There are a number of structural considerations to think about prior to launching a hedge fund or other investment fund, such as a private equity fund or a real estate fund. Some of these considerations include the type of entity to structure, the domicile, whether to structure an open end fund or closed end fund, the amounts and frequency of management and performance fees, along with reporting requirements and regulatory filings.

1. Fund Domicile

The decision of the fund domicile is one that involves numerous considerations, such as the geographical location of the investment manager and the location of investors, preference of the target investors, tax concerns, investment manager budget, and other various considerations. There are numerous offshore jurisdictions including BVI, Cayman, Bermuda, and other popular venues for offshore investment funds. Most US (domestic) funds are established in Delaware.

A US domestic fund is typically used when the investors are US-based, taxable investors. An offshore fund structure is utilized for foreign, global investors and US tax-exempt investors. Again, there are other factors involved in the decision of where to establish the investment vehicle.

2. Open End and Closed End Funds

The strategy of an investment fund can play a large role in determining the type of fund vehicle used, and thus determines various restrictions a management company might implement for investors who are looking to participate as limited partners.

Investment funds that trade liquid instruments such as stocks, options, bonds, and other listed, marketable securities, are typically managed in an open-end fund structure and are considered to be “hedge funds”. Hedge funds typically have quarterly or even monthly liquidity for its investors.

Illiquid investment funds that invest in instruments that are not easily marked to market require investors to have a long-term horizon when looking for returns. Investments in private companies, real estate, commercial lending, commodity finance, and other similarly illiquid strategies require capital to remain within the investment vehicle for an extended period of time. A closed end fund structure is typically utilized for these types of investments, and the fund vehicle is considered to be a private equity fund, a real estate fund, or an ABL fund, depending on the underlying instruments. Investors in closed end funds also don’t have access to their capital for a specified period of time. Closed end funds usually only accept a specific amount of capital with redemption upon liquidation.

3. Management and Performance Fees

The management company usually receives compensation for managing the investment fund (which is generally referred to as a management fee), as well as, a portion of the profits, which is called a performance fee or performance allocation. For tax considerations it is typically preferable to segregate fees for services and profit participation. In some cases funds should be separated where management fees and incentive fees flow into separate entities. Additionally, determining the appropriate entity through which to pay expenses, including organization and marketing fees, are other considerations for startup hedge funds.

Most hedge funds have a combination of fees that are used to compensate the management company for their efforts in increasing the net asset value of the fund. Management fees are charged to each investor and are usually calculated as a percentage of the capital that is managed. These fees can run from 0% to 5%, but are typically set at 2%. The fees can be calculated in advance or in arrears and each approach has benefits to the management company. While performance fees can typically range from 10% to 80%, they are most often between 20% and 30%. The level of performance allocation is also affected by the amount of the management fee charged, with a higher performance allocation when a low management fee is assessed.

4. Tax and Liability Considerations

When starting an investment fund, there are a few tax implications and liability considerations at the management company level. Most managers wish to avoid double taxation and also protect the capital gains treatment of the founder’s capital. This decision affects the allocation of funds that are earned by the management company. Additionally, the liability of the owners should be limited to their investment in the management company.

Incentive fees are defined as a share in the profits that are earned by the management company. The structure of this fee has important tax implications when they are transferred to a general partner or a managing member. The allocation of an incentive fee is based on realized and unrealized gains (and losses). If profits are unrealized and allocated to the management company as increasing the percentage ownership within the fund, the gains occur without tax implications to the management company. If these funds are paid as fees, the management company pays taxes on the gains.

The portion of the allocation to the management fee that represents realized gains has the same tax treatment for the management company as it has for the Fund. If the allocated amount is considered to be a fee, the management company would pay ordinary income tax on the specified amount of revenue. Allocations to the management company reduce profits allocated to the fund. If this amount were considered a fee, the deductibility of the fee might be subject to tax implications to some investors.

