a guide to establishing a hedge fund 2009

8/4/2019 A Guide to Establishing a Hedge Fund 2009

1/44

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A Guide to Establishing a Hedge Fund


2/442 A Guide tO estAblishinG A hedGe Fund

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3/44A Guide tO estAblishinG A hedGe Fund 3

excv smmary

Owning and operating a successul hedge und can be both personally and inancially rewarding. However,

launching a hedge und can be a challenging and sometimes overwhelming experience. How should you

structure your business? What service providers do you need? What do you need to do irst?

Fortunately, you need not ace these decisions alone. Pershing Prime Services tapped into our wide network o

industry experts, in-house expertise, and extensive experience working with businesses like yours, to oer you a

ramework o practical options, knowledge, and resources to help you make inormed business decisions.

Tis guidebook addresses the key areas that every hedge und manager should consider:

>Legal and tax considerations. A number o decisions must be made beore a hedge und can be successully

launched. First and oremost is your unds strategy. While this guidebook will not help you pick a strategy,

it will give you the necessary ramework o a hedge unds ormation by providing relevant inormation on

the key legal and tax inormation aecting hedge unds. Stark & Stark, Attorneys at Law, walks you through

the legal landscape, and Sasserath & Zoraian LLP provides an overview o the tax environment and other

necessary considerations.>Technology. In todays nancial services industry, technology plays a major role in dening a rms

capabilities. I you previously worked in a larger, ull service organization, you may have been constrained

by the choices made by a separate inormation technology (I) department. Now that you will make these

decisions or yoursel, you are ree to build a technology environment that supports your own personal

business vision. With that reedom, o course, comes the responsibility or every decision, including

technology outsourcing, purchases, development, maintenance, and enhancements. EzeCastle Integration,

Inc. discusses your rms technological building blocks: the systems, processes, and tools available and

necessary or organizing the workow within your rm. echnology experts weigh in on the decision-

making process or selecting the most appropriate options.

>Service providers. Tird-party service providers will play a major role in your hedge unds success. Tissection provides you with inormation about the service providers typically used by hedge unds and oers a

process that can be used in the selection process or your new und.

>Human resources. Tere are a number o human resources considerations to keep in mind as you prepare to

launch and operate your new hedge und. Generally, the single largest expense category or a und relates to

compensation or the individuals operating it. Tis section includes inormation on compensation and some

o the associated costs, such as benet packages and equipment allocated per sta member.

>Insurance. Beore beginning any work to establish your und, it is necessary to address all the business

insurance requirements that hedge your business risk. Tere are dierent types o business insurance and

protection you will need to procure to minimize business risk and protect your personal and business assets,

and this section walks you through some options you should consider.

>Operational infrastructure. For a single-strategy und with limited sta, the operations o the rm are

relatively straightorward, as the manager is typically responsible or every task. A thoughtul approach to

the structure o your operations will help you establish the most productive relationship with your service

providers and maximize the time you have available or managing your und. Tis section also covers

the decisions involved in nding the right physical location or your new rm, common types o leasing

arrangements available, ways to best estimate the amount o ofce space to meet your specic needs, and

describes how to maximize the time you have available or managing the und.



>Capital. he single largest component o success in the hedge und industry is the ability to raise capital. It

will take a plan that ocuses on how capital will be raised and how perormance will be recorded to

successully establish and grow your und. Even with solid preparation, many managers ind it diicult to

survive the irst ew years o operation. Prudent managers will take steps to ensure that they will have the

longevity to realize the results o their labor and investment. his section provides an outline or

ormulating your own capital-raising strategy.

Tis guidebook is meant to help you understand many o the issues you will ace as you strike out on your

own. Not every issue presented in this guidebook will be applicable to your unique situation, and may not be

as complexor as simpleas discussed. Our goal is to share dierent considerations and provide a reerence

as you work through your hedge unds start-up phase, and to help you address key questions including:

>What is my investment strategy? You have probably been thinking about this or some time; however,

establishing your new unds investment strategy is the rst step toward the ultimate launch. Your strategy

will aect many o the other decisions you will ace as you build your rm.

>Do I have a marketing plan? In its most basic orm, your marketing plan should identiy who will be

raising capital to invest in the und and how it will be raised. Tis responsibility could all on you or yourpartners, or you may seek outside assistance; however, capital, above all else, is what is needed or a und to

be successul.

>Do I have sufficient resources to fund my new business during start-up? he process o establishing your

hedge und, creating the inrastructure o your own irm, and executing your irst trade can take up to 16

weeks or more. Pershing Prime Services developed the Hedge Fund Start-Up Simulator to provide you with

detailed inormation about the inrastructure and inancial workings o a hedge undincluding how the

allocation o resources and other initial planning decisions may aect the viability o your start-up hedge

und. During the start-up phase, you will be investing time and money in your new und, so it is crucial to

careully assess i you have enough to sustain you through this period o growth and development.

Answering these questions will lay the oundation or how you select the structure, sta, and systems or yourhedge und. It will rame the business decisions you make going orward, ensure that you remain on track to

achieve eicient implementation, and create a irm that ulills your hopes or personal and proessional success.

