Articles & Alerts

Key Considerations for Starting a Hedge Fund – Part II

May 5, 2021

This is Part II of Key Considerations for Starting a Hedge Fund that was published on April 29, 2021. 

Hedge funds comprise the largest segment of the alternative asset market. Many talented traders and investment professionals consider starting their own funds at some point during their careers. After setting out your initial steps with strategic planning, budgeting, raising capital and going over legal considerations, the next steps we outline below will be crucial in the success of your fund.

Taxes and Accounting

You will need to engage an accounting firm to perform an annual audit of your fund and prepare the fund’s tax returns. It is prudent to meet with a firm familiar with startup hedge funds before you finalize your legal documents, so you can discuss and understand various issues involved with your strategy. These include reviewing options available to you, identifying necessary Federal and state tax filings, reviewing potential issues relating to foreign investors and retirement plans, beneficial tax elections, your plan for manager and employee compensation, and the overall tax impact of running your fund.

Ideally, hire a firm that not only covers the basics for your accounting needs, but also is capable of helping as you grow your fund. The firm should be actively working with you to minimize tax exposure and consult on your operations. Look for a firm such as Anchin with a strong reputation for working with emerging managers, as larger accounting firms may not be focused on smaller client needs. A coordinated team focused on your personal needs, as well as those of the fund, is ideal.

Setting up Fund Operations

Before you formally launch, you also will need to hire other third-party service providers to handle specific aspects of fund operations. These service providers may include:

  • A prime broker to execute the trades for your fund. A prime broker typically also provides custody and financing services. Look for a prime broker experienced with your target trading strategy, as the pricing, available services, and execution can differ depending on which broker you use.
  • A fund administrator to handle the accounting and back-office operations of your hedge fund. A fund administrator typically maintains the books and records of the fund, including reporting to the fund’s investors, calculating the fund’s net asset value; tracking investor contributions and withdrawals; determining the fund’s profit or loss for each period; computing management and performance fees.
  • Technology providers to assist with trading systems, infrastructure, hosting services, communications, business continuity, and disaster recovery are crucial. A cybersecurity provider is now also considered a critical partner.
  • A compliance consultant to make sure that you follow the applicable government regulations. Though you may not initially need to register as an investment adviser with the SEC, it is always prudent to adopt “best practices” at the onset of the fund.

Additionally, you may need to secure office space. These operational costs can run over $250,000 during the first year.

Registering with the Government

The registration requirements that apply to your hedge fund depend on its size. If you have less than $150 million in gross assets under management (AUM), you may only need to register with the state where your principal office is located. Once you approach the $150 million in gross AUM, then it is time to begin to get ready to register with the SEC.

Hiring Your Team

In addition to your third-party service providers, you should also consider how many employees you need to manage the fund, including your investment team, marketing staff, and administrative support.

If you plan to oversee the investments, your first hiring priority should be finding someone to assist with operations and administrative work; otherwise, you will be taking valuable time away from the investment process. A ratio of one or two support people for each investment professional is commonplace.

As most startup funds are conscious of costs, some are operated by the manager alone. While this might work initially, as the fund grows so do responsibilities. Larger investors will want to see a robust infrastructure including seeing all checks and balances in place.

You can lower your salary costs by outsourcing these roles. The tradeoff is that these professionals would not be fully dedicated to your fund and may not be available to you when needed.

When you are just starting out, your AUM-based fees may not be enough to cover your expenses. Your goal is to prove your investment ability by generating good returns and survive the first few years as you continue to build your fund. Launching a successful fund takes capital, a sharp investment plan, drive, and some good luck.

If you are considering starting a fund, have questions, or would like our assistance, please contact a member of Anchin’s Emerging Manager Platform or your Anchin Relationship Partner.