with respect to income tax withholding described in Figure B.2.
Source: Created and reprinted by permission of Maury Cartine, JD, CPa.
Domes c
En ty
General
Partner Investment
2% Management Fee Manager
and 20% Incen ve
Alloca on
O shore
Domes c Corpora on
Limited Limited Limited
Partnership Partner Partner
S1 S2
O shore Foreign U.S. Tax-
LP 1 LP 2 Limited Person exempt org.
U.S. U.S. Partnership
Person Person
General
Partner
Ac vi es
Domes c
En ty
Securi es Securi es
FIGURE B.4 Modified Alternative I Master-Feeder Structure

This figure demonstrates a variation to the payment of management fees, incentive
allocation, and incentive fees in master-feeder structures. Instead of determining
fees at the domestic and offshore feeder levels, the fees are determined at the master
fund level. There is some potential U.S. income tax benefit to this structure for the
limited partner of the domestic feeder. Several years ago, the Internal Revenue
Service issued Revenue Ruling 2008-39 that denied limited partners a trade or
business deduction for their share expenses incurred inside a fund of funds even if
the fund of funds only invested in other partnerships that were in the business of
trading securities for its own account (a “trader”). In effect, the trader status of the
fund of funds’ investments cannot be attributed to the fund of funds’ own
expenses. Consequently, these expenses can only be deducted by a limited partner
as a portfolio deduction that is subject to a number of limitations including the 2
percent AGI limitation and the AMT add-back. There is a quiet concern among tax
professionals that this same logic could be applied by the Internal Revenue Service
to the expenses of the domestic feeder fund. Thus, the limited partners’ benefits
from the deduction for the management fee paid directly by a domestic feeder
would similarly be limited even though the master fund is clearly a trader fund.
Domes c
En ty Domes c
En ty
Investment
Manager
20% Incen ve General 2% Management Fee
Alloca on Partner 2% Management and 20% Incen ve Fee
Fee
O shore
Investment Corpora on
Manager Domes c
Limited Limited
Limited
Partnership Partner Partner
S1 S2
Foreign U.S. Tax-
O shore Person exempt org.
LP 1 LP 2 Limited
Person Person General
Partner
Domes c Ac vi es
En ty
Securi es Securi es
FIGURE B.5 Simple Master-Feeder Structure

This figure illustrates the classic master-feeder dressed with a belt and suspenders.
Unlike Figure 3.2, the management fees paid by the domestic feeder and the
offshore feeder are now paid to a separate entity, and the general partner only
receives the incentive allocation. There are a number of reasons this structure is
preferable to the structure illustrated in Figure 3.2 that any hedge fund lawyer or
accountant should be able to provide. However, the extra entity does increase some
administrative costs for the investment manager. There will be an extra book of
accounts and extra tax returns. The segregation of management fees from the
incentive allocation remains important for funds located in New York City and,
therefore, are subject to the New York City unincorporated business tax.
Domes c
En ty
2% Management Fee Investment

and 20% Incen ve Fee Manager
2% Management Fee
and 20% Incen ve
Alloca on Investment General O shore
Manager Partner Corpora on
Domes c
Limited Limited
Limited
Partner
S1 S2
Partnership Partner Foreign U.S. Tax-
Person exempt org.
O shore
LP 1 LP 2 Limited
Person Person
General
Partner
Ac vi es
Securi es Securi es
FIGURE B.6 Alternative I Master-Feeder Structure

This illustration depicts an investment manager’s maniacal attempt to eliminate as
many entities as possible from the master-feeder structure. Here, the belt and
suspenders separate investment manager depicted in Figure B.5 has been
eliminated as well as the separate general partner of the offshore limited
partnership master fund. This is probably the best example of how not to create a
master-feeder structure.
Domes c
En ty
2% Management Fee Investment

2% Management Fee and 20% Incen ve Fee Manager
and 20% Incen ve
Alloca on
Investment General
Manager Partner
O shore
Corpora on
Domes c
Limited Limited S1 S2
Limited Partner
Partnership Partner Foreign U.S. Tax-
Person exempt org.
O shore
LP 1 LP 2 Limited
Person Person General
Partner
O shore Ac vi es
En ty
Securi es Securi es
FIGURE B.7 Alternative II Master-Feeder Structure

This figure merely replaces the domestic general partner to the offshore limited
partnership master fund with a foreign general partner. In certain foreign
jurisdictions, this may be administratively more desirable or perhaps even required,
depending on the laws of the jurisdiction.
Domestic Offshore
Entity Administrator
Incentive and
1% Management Fee General Management
20% Incentive Partner Fee Agreement
Allocation
Domestic Offshore
Limited Limited Limited
Partner Partner Corporation
Partnership
Offshore
Limited
LP 1 LP 2 Partnership S1 S2
General
Partner
Activities
Domestic
Entity
Investing in Trading in
Securities Securities
FIGURE B.8 Alternative III Master-Feeder Structure


Examples of Hedge Fund Structures: Appendix

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Examples of Hedge Fund Structures: Appendix

Uploaded by

Copyright:

Available Formats

JWBT709-bapp02 JWBT709-Strachman Printer: Courier Westford April 14, 2012 2:38 Trim: 6in 9in

The Fundamentals of Hedge Fund Management, Second Edition

he purpose of this appendix is to provide you with examples of various

190 APPENDIX B: EXAMPLES OF HEDGE FUND STRUCTURES

FIGURE B.1 Simple Onshore Structure

Appendix B: Examples of Hedge Fund Structures 191

FIGURE B.2 Classic Master-Feeder Structure. In some cases, an investment

192 APPENDIX B: EXAMPLES OF HEDGE FUND STRUCTURES

FIGURE B.3 Modified Master-Feeder Structure

Appendix B: Examples of Hedge Fund Structures 193

FIGURE B.4 Modified Alternative I Master-Feeder Structure

194 APPENDIX B: EXAMPLES OF HEDGE FUND STRUCTURES

FIGURE B.5 Simple Master-Feeder Structure

Appendix B: Examples of Hedge Fund Structures 195

2% Management Fee Investment

FIGURE B.6 Alternative I Master-Feeder Structure

196 APPENDIX B: EXAMPLES OF HEDGE FUND STRUCTURES

2% Management Fee Investment

FIGURE B.7 Alternative II Master-Feeder Structure

Appendix B: Examples of Hedge Fund Structures 197

FIGURE B.8 Alternative III Master-Feeder Structure

You might also like