What does it take to start a hedge fund? The scary truth is that virtually anyone can start a hedge fund; and, it can be fairly inexpensive and easy to do. Why is this so scary? Among other reasons, hedge funds can attract investors while providing very little information; so, investors may not be able to make well-informed decisions. Then, hedge funds don’t need to provide regular (or audited) information on an ongoing basis. If your manager is a crackpot and you have to stay invested for the remainder of the year (or quarter or whatever), you could wind up with very severe losses.
(Prospective investors should choose very carefully.)
Of course…that won’t stop me from telling you how to set up a hedge fund. After all, I get a kick out of divulging Wall Street’s billion dollar secrets for free.
THE HEDGE FUND ENTITY
Hedge Funds are typically structured as:
- a limited (or limited liability) partnership, or
- a limited liability company, or
- a trust.
What structure you choose depends entirely on what you want and the laws in the state in which you are forming. (Non-U.S. readers should explore the entities in their home countries as well.)
For the remainder of this article, I’ll be referring to the most common hedge fund structure – the Limited Partnership, or LP.
To set up a limited partnership is fairly easy and inexpensive. In Illinois, you answer six questions on a fill-in-the-blank form, get a cashier’s check for $150, and send it to the secretary of state. How tough are the questions? If you can come up with a name and write your address, you are in business.
Running Total: $150.00
GETTING THE TAX ID NUMBER
You’ll need to get a tax id (FEIN) number from the IRS. Simple enough – go to the IRS website and get it online in a matter of minutes. It’s fast, easy, and free.
Running Total: Still $150.00
BECOMING AN INVESTMENT ADVISER
If you will have 15 or more investors in your hedge fund, you’ll need to register as an investment adviser with the SEC. (Note: That doesn’t mean you’ll have to register the hedge fund. We’ll get to that in a bit.) If you’ll have less than 15 investors, you may still have to register in one or more states. (See Rule 203(b)(3)-2 of the Investment Advisers Act of 1940.) I’d play it safe and register with the SEC. It’s not scary – they’re actually there to help you so long as you are not defrauding investors.
To become an investment adviser, you’ll need to sit for a regulatory exam – the Series 65. The Series 65 is a 3-hour, 140 question exam, of which 130 count towards your final score. It’s not the hardest exam in the world (part of the “scary” conversation above); but, you’ll need to score a 68.5% or better to pass.
The Series 65 doesn’t teach you a darn thing about investing. Instead, it’s a “minimum competency” exam designed to test your ethics and understanding of basic securities laws and practices. A study guide and a few hours of quiet reading can make you a pro.
SCHEDULING YOUR EXAM
Your state will generally “sponsor” you to take the exam (as opposed to the Series 7, which requires a firm’s sponsorship); so, you fill out Form U-10, sign over a check for $120, and schedule your exam.
Once you’ve successfully completed the exam, you are now licensed (though not yet registered) as an investment adviser.
Running Total: $270.00
THE “REGISTERED INVESTMENT ADVISOR” VS. “INVESTMENT ADVISOR REPRESENTATIVE”
At this point, you have a decision to make – Do you run your partnership/advisory business as a sole proprietor (eg., Joe Ponzio Sole Proprietor) or do you (as is more commonly done) create an investment advisory company to shield yourself from personal liability (eg., Joe Ponzio Funds, Inc.)?
To be safe, you create a corporation (or LLC, whatever) to act as general partner of your LP. (Your investors will be the limited partners). You’re cheap; so, you create your Illinois corporation for $175 instead of expediting for $300. Once incorporated, you’ll get a FEIN for your company as well.
Thus, you will personally be the Investment Advisor Representative (IAR) of your company, which will act as the Registered Investment Advisor (RIA).
Running Total: $445.00
REGISTERING YOUR RIA AND IAR
You’re just about there. First, you have to register your company as the RIA, which you will do through the Investment Adviser Registration Depository (IARD). The instructions are on the IARD site; so, I’ll spare you the details. It’s not rocket science; but, it will likely take you a few hours to figure it all out. (When I was starting my firm, I spent the better part of three months figuring all of this out. Then again, I didn’t have an article like this one to read!)
As of the time of this writing and through July of 2009, it is free to set up your firm on the IARD system.