I you would like to explore any o the topics covered in this guidebook in greater depth, or or a copy o our

Hedge Fund Start-Up Simulator, please contact Pershing Prime Services by emailing primeservices@pershing.

com or by calling (866) 538-5046.



lga a tax Ovrvw eag Yor F

he decision and commitment to establish a hedge und puts you on a path on which your choices will

largely determine your level o proessional success. Along with the reedom to pursue this level o success

comes a host o decisions and responsibilities. he irst decisions that must be made are not about the legal

structure o your irm or inding someone to ask or help. hey are about making a decided commitmentto the unds success, developing a thoroughly vetted and articulated investment strategy, and creating a

ramework or how capital will be raised.

With the appropriate groundwork already having been laid, the process or starting the hedge und is airly

linear in nature. Completing the irst steps logically leads to the next decisions to be made. he start-up

timeline on the ollowing pages shows the general process and timing o key milestones in the launch o a

hedge und. While the actual time to complete each step may vary, it is important to know that none o

them will happen overnight. You will need to identiy and select numerous service providersa lawyer, an

accountant, an administrator, and a prime brokerbeore an inrastructure can be built, capital raised, and

the und launched.

As the manager o a und, you will be responsible or both the technical aspects o managing the und, as well

as all o the business aspects o owning the management company. hroughout this guidebook, you will be

prompted to consider the business issues, in addition to the technical aspects, which are critically important

to the success o your und.

During the typical start-up period or a newly launched hedge und, which is approximately 16 weeks in the

projected timeline, signiicant time and money must be committed to getting the und up and running. It is

important or you and any potential partners to be prepared to be expending both while not generating any

revenue, at least until the launch; it is also likely that you will not be generating any signiicant revenue or

the unds irst year or two o operation. he better prepared you are in understanding the process and

managing expectations, the greater your chance o success.

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lga Ovrvw

here are a number o legal considerations that should be taken into account when deciding how to best

structure a und. hese include who can invest in the und, how it is marketed to potential investors, and

how compliance with applicable laws is maintained throughout the entire process. he ollowing overview

o the hedge und legal landscape has been prepared by Stark & Stark, Attorneys at Law.

Formao

he ormation o a private equity und requires a consideration o the nature o the business operations and

investments in which the proposed und intends to invest. Most private equity unds are set up as general

partnerships with a limited liability company (an LLC) installed as the general partner (although some

orm two LLCs, with one LLC acting as the managing member o the other). A general partnership is commonly

known to be the better corporate structure. While an operating agreement will allow you to deine the operation

largely as you wishto the extent an item is let undeinedstatute will deine it or you. Partnership

statutes deine a considerably lesser number o items, so the und is ar more unlikely to have a solution

imposed on it by statute. More eort is also needed to deine the ownership status o the managing member.

Once you have determined the type o vehicle, the next step is to orm the entities and have an operating

agreement created or the LLC and a limited partnership agreement drated or the investment vehicle. he

limited partnership agreement deines what the partnership can and cannot do. All the relevant control,

operations, and ees are deined by the limited partnership agreement. Consultation with counsel concerning

the precise nature o the und, its investment strategy and ee structure, the admissions and withdrawals o

members, and management o the und are crucial at this early stage. At this time, the oering documents

can also be prepared. he operating agreement sets orth the operation and duties o the general partner.

Once the limited partnership agreement and operating agreement are prepared, the incorporation process can

take place, and counsel can orm the entities in the preerred state. Delaware is most oten chosen because o

its avorable legal and judicial structure.

When the entities are ormed, preparation o the materials or the oering can begin in earnest. ypically, the

oering o the und is done through the preparation o a private placement memorandum and a subscription

agreement. he private placement memorandum describes the oering, the strategy o the und, the

minimum investment amounts, the background o the individuals involved, and summarizes the limited

partnership agreement or operating agreement. he private placement memorandum also contains the

description o the risks o the investment, which is vitally important to the oering documents. Full

disclosure o the risks is necessary in order to comply with the antiraud provisions o securities laws and

as a protection against litigation in the event the und is unsuccessul.

t Org Proche marketing o interests in the equity und is considered a securities oering and is governed by the

Securities Act o 1933 (the 1933 Act). Additionally, the Investment Company Act o 1940 (the Company

Act) is also implicated because o an equity unds nature as a company to manage investments. Fortunately,

both have registration exemptions, although the exemptions do not ree you rom the antiraud provisions o

the 1933 Act. Lastly, the Investment Advisers Act o 1940 (the Advisers Act) is implicated where there is a

consideration o the kind o ees that may be charged.



In order to avoid registration under the Company Act, the und must not exceed 100 investors. here is a

registration exemption pursuant to Section 3 o the Company Act or all investment companies that have 100

or ewer investors. Because registration is costly and makes operation more expensive and diicult, registration

is generally not preerred. Accordingly, no more than 100 investors should be allowed into the und.