5. High water mark

Profits received by a management company in the form of incentive compensation for a specific period usually only occur to the extent that the profits exceed any losses that occurred in the current period or prior periods. If a hedge fund generates losses, the management company will not receive incentive compensation until the losses are recovered and profits are made in excess of losses. Generally, management fees are charged to investors without recognition of profits or losses. Some funds have provisions that will reset losses after a specific period of time.

6. Regulations and Registration

Hedge funds are subject to different regulations typically based on the state in which the management company operates and other factors such as the number of investors and the total assets under management. Certain states, and in some situations the SEC, consider a manager of a fund to be an investment adviser. In some situations, there are various exemptions and de minimis exemptions available to investment managers of investment funds.

7. Summary of Fund Structural Considerations

The decision to utilize a particular fund structure is primarily based on the underlying investment instruments, and it is prudent to plan ahead and think about specific structural considerations prior to establishing a company that will manage investor capital. Fund domicile, management and performance fees, tax implications, risk/liability, and potential regulatory and reporting requirements are all additional considerations for a fund manager prior to opening an investment fund to investors.

An investment manager should speak with a knowledgeable hedge fund attorney regarding risk and liability issues. Fund managers should also work with an experienced hedge fund administrator regarding structural issues, and should discuss specific tax implications and questions with their hedge fund audit and tax counsel.

Starting a hedge fund is a straightforward process with Stonegate Global Fund Services. The firm’s industry-leading Hedge Fund In A Box^SM solution is a comprehensive service offering including domestic and offshore hedge fund formation, fund administration, fund compliance, prime brokerage, marketing/ media, audit and tax, and website development.

“7 Keys for Starting a Hedge Fund – Structural Considerations” – August 2012

Author – John McCorvey III, Chief Executive Officer, Stonegate Global Fund Services, LLC

About the Author

John McCorvey III, is the Chief Executive Officer of Stonegate Global Fund Services, which is an offshore and domestic hedge fund consulting firm specializing in the creation and operational management of offshore and domestic hedge funds. Mr. McCorvey created the firm’s industry-leading and patent-pending Hedge Fund In A Box ^SM and PrimeOne^SM solutions.

Mr. McCorvey is the Chairman The Hybrid Group and Hybrid Investment Management, which is a hedge fund seeding and incubation platform that manages a family of emerging manager hedge fund of funds products, providing customized hedge fund portfolios for accredited and ultra-high net worth clients.

Mr. McCorvey has more than 17 years of professional experience in the institutional investments industry, including institutional asset management; prime brokerage and investment banking; third-party marketing; fund formation and fund administration; institutional electronic trading; and technology. He has consulted and advised hedge fund managers on almost every aspect of their businesses during his career.

Mr. McCorvey studied investment management at the Harvard Business School, successfully completing the Private Equity and Venture Capital program. He holds a BS in finance with a minor in economics from Florida State University, and was a member of the 1993 Florida State University Seminoles National Championship Football Team.

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Phone: 770.393.6009

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HONG KONG

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The key to success for an emerging hedge fund manager is increasing assets under management (“AUM”).  For smaller, emerging managers, a realistic first-level goal is to reach between $50mm-$100mm AUM.  This range of assets becomes the stepping-stone to attract larger allocations from institutional investors.  To achieve this goal, a manager needs to produce above average risk adjusted net returns.  Without a close watch on initial expenses, a manager is less likely to generate strong net returns.  Reducing fund expenses has a positive impact on net performance and can also change the risk/return profile of the portfolio.

Capital Raising

As an emerging hedge fund manager, your hedge fund’s net performance is one of the key drivers that will determine how quickly you as a manager will be successful in attracting and raising capital from Institutional Investors, and thereby increase your assets under management. Your fund’s increase in AUM is ultimately the primary factor that determines whether your hedge fund be- comes a viable and ongoing business concern, or if your fund is ultimately closed down due to lack of growth.

“How do I increase the AUM of my hedge fund?” “How do I increase my fund performance?” Questions often contemplated by global hedge fund managers.

There are two primary driving factors related to the process of increasing hedge fund assets under management: net performance and implementing a strong institutional marketing strategy.

So how do you as an emerging manager accomplish your goal to build a solid base of assets?  The answers to these key questions lies in the following formula:

Strong Net Hedge Fund Performance X Institutional Marketing Strategy / Fee Drag = Increase AUM

For emerging managers, it is critical to act quickly in order to change the landscape of your hedge fund’s return profile.

Our Hedge Fund in a Box^SM solution assists global hedge fund managers in accomplishing their goal of increasing hedge fund AUM… Thereby, the above equation can be expressed as follows:

HEDGE FUND IN A BOX =

Strong Net Hedge Fund Performance X Institutional Marketing Strategy / Fee Drag = Increase AUM

How to Increase Assets Under Management by Reducing Fee Drag

Have you as a hedge fund manager ever noticed the material impact of fees and the fee drag effect on your hedge fund’s performance? Many managers have experienced the excitement of nailing a trade or series of trades during a given Net Asset Value (“NAV”) period and creating great returns for the fund, only to be deflated as their hedge fund administrator calculates the hedge fund’s returns, net of fees, which results in a significant reduction in the fund’s gross performance.

Granted a portion of those fees go to your compensation as the investment manager/general partner of the fund. However, a significant percentage of this fee drag is the direct result of substantial fund expenses for various hedge fund services and service providers. High costs for prime brokerage, legal services, hedge fund administration, regulatory compliance, audit, tax, capital introductions and third party marketing result in erosion of the hedge fund’s performance and causes it to fall far too short of where it should be.

Fee Drag is an interesting phenomenon, and one of the most interesting consequences the Fee Drag effect on hedge fund performance is that is has a exponentially larger effect on emerging managers relative to more established funds.  This phenomenon exists because many of the costs relative to a hedge fund are fixed and are not a variable function of increasing size.   This concept is expressed visually by comparing the four graphic illustrations below:

This fee drag effect is exponentially worse for an emerging hedge fund versus a larger, more established hedge fund.

Stonegate Global Fund Services’ “Hedge Fund in a Box” solution assists hedge fund managers implement optimal expense management programs.  The comprehensive service offering provides emerging managers with all of the components needed to start a hedge fund and launch a successful business.

In order to mitigate the fee drag impact for smaller hedge fund startups, emerging traders can leverage our “Hedge Fund in a Box” solution that places emerging managers on the same relative expense plane as established managers enjoy.

Stonegate Global Fund Services is proud to announce the release of “How Do you start a hedge fund?”, a white paper we Co-authored with Grant Thorton. Please read for details on how to start a hedge fund.

Meet the Manager – Hedge Fund Capital Introduction Event

Stonegate Global Fund Services, LLC  -  December 2011 Meet the Manager – Capital Introduction Event

November 17, 2011 –  FOR IMMEDIATE RELEASE – New York, NY

NEW YORK:   Stonegate Global Fund Services is sponsoring our quarterly capital introduction event on December 13^th in NYC.  The event will be held at a private venue in midtown Manhattan on Tuesday, December 13, 2011.

The event will feature 25 hedge fund managers to discuss opportunities they see in their strategies.  There will also be an opportunity for investors and hedge fund managers to meet one-on-one to ask more detailed questions regarding their views on the global markets.

Accredited and institutional investors are invited to join us, as numerous qualified investors will be attending to hear the management presentations.

Stonegate Global Fund Services will give a brief presentation on “How to start a Hedge Fund”, discussing its most recent White Paper, entitled “How do you start a hedge fund?  The new era of hedge fund creation and operational management”.  The White Paper will be released in early December and will cover the firm’s industry-leading “Hedge Fund In A Box^SM” solution.

The event will conclude with a wine reception for additional networking.

We hope to see you there!

If you are interested in attending our upcoming or future capital introduction events, please contact us:

Info@StonegateCapitalPartners.com

New York:  212.810.9024

Atlanta:  404.941.2903

Additional information about Stonegate Global Fund Services, LLC is available at:   http://howdoyoustartahedgefund.com/