Once your firm is set up, you’ll need to “register” yourself with your firm by filing a Form U-4. Coming in at 28 pages, it looks like a beast. (You can also file it electronically.) So long as you don’t have a lot of disclosures (eg., if you’re not a criminal), you won’t fill in half of them.
Submit your U-4 with a $30 check…
Voila! You are now an investment adviser, running an investment advisory firm and a hedge fund.
Total Cost: $475.00
I told you that it was scary easy.
SOME THINGS TO CONSIDER
For less than $500, you could technically be in business. You’ll need a few things to get started:
For Your Investment Advisory Firm:
- By-laws
- Compliance manual
- Code of Ethics
- Supervisory Procedures Manual
- Investment Adviser/Portfolio Management Agreement
- Everything else to run your business (website, business cards, etc.)
For Your Hedge Fund:
- A LP agreement
- Private Placement Memorandum
- A presentation or brochure about your proposed investment style (needed for capital raising and road shows)
- A custodian/brokerage account to house the fund’s securities
…along with checking accounts, etc.
If you are feeling really cheap, you can find a lot of this stuff online, and then tweak it for your business; or, you can pay a compliance service to provide you with many of these things.
REGISTERING YOUR HEDGE FUND WITH THE SEC
Hedge funds don’t technically register with the SEC. Instead, you’ll have to register your LP interests offering (corporations have stock; LP’s have interests; LLC’s have memberships; trusts have units of beneficial interest) with the SEC if you are offering the hedge fund to investors other than friends and family. So…you don’t register your fund; you register your offering, usually under Rule 506 of Regulation D of the Securities Act of 1933.
Though there is no fee for registering your offering, you will have to get a CIK number from the SEC and file Form D with the SEC and with each state in which you plan to offer or sell interests.
OBVIOUSLY…
Having gone through a lot of these steps over the years, it’s a lot easier for me to say than for you to do. Though I spent a few months digging around in the dark to get my firm started, I can now say that it is not all that difficult or expensive if I had to start over again.
As you can see that hedge funds are not as mysterious as Wall Street wants you to believe. In the end, a hedge fund is a partnership – not some special entity – that has a general partner (you or your investment firm) and limited partners (your investors).
Then again, don’t mistake this article as advice or compliance help. This is a broad overview of how to set up a basic hedge fund. The laws, rules, and regulations can change; so, make sure you are up to speed based on your situation.
Filed under: Miscellaneous
Great communication!
I’ll have to check with my state (NY) again. According to the A.G. office of my state, it’s even easier to start a private investment company (hedge fund) than you describe. For example, I am told you don’t have to register if the partnership stays under 5 investors.
Anyway, Great Post.
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Jason – That depends on the states’ regulations. Some states have a 5 investor minimum; some have a 15 investor minimum; some have a 15 investor or $5 million minimum.
You’re looking for the state’s de minimus registration requirements. And remember – you need to consider the registration requirement of:
- the state in which you (and/or your investment firm and/or hedge fund) reside;
- the state in which you are offering interests; and,
- the state in which your investors reside.
They are not always one in the same.
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This is a great blog!!! glad I found it..%u2026.very educational%u2026thank you%u2026I will put it on my favorites list.. I also learned a lot about trading strategies from 3 other great books. Hedge Fund Trading Secrets Revealed..by Robert Dorfman..and Confessions of a Street Addict of course by Jim Cramer..written before he got really famous.and Richard ARMS..STOP AND MAKE MONEY%u2026.all 3 are riveting and very informative. You should check them out if you like reading behind the scenes stuff about hedge fund and what methods they use to make money.
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Joe,
Thanks for the info. I have a customer of mine who cold have used this info. He used an attorney to set up his fund, cost approx $3,000. Which as far as attorneys go that is relatively inexpensive for this type of work I would think.
Anyway, nice post.
Casey
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Hi Joe; this is a very timely post for me. I am glad to have stumbled upon your site. I have worked as an analyst for a couple of hedge funds and am now consulting for one while launching my own business on the side, all in the NYC area. I’ve spoken with a few attorneys and each have said that in total it would cost me between $25k and $35k to establish only an onshore fund and $50-$60k to setup both an onshore/offshore in a master-feeder structure.
I have no clue as to why the cost is so high, as I have already cheaply setup my LLC in the state of Delaware, have attained a tax ID number, etc.
With regard to attaining the following, however:
# PPM
# Subscription docs
# Investment Adviser/Portfolio Management Agreement
Don’t you need an attorney? Also, if you are open to a brief telephone convo, please shoot me an email… can’t hurt to make another connection…
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So now we know how to set up a fund. All we need is a good manager and some clients.
Why would I be a succesfull hedge fund manager or how would I identify an above average manager ?
Would a well run fund be open to any and all clients or would it target a specific group ?
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Hi,
I have absolutely no experience in managing money or dealing but think I’d be really good at running my own hedge fund and I hear there’s lots of money in it. Do you have any suggestions on how I could set up my hedge fund asap and start making the big bucks?
I also live in the UK and assume the laws are different over here. Any advice would be appreciated and would also appreciate you pass the provisional name of my hedge fund on to any wealthy individuals you know, “Dollar-fest and co. LLP” as I am sure it is going to be a great success.
Jason.
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Folks – I’m not saying you shouldn’t talk to an attorney. What I am saying is that a lot of the work that the $30,000 or $60,000 attorney is going to do can be done on your own, for much less money. You can start up for a few hundred bucks. As far as subscriptions agreements (aka “account” forms), legal documents, etc., you have to decide if you draw them up yourself or hire an attorney to do it.
Jason – Your sarcasm and wit is actually quite profound. At the end of 2007, there were 16,079 registered investment companies managed by 683 financial firms (2007 Mutual Fund Fact Book), and that doesn’t include the thousands of hedge funds. Oh…and that’s just in the US.
Thus, you have a lot of competition. Considering that 80% to 90% of managers fail to beat the markets over the long-term, there are quite a few “Dollar-fest and Co.” funds out there.
Let’s not forget – we’re on “F Wall Street” here; so, we all share your cynicism and skepticism. 
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Joe,
My sense is that the cost of starting a fund depends a great deal on who you expect your clients to be. If you plan to raise money from friends and family and individuals you know, you can probably avoid a lot of expense. As you wrote in your post, it can be done on the cheap.
However, if you plan to raise funds from wealthy people, strangers, and institutions, then you will probably have to spend considerable amounts of money to start your fund and to keep it operating.
For example, larger investors are likely to require detailed legal documents, often with pages devoted to tax issues alone. Good, cheap hedge fund lawyers can produce documents like this for $5,000 to $10,000. If you plan to go after serious institutional clients, you probably want your documents drafted by a prominent law firm (Sidley Austin, or Seward and Kissel, or Katten Muchin and Rosenman, or Schulte Roth and Zabel). A firm like that will charge $25,000 and up for legal documents. But large investors will recognize its name (indeed, it may make some introductions for you). Should large investors negotiate terms with you, an expert firm may be of more help in the back and forth.
Also, most investors will require a fund to be audited annually. One of the red flags in the Bernie Madoff scandal was that the firm’s auditor was not a legitimate company. Good, cheap auditors will cost $5,000 to $10,000 per year, while the top firms (Rothstein Kass, Deloitte, etc.) will cost $20,000 and up. Sophisticated investors will require an audit, and the name of the firm doing it will matter to some of them, particularly in the wake of recent scandals (though a “name” auditor is, of course, no guarantee of safety or even lack of chicanery).
Lastly, it is becoming more and more necessary for funds to hire independent fund administration firms to handle bookkeeping and to process redemptions and contributions (in part so that a third party is handling the money, to keep the manager from running off with it, and in part for legal reasons related to anti-money-laundering checks). An admin firm can cost $10,000 per year on the cheap side, and likely $25,000 and up.
Between a one-time legal fee of at least $5,000 to draw up documents (and possibly over $25,000), annual fees of at least $20,000 (and possibly $40,000), for audit and administration, the cost of starting a fund that large, sophisticated investors will be likely to invest in is quite a lot higher than you suggest.
I suspect the difference is a matter of who your target audience is, and also reflects the fact that, thanks to regulation, it is getting more expensive for everyone to start an investment business.
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Joe and team,
I thought this site a very educational value investing site. I also found people on this site very close and supportive to each other because, to a large extent, the philosophies behind value investing are so sound and profound that they pull like-minded people even closer. I deeply appreciate the great effort by Joe – I learnt a great deal here. I will try my best in the future to contribute but feel a little humbled at present because I feel I am just at the door.