Avoiding the limit o 100 investors cannot be done by closing the und to new investors while simultaneouslyopening a new und that is identical to the irst and having new investors invest in the new und. In that

event, the U.S. Securities and Exchange Commission (SEC) will likely take the position that the second und

was ormed solely or the purpose o avoiding registration under the Company Act and integrate them, or

treat both entities as one. he und will then be above the investor limit and you may be charged with the

sale and operation o an unregistered investment company without an appropriate exemption. Such a charge

can lead to signiicant penalties, which makes it vital that, i multiple unds are being operated, the unds

investment strategies are not identical.

> The Securities Act of 1933: full and fair disclosure. he provisions o the 1933 Act require that the

documents oering the und ully and airly disclose all material inormation about the documents,

including the risks. Failure to disclose all material inormation, or to leave out inormation that would

make the oering documents misleading, is considered a violation o Section 12 o the 1933 Act, which

carries severe civil and criminal penalties. Disclosure o more, rather than less, inormation is usually

advisable, especially negative inormation. A private placement memorandum should be prepared, which

details all the material disclosures required. he private placement memorandum will describe the

background o the individuals charged with und operations, the investment strategy, the ee structure,

withdrawal provisions, a description o the limited partnership agreement, certain tax considerations, and

implications o the Employee Retirement Income Security Act o 1974 (ERISA), and, most importantly,

ull disclosure o the risks vital or adequate protection in the event the und is not successul.

> The Securities Act of 1933: antifraud provisions. here are two considerations that relate to the 1933 Act.

First, the und is required to conorm to the antiraud provisions o Section 12, even i it is oered

pursuant to an exemption rom registration. hereore, ull and air disclosure o all material inormation

is required. It is vitally important that the risks o loss be ully and completely described as part o these

disclosures, as such disclosures provide signiicant protection rom liability in the event the und is not

successul. Most oering memoranda have a signiicant number o risk actors listed or that reason.

Speciically, Section 12(2) o the 1933 Act makes an oer absolutely, civilly liable or the oer or sale

o a security, whether or not exempt, using statements or oering documents that include an untrue

statement o a material act or omits to state a material act necessary to make the statements, in light

o the circumstances under which they were made, not misleading . . . Risk actors are considered acts

necessary to ensure that the more positive statements are not misleading.

In general, a greater disclosure o investment risks is always preerred to ensure compliance with Section 12

o the 1933 Act and, thereore, protect against potential liability. Accordingly, in addition to a descriptiono the positive aspects o the und, its strategy, and its management, negative acts through risk actors

should be disclosed.



> The Securities Act of 1933: registration requirement. Te second aspect o the 1933 Act, which implicates

the und, is the requirement that securities oerings, unless exempt, must be registered. Te SEC has

promulgated Registration D, which is an exemption rom the registration that is applicable to most private

equity unds. Te ailure to register the und or comply with the Regulation D exemption requirements can

carry signicant penalties. Regulation D provides an exemption rom registration or private placement

oerings, though this is subject to certain conditions. Oerings pursuant to Regulation D have relevantinvestor criteria designed to ensure that the investor is sophisticated enough to evaluate the investment or,

i not, that the investor has assistance in such evaluation. Oerings to investors deemed to be sufciently

sophisticated or accredited have no limits on the number o investors, though the Company Act limits

still apply. Accredited investors, as dened in Rule 501, are, in general, wealthy individuals or nancially

sophisticated entities such as banks. Specically, accredited investors are dened as ollows:

>(1) Any bank as dened in Section 3(a)(2) o the Act, or any savings and loan association or other institution

as dened in Section 3(a)(5)(A) o the Act, whether acting in its individual or duciary capacity; any

broker or dealer registered pursuant to Section 15 o the Securities Exchange Act o 1934; any insurance

company registered under the Investment Company Act o 1940 or a business development company

as dened in Section 2(a)(48) o that Act; any Small Business Investment Company licensed by theU.S. Small Business Administration under Section 301(c) or (d) o the Small Business Investment Act

o 1958; any plan established and maintained by a state, its political subdivisions, or the benets o its

employees, i such plan has total assets in excess o $5 million; any employee benet plan within the

meaning o the Employee Retirement Income Security Act o 1974, i the investment decision is made

by a plan duciary, as dened in Section 3(21) o such Act, which is either a bank, savings and loan

association, insurance company, or registered investment adviser, or i the employee benet plan has total

assets in excess o $5 million, or, i a sel-directed plan, with investment decisions made solely by persons

that are accredited investors;

>(2) Any private business development company as dened in Section 202(a)(22) o the Investment Advisers

Act o 1940;

>(3) Any organization described in Section 501(c)(3) o the Internal Revenue Code, corporation,

Massachusetts or similar business trust, or partnership, not ormed or the specic purpose o acquiring

the securities oered, with total assets in excess o $5 million;

>(4) Any director, executive ofcer, or general partner o the issuer o the securities being oered or sold, or

any director, executive ofcer, or general partner o a general partner o that issuer;

>(5) Any natural person whose individual net worth, or joint net worth with that persons spouse, at the time

o his purchase exceeds $1 million;

>(6) Any natural person who had an individual income in excess o $200,000 in each o the two most recent

years or joint income with that persons spouse in excess o $300,000 in each o those years and has a

reasonable expectation o reaