Setting Up An Investment Fund: A Us Guide

Setting up an investment fund in the US involves several steps, from defining your business strategy and creating a business plan to registering with the Securities and Exchange Commission (SEC) and state agencies, and raising capital. Here's a step-by-step guide to help you navigate the process:

1. Define Your Business Strategy:

Clearly outline your business and investment strategy, including the sectors or geographic regions you plan to target. This step involves thorough research to differentiate your fund from competitors and establish a unique value proposition for potential investors.

2. Create a Business Plan:

Develop a comprehensive business plan that includes cash flow projections, timelines for raising capital and exiting investments, and a strategy for fund growth. A solid business plan also incorporates a marketing plan to attract future investors and an executive summary that ties all the sections together.

3. Set Up Operations and Choose a Business Structure:

Establish an external team of consultants, including independent accountants, attorneys, and industry experts, to advise on your fund's operations. Choose a business structure, such as a limited partnership or a limited liability company (LLC), and register with the secretary of state in your chosen state. Don't forget to obtain an Employer Identification Number (EIN) from the Internal Revenue Service (IRS).

4. Register with the SEC and State Agencies:

Comply with regulatory requirements by registering your fund with the SEC and the relevant regulatory bodies in your state. This typically involves completing and submitting specific forms, such as Form D for registering the hedge fund offering. Additionally, ensure you register as an investment advisor and have your representatives do the same by passing the necessary exams, such as the Series 65 regulatory exam.

5. Comply with Consumer Protection Provisions:

Adhere to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which imposes registration and reporting requirements on hedge fund managers. Familiarize yourself with the laws of your home state regarding registration and licensing, especially if you manage less than $25 million in assets.

6. Establish a Fee Structure:

Determine the provisions related to management fees, carried interest, and hurdle rates for performance. Private equity managers typically receive an annual management fee of 2% of committed capital from investors.

7. Raise Capital:

Convincing others to invest in your fund is a critical and challenging step. Be prepared to invest your own money, as fund managers are often expected to contribute 1% to 3% of the fund's total capital commitments. Target institutional investors, such as insurance firms and pension programs, and accredited investors who meet specific income or net worth thresholds.

Define your business strategy

When defining your business strategy, the first step is to outline your business strategy and differentiate your financial plan from those of competitors and benchmarks. This requires significant research into a defined market or individual sector. For example, some funds focus on energy development, while others may focus on early-stage biotech companies.

You should also consider whether you will have a geographic focus. Will the fund focus on one region of the United States, or will it have a broader focus?

It is critical to determine the purpose of each investment. For instance, is the aim of the investment to grow capital for mergers and acquisitions activity, or is it to enable existing owners to sell their positions in the firm?

Your business strategy should also include a clear, replicable, and scalable investment strategy. It should not rely on certain policies or economic environments to succeed. Common hedge fund strategies include long/short equity positions on undervalued/overvalued stocks, merger arbitrage, buying distressed companies, and algorithm-driven quantitative approaches.

Write a business plan

Writing a business plan is a crucial step in setting up an investment fund in the US. Here is a detailed guide on what to include in your business plan:

Executive Summary

Begin your business plan with an executive summary, which provides an overview of your investment fund business. This section should clearly state the purpose and goals of your fund, including the investment strategies you plan to employ and the target market you aim to serve. It should also highlight the key strengths and competitive advantages that will contribute to the success of your fund.

Investment Strategy

Clearly articulate your investment strategy, including the specific sectors or industries you plan to target. Define whether your fund will focus on a particular region or country and the types of investments you will pursue. Explain the purpose of each investment, such as capital growth or facilitating the sale of existing owners' positions. It is important to note that private equity funds typically invest in companies that are not traded on the public market.

Financial Projections

Provide detailed financial projections for your investment fund. This includes calculating expected cash flows, establishing timelines for raising capital and exiting portfolio investments, and outlining the expected growth trajectory of the fund. Be sure to support your financial projections with robust analysis and assumptions.

Marketing Plan

Develop a comprehensive marketing plan to attract potential investors. Identify your target investor profile and outline the strategies you will use to reach them, such as networking events, conferences, or online platforms. Highlight any unique selling points or value propositions that will set your fund apart from competitors.

Operations and Team

Describe the operational aspects of your investment fund, including the external team of consultants, accountants, attorneys, and industry experts you plan to engage. Outline the roles and responsibilities of key personnel within your fund, such as the CEO, CFO, and chief compliance officer. Discuss any plans for establishing in-house operations, such as office space, technology requirements, and staffing considerations, including compensation and benefits.

Risk Management

Address the risks associated with your investment fund and outline your risk management strategies. Discuss the compliance and regulatory guidelines you will adhere to and any disaster recovery strategies you have in place to mitigate potential threats, such as cyberattacks or market downturns.

Remember to support your business plan with relevant data and industry research. Consult with legal and financial professionals to ensure your plan complies with the regulatory requirements specific to the jurisdiction in which you plan to operate.