The reason I write this post is to seek advice from fellow value disciples on a career choice. To do that let me give a brief introduction of myself. I am a Chinese national (yes, Joe, you have a fan in China!) and was a top 25 physics competition high school student in the largest city in China (i.e., I have good quantitative skills). I attended a small liberal arts college in the U.S. studying physics and business. I later attended Harvard Law School as the twist of fate would have it. I was not so fond of law and law practice, to say the least. So 9 years after I stepped into law school (I know, it was too long), I finally freed myself from law.
For the last two years, I tried entrepreneurship here and there but was really drawn into Mr. Buffett’s value investing. I read tons of 10-Ks and 10-Qs and many other things and managed my own portfolio on the side.
Now I feel value investing may lead me to a second career for a few reasons. One, the skill sets I acquired so far seem helpful for value investing. Two, my temperament may be suitable for value investing (I think.) Three, the first two years of my value investing when I think I just touched the skin of value investing have seen encouraging results (31.6% v. S&P500 5.5% in 2007 and -2.5% v. S&P500 -36.5% in 2008).
I am now confronted wtih the similar kind of issues facing many value investing professional-wanna-bes. I know many reading this site are probably professionals and may provide me with some realistic advice to my dreamy aspirations. The options I can think of now are the follows.
1. Start an Early Buffett-style partnership/hedge fund. I have indeed just started to work on this. But as you could see, with my limited experience, people tend to be skeptical. The best result I can achieve so far is people willing to invest very small amount (not feasible for livelihood) for 3 years as trial. Also I mainly solicit people in China which is both necessary and limiting. I think this is the most likely course, but understand it may not be the best. (BTW, Joe, this is a fantastic piece on the logistics of starting a hedge fund. I know it may not be possible, but you may think about starting a discussion on the logistics and strategies of fund-raising.)
2. Join an investment house, honing my skills while securing a regular income. It could either be in China, Hong Kong or US (in my primitive opinion, US is more suitable for my style of value investing). However, maybe I am not an eternal optimist, I could list many faults with this approach without so much first hand experience. Below are two most prominent ones I can think of.
a. Losing independent thinking. I balk at the prospect of lemming-like mentality and institutional imperative as experienced in my previous professional job and reputed for an ordinary investment institution.
b. Lack of qualification. I thought briefly about an MBA degree as a knocking tool but feel it too big a commitment and tortuous route for my age (mid 30s). The alternative, though, would be an unconventional job application. Any investing professionals care to shed some light on this?
I would stop here to avoid making it look like a job application here:-) But I sure would like to hear from my fellow value investors and appreciate your critiques, opinions or suggestions.
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Hey Aigle, we appreciate you opening up man…
I feel like we are all very familiar…especially in the following point:
“Losing independent thinking. I balk at the prospect of lemming-like mentality and institutional imperative as experienced in my previous professional job”
Amen brother lol,
You’ll notice we are all independent thinkers here, so we try to share each others thoughts and mental models in order to incite discussion and analysis from others.
I do hope you find what your looking for here!
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Aigle,
I would think it would be tough to raise enough money to invest and support yourself full-time with your lack of experience. Even Buffet worked as a stock broker for a while both in Omaha and Wall Street to gain experience and contacts. Based on what I read in his recent biography, even with this experience and people’s initial perceptions of him being favorable, he had trouble raising a lot of money at first and stuck to mainly friends and family.
If you are serious about this as a career choice, I would highly recommend you try and get a job with an investment advisory firm, preferably one that focuses on value investing since that seems to be your interest. Just be forewarned that in this current market, it may be hard getting a job in finance, half of Wall Street has been laid off recently and will be looking for jobs. Your lack of formal education in business finance and/or accounting may also make things difficult. As intelligent as you sound, unfortunately education does matter. I would give serious consideration to getting that MBA.
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robin: It’s not the easiest question to answer without knowing the particulars of your fund. If you are starting a fund that makes plain vanilla purchases and sales of stocks and/or bonds and/or options, with minimal (<20%) or no margin, you can use just about any discount brokerage because, from an investment standpoint, you don’t need anything more than a brokerage account (and a checking account to accept investor funds).
If you plan to get buck wild with your investing, or if your assets soar to the tens and hundreds of millions, you will then want to start looking at prime brokers, trading platforms, and a clearing house that will coordinate the two. The reason is simple: a TD AMERITRADE isn’t designed to help you “sneak” $100 million into a $600 million company. You’d likely end up doing a lot more work and possibly paying more in commissions/trading fees at a discount brokerage house.
Aigle: I think the first step is figuring out what you want to do. There is a huge difference between running a partnership and being an investment advisor to many clients:
Running a Partnership: You have one portfolio to manage, and total freedom to manage it (within the limits in your limited partnership agreement and disclosure documents). Though the freedom is wonderful, the drawbacks are huge. Two that I can think of immediately are:
- Nobody knows you. I don’t know what the “advertising” rules are in China; but, in the United States, you can’t advertise your fund. The best you can do is advertise your RIA/investment firm, but you have to be careful that you don’t mention the fund to anyone except accredited (or qualified, depending) investors with whom you have an established relationship.
- People are skeptical. Once you’re in front of a potential investor, you have to explain why it’s okay that they won’t have access to their money but once a quarter or year, that they won’t get statements but once a quarter or year, etc.
Working at an investment house: You manage many portfolios for many investors within the bounds of what the firm allows. You get to advertise; you get the name/reputation of the firm behind you; you can be “known;” steady pay, at least during training or the first year or so. The drawbacks:
- You will likely be constantly pressured into finding newer, bigger clients.
- Without an awesome portfolio management system, your “B-list” and “C-list” clients will probably get lost in the shuffle. (We had a system built because most software we saw was designed for selling products, not managing money.)
- Though they’ll likely sell you the dream of “working for yourself, not by yourself,” you’ll be limited in what you can do/invest in. (Many “captive” brokers will disagree with this statement. I mean no disrespect; but, I say this: Until you’ve tasted the true freedom (and headaches) that come with being the owner/operator of an investment firm, you won’t truly realize the captivity, however small, of the large wirehouses.)
The third option, which is extremely tough, particularly when you have no experience at any firm, is to start your own. Starting any business is tough; but, when you have to set up an investment firm — with all its compliance, intricacies, licensing, etc. — it can be a real headache. Even with industry experience, it took me a long time to figure out how to get my firm started. (Of course, I was too cheap to pay someone to do it for me.)
If you go with the third option, you can run a partnership and/or manage client accounts. You get the absolute best and worst of both worlds…magnified by ten because you have to wear all the hats.
So, I go back to my original question — the question I ask everyone that turns to me for investment career advice (dozens over the past seven years): What is your ideal job?
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Understood, Joe. Last comment on this -
Here is a particular example that the readers might be interested in completing through their broker:
EXC has offered 0.485 shares of EXC in exchange for NRG until Feb 25, 2009. NRG is trading at ~$22 while EXC trades at ~$53. So theoretically I could buy NRG shares, convert to EXC and sell EXC shares for a ~15% arbitrage (excluding transaction costs). What broker would enable this exchange for $1M of available funds? Are there any cheaper options than a prime broker like Goldman Sachs?
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in establishing a hedge fund and then marketing it, how can i diffirentiate it from the business model of a registered investment advisor. in other words, if my client base is mostly already invested with an RIA, what are the benefits of investing in a hedge fund v. the RIA? What are the differences, other than fee structure?
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Great Article! Does anyone know where I can find sample documents for the private placement memorandum, the LP agreement for the fund, the LLC operating agreement for the management company, etc. that I can modify to suit my needs? I have set up the necessary companies, but would prefer to get some inexpensive template legal documents, modify them myself then have a lawyer review them. Getting a lawyer to craft these documents from scratch seems like the largest cost of getting started and I would like to minimze this.
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Thanks Joe, a fascinating account. It is scary how little goes in to creating a fund but also how few other things hedge fund managers consider when setting up. HR, business administration, and communications: http://marcoms.cognitomed... often get pushed to the wayside in the scramble to establish a firm…
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Great info. to be utilized in order to get up and running. The key being to take action.
Does anyone know if there are restrictions on fee structure with an RIA? Can you do 2/20 or is it only based on AUM? I did note some of the concerns over raising funds and it is true that there are obstacles but what I have found over the past 6 months is that there are still folks interested in viable investing strategies to help them achieve some modicum of wealth.
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Robin: Any broker that allows you to short would do such a transaction, in which you buy one company and immediately short the other in an amount equal to the conversion amount. For smaller dollar amounts, you don’t need a prime broker for these transactions. Now, if you want to spread $80 million across such a transaction, you’d have to have a prime broker that can go out and borrow the short shares from other houses. (Many “retail” brokerages will often allow shorts only to the extent that their other clients hold the shares in their accounts.)
Syril: The hedge fund is the investment company; the RIA is the advisor to the hedge fund. You would market your RIA as an intelligent advisory firm, and then have investors invest in your fund.
Dan: Google is your friend. I don’t have a specific resource, but you will definitely find stuff through Google if you are willing to tirelessly search through the results.
Jedburgh: RIAs can charge performance fees only to certain clients. You can see the law here.
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Good Stuff…some simple questions…
For ease, lets just say i have 1 client with 100,000k to start..(really 10 )
I have a agreement with them to charge 30% of all profits.
So I start with 100k turn it into 200k at year end. Lets say i am using a discount broker, like fidelity. Lets say that my trading platform allows me to debit his account for 30k….’
1) I assume fidelity will send him a 1099 for gross sale wih a profit of 100k and not 70k
2) So the person I was trading for has to pay taxes on the 100k or deduct 30k on schedule A (itemized deductions)??
3) I report the 30K as income
Is there any way that the discount broker would send your customer a 1099 for 70K profit??
how would you register the account where you would get the 1099’s and then resend 1099’s less fees to the clients????
Thanks in advance
sam
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I think under your scenario the client would have to pay capital gains on the $100K and then deduct the $30K on schedule A as investment expense.
The other option would be to setup a partnership or LLC and admit your clients as partners. Trade under the partnership or LLCs name and it will be responsible for the capital gains, not your client. For tax purposes the partnership or LLC would act as a pass-through entity and each partner would report their share of the profits, which would be equal to their share of the capital gains less their share of the management fee (in your case 30% of gains).
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Joe, wonderful post. Here’s a stupid question: what if you don’t want to go on the road and “pitch” your company to potential investors? What if you simply want to borrow some cash and make money “on” your own and “for” your own? Can you just set up a corporation (to avoid personal liability) with you being the sole shareholder and go from there? What would the differences be in setting something like this up? Thanks!
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So, I am setting up my business. It will be a Investment Advisory Company. My clients won’t qualify as the sort of investors that can be charged performance fees (friends and family). So this is my idea:
I will sign the clients to my registered investment adviser firm with myself as the investment adviser representative Then, I’ll advise them to join a L.P., whose strategy would be investing value style (big surprise). Pool all their assets and have my firm serve as general partner AND investment adviser to the L.P. (is this possible?) and as the adviser be compensated based on a percentage of assets under management.
Also, I plan on being a member of the L.P., personally. Just to complicate things a bit more.
I am aware of all the details involved here, this is just the big picture of my dream. I’m not asking for professional advice here. Just some opinions, from Joe or anyone else, on my plan is and what I may want to consider.
Great Site Joe!
Thanks
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Thanks for the great article. I would like to point out that there is a different route that I would advise anyone seriously considering doing this to take. We spent over $70,000 on legal and felt lucky at that, not to mention a fortune on other articles that make investors comfortable. If you want to manage a couple of VERY close family members’ money, do-it-yourself might be fine. Otherwise, it’s not.
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Sam: BPal is right. Odds are that your discount broker won’t include your performance fee. You have to send the client an invoice that (s)he could use when filing his/her taxes.
Scoop: If you don’t plan on attracting investors, you need not do more than open your own brokerage (or other) account and begin investing. Or am I missing something in your question?
Jason: If your clients aren’t accredited, you could run into problems with your hedge fund. You might want to consider finding a discount broker that allows you to run a “model” portfolio to which they all subscribe through their own individual accounts. When you buy or sell something in the model, you would, in turn, buy or sell in the same amount for their individual accounts. Basically, you’d be running “separate accounts” instead of a hedge fund.
TD Ameritrade offers this and a friend of mine — Cale Smith in Florida (Tarpon Fund) — is doing this (or something similar) as well. Check him out here.
HEDGER: Thanks for the “other” side of the business and great advice.
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Joe/All
Can you give us an idea of how much it costs on an average annual basis to operate a hedge fund?
Possible costs I can think of are third party administrator, audit, brokerage fees, and of course general things like internet service, research applications such as FactSet and Bloomberg (of course both not neccessarily needed). If you could provide a list of these types of costs and a range for them it would be much appreciated. I pretty much want to know how much I would need to make to break even.
Thanks!
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Thank you for the article. Very helpful.
My question is about brokerage/custodian accounts. I’m trying to find an entity that can just settle trades, transfer money, etc. and do the bare-bones minimum to support my trades and holdings. Does this type of business exist? All I see are prime brokerage services offering research and other features that I’m not interested or “regular” broker who don’t really support directed trades.
Can you offer any advice here? Does this type of service exist? With respect to earlier advice you gave to a fellow blogger, google has not been my friend in getting to my answers.
Regards and keep up the good work.
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Just a clarification regarding the exemption from registration. Most large hedge fund managers ( like Soros ) don’t register as RIA’s. The exemption mentioned in the article is correct in that if you have 15 or fewer clients and don’t generally hold yourself out to be an investment advisor, then you are typically exempt from registration ( depending on your state). If you structure your fund correctly and adhere to the rules regarding who is solicited to invest, then your hedge fund ( and those who invest in it) are considered only one client. I manage several hedge funds and I am also an RIA registered with the SEC. State laws do vary though.
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Boston: As with anything, it depends. If you are one person working in a home office pouring over annual reports, you don’t need much. The flip side is that you could spend millions a year on offices, information, etc. I know some people that are running funds for just a few thousand dollars a year and are break-even with $700k in assets.
RobertMiller: You can find an institutional custodian (US Bank does this, though don’t take this as a recommendation – do your homework!) and then an “executing broker” that will place your trades for, say, $0.01 per share. Institutional custodians can get costly – starting around $1,800 a month plus 10bps (0.10% of assets).
You would place your trades at the executing broker(s), but they would all settle and be held at the institutional custodian.
20 YR Trader: Great point. Aspiring managers should be aware of the distinction between “accredited” investors and “qualified” investors, and how that would affect their registration requirements.
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Joe,
Wonderful article. Exactly what I was looking for. I still have one question, though:
I’m trying to set up a fund on the cheap to manage the money of close family and friends. One of the investors is a foreign national not subject to U.S. taxes. I’ve read that an offshore feeder fund will be necessary to shield him from U.S. taxes. So my questions are
(a) is it true that I will need an offshore feeder fund?
(b) is there a cheap way to do this?
Thanks!
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All: I can’t give specific advice. Once you start with foreign investors or offshore funds, you’ll probably want to talk to an attorney. This article is geared more towards the smaller investor looking to set up an early Buffett partnership for friends and family (to start).
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Great article, love to see things boiled down like this.
I’d like to invest for a close group of family/friends. I had found that hedge funds are the best description for what I want to do. I’m wondering if I can just do like you said in response to another person and just open another trading account and checking account – this I will research on the requirements for my state. My real question here is about the tax rules for a hedge fund and associated LP & LLC. Is there a tax advantage to managing my investors funds via the hedge fund at all? Can I pay myself via the advising firm money taken off the profits without the capital gains that I’d typically have for ‘managing’ the fund and acting as the primary adviser?
Thanks for any input.
Jon
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mar: I’m afraid not. Obvious legal/strategy/track record/liability reasons aside, we’re not a commission-based broker/dealer firm so we can’t sponsor people to take the Series 7.
Jon: You can run “separate accounts” for family and friends, whereby you make all the investment decisions but the accounts are in their name. We do that at Meridian. When running separate accounts, you can’t have a performance fee except in limited circumstances. Check out this explanation on Meridian and Section 205 of the Investment Advisors Act of 1940.
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So this is a great post.. However, what is required if I were to purchase stocks, bonds, shares of mutual funds, or shares of DPP programs for a client? do I purchase these securities in the name of the client or are these securities purchased in the name of the corporation, and held in the corporations brokerage account?
Thanks
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Eli: You will have to check the regulations as to whether or not you qualify/need to register as an investment advisor. It depends on your clients – the number, type, etc.
Lunn: If you start a fund, you would have one single account. If you managed “separate accounts,” the securities are purchased and held in the clients’ accounts.
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Joe ponzio,
Hi I pretty much have the money as im starting up my fund.
I’m gearing toward very wealthy individuals and entities.
and placing funds into the private placement world as I work with a few private trading
platforms.
what advise should I have and need to know to target the wealth?
How do I find these individuals?
whats my approach?
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I really need a fund manager.. what would the best way to go about finding a really good one?
I was thinking of soliciting to fund managers at smaller companies. would that be wise?
I understand how that can be so unethical, how ever just want to acquire really good arsenal.
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Joe,
I have a lawyer in the family. A very god one. But he doesn%u2019t deal with setting businesses up. Does one need to seek out a lawyer that specializes in a specific area to get help or will my father in law do? For what it is worth, we all get along very well.
Are there any new laws coming down the pipe that might affect you? I think there is talk of making hedge funds more transparent post Maddoff.
It%u2019s interesting to read your comment about being able to use Ameritrade as your brokerage (discount).
The hardest thing for me is that if I did set p a hedge fund I would feel like a thief using the commonly heard of fees. A flat rate and 25% of anything over 6% in gains each year. The thing is, until many millions are managed, this is the only way to do this FULL TIME until enough money is managed in order to make people not feel ripped off. Any advice on how to handle fee structures?
Since there are some outlandish fees regarding minimum net worths for your clients, is there any way around this?
I like the idea behind the Tarpon Fund. What kind of fee structure does he use?
Wow, I read this entire discussion on setting up hedge funds. Fascinating! Off to read more about this “spoke fund” that Tarpon Fund basically is.
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Many thanks for your great help!
I would like to lunch my investment advisory and HF but not sure if I got some points right:
1) If I start HF and take money from unqualified investors I cannot charge performance fee but I can charge fixed fee or a percentage of assets value taken into this fund %u2013 is it correct?
2) Can I mix in the same Fund (organized as LP) money from qualified and not qualified investors but charge performance fee only to qualified?
Thank you!
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Joe,
First of all, your blog is really great; I really appreciate your insight. Regarding what you said:
“Jon: You can run “separate accounts” for family and friends, whereby you make all the investment decisions but the accounts are in their name. We do that at Meridian. When running separate accounts, you can’t have a performance fee except in limited circumstances. Check out this explanation on Meridian and Section 205 of the Investment Advisors Act of 1940.”
I would like structure my company in a similar fashion…if I understood what you wrote correctly, your company is running separately managed accounts (SMA).
So would these be the step I need to take for the SMA process (vs hedge fund)?:
1. Set up my LLC through my state
2. Get a tax ID number (IRS)
3. Become an investment advisor (i.e take the Series 65 exam)
4. Since I don’t want to run a hedge fund, but SMA (i.e my master account linked to my clients’ accounts), do I still need to create an investment advisory company to shield me from personal liability, or is the LLC I created in step 1 going to do that for me and allow me to manage clients’ accounts?
5. Register my LLC company as the RIA through the Investment Adviser Registration Depository (IARD). Then “register” myself with my firm by filing a Form U-4.
6. Set up an institutional account with broker (TD Ameritrade, Scottrade, etc) and have client do the same and authorize me to trade on their behalf (like Meridian does, if I got it right)
So, to sum it up, can I manage account via my investment advisory firm without using a hedge fund?
Thanks again!
David
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Folks,
I will no longer be responding to comments on this particular post as I do not want to cross into the realm of providing (or seeming to provide) legal, accounting, or securities advice. This article should give you enough to start your research on how to start a fund.
Thanks for understanding.
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I guess I’m a little confused about all of this. I understand the steps but I’m curious about the hedge fund vs. the investment advisory firm. I know that I cannot legally advertise my hedge fund but can I advertise the investment advisory firm and if so what purpose can/will it serve? Will I essentially have two entities through which I can invest other people’s money or will it just be one firm with two separate segments? Please advise.
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And this is why we have to many unqualified individuals with too much money which then equates to forced selling. Which of course equates to individuals losing their retirement basket,etc..
Awesome post Joe. Its a bit tougher to start a mutual fund (although still possible) but mutual funds are very regulated compared to hedge funds
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