Establish a legal structure

Establishing a legal structure for your investment fund is a critical step in the fund formation process. Here are the key steps to follow to set up a solid legal foundation for your fund:

• Choose the Right Structure: The first step is to choose the appropriate legal structure for your fund. In the United States, investment funds are typically structured as either limited partnerships (LPs) or limited liability companies (LLCs). LPs are the most common structure, where the fund manager is the general partner and the investors are limited partners. LLCs offer more flexibility, with the ability to designate different classes of ownership and customize management structures.
• Select a State for Incorporation: Different states have varying laws and regulations regarding investment funds. Delaware is a popular choice due to its business-friendly laws, but other states like Wyoming and Nevada have also introduced business-friendly provisions. Consult with legal professionals to determine the best state for your fund's specific needs.
• File Articles of Incorporation: Once you've chosen the legal structure and the state for incorporation, you'll need to file the articles of incorporation with the secretary of state in your chosen state. This process typically involves registering your fund's name and providing information about the fund's structure, purpose, and management.
• Obtain a Federal Employer Identification Number (FEIN): Apply for a Federal Employer Identification Number (FEIN) from the Internal Revenue Service (IRS). This is a unique identifier for your fund and is necessary for tax purposes and other regulatory compliance requirements.
• Draft Corporate Bylaws: Create comprehensive corporate bylaws that outline the fund's mission, compliance guidelines, code of conduct, supervisory procedures, and portfolio management agreements. These documents are crucial for ensuring the smooth operation of your fund and maintaining compliance with relevant regulations.
• Register with the Securities and Exchange Commission (SEC): If your fund meets certain criteria, such as having a certain number of investors or assets under management, you may need to register with the SEC. Consult with legal professionals to determine if your fund is subject to SEC registration requirements.
• Comply with State Regulations: In addition to federal regulations, your fund must also comply with the regulations of the state in which it is incorporated. This may include registering with the state's regulatory bodies and adhering to specific investment advisor laws and consumer protection provisions.
• Consult Legal Professionals: Throughout the process, engage the services of experienced legal professionals who specialize in investment fund formation. They can guide you through the complex regulatory landscape, ensure compliance with applicable laws, and help you avoid costly mistakes.

Determine a fee structure

Setting up an investment fund in the US requires determining a fee structure, which outlines the expenses that investors will incur when investing in the fund. Here are some key considerations for determining the fee structure:

Management Fees

Private equity and hedge fund managers often charge an annual management fee, typically ranging from 1% to 2% of the committed capital or assets under management. Less experienced fund managers may receive a smaller management fee to attract new investors. These fees are usually paid monthly or quarterly and cover the operational costs of running the fund.

Performance Fees

In addition to management fees, fund managers often charge a performance fee, also known as carried interest or incentive fee. This fee is calculated as a percentage of the fund's profits, typically ranging from 20% to 30%. The performance fee rewards the fund manager for generating positive returns and aligns their interests with those of the investors.

Hurdle Rate

The hurdle rate is an important component of the fee structure. It refers to a predetermined return threshold that the fund must exceed before the fund manager is eligible for the performance fee. For example, if the hurdle rate is set at 5%, the fund manager will only receive the performance fee if the fund generates returns above this threshold.

Negotiation and Variations

The fee structure is not set in stone and can be negotiated, especially for new fund managers trying to attract seed investors during the fund formation. Alternative fee arrangements may include incentive hurdles, triggers, clawbacks, and modified highwater marks. It is important to seek legal advice when determining the fee structure to ensure compliance with regulations and to protect the interests of both the fund managers and investors.

Regulatory Compliance

When establishing the fee structure, it is crucial to comply with regulatory requirements. In the US, investment funds must adhere to the regulations set forth by the Securities and Exchange Commission (SEC) and state-specific laws. Proper registration, disclosure, and reporting are essential to avoid legal issues and maintain a transparent relationship with investors.

Raise capital

Raising capital is often the most challenging step in starting an investment fund. Fund managers will be expected to contribute between 1% and 3% of the fund's capital. For example, if a fund manager has a $10 million target, they will need to provide at least $100,000 to $300,000 of their own money.

There are several sources of capital for investment funds, each with its own requirements and challenges. Here are some options to consider:

• Institutional investors: These include insurance firms, sovereign wealth funds, financial institutions, pension programs, and university endowments. They typically have strict requirements and conduct extensive due diligence before investing. It is crucial to have a solid track record and a well-thought-out investment strategy when approaching these investors.
• Accredited investors: These are individuals who meet specific criteria, such as having a certain annual income or a high net worth. They are often high-net-worth individuals or sophisticated investors who understand the risks involved in investing in alternative investments. Networking and building relationships with potential accredited investors are essential.
• Family offices: This approach involves pooling money from family members or friends to start the fund. It can be a good option for those with a strong personal network and the ability to raise significant capital from within their circle.
• High-net-worth individuals (HNWIs): These individuals have a substantial amount of investable or liquid assets, typically $1 million or more. Building a network of HNWIs can be challenging but can provide access to significant capital.
• Incubators or accelerators: Hedge fund incubators or accelerators can provide support and resources to help new fund managers get started. They may offer mentorship, office space, and access to potential investors. However, it is important to note that the competition for these programs can be fierce, and they may take a portion of the fund's profits in exchange for their services.
• External investors: Approaching external investors, such as endowments, pension funds, family offices, or high-net-worth individuals, requires a well-crafted pitch and a solid investment strategy. It is crucial to have a clear and scalable strategy, a strong track record, and a compelling story to attract these investors.

When raising capital, it is essential to have a well-defined investment strategy, a solid track record, and a professional team in place. Building relationships and networking are crucial, as most investment opportunities come through personal connections. It is also important to be personable and demonstrate strong character, as institutional investors often place significant weight on these factors. Additionally, be prepared for a lengthy process, as raising capital can take several meetings and pitches to secure commitments from investors.

Frequently asked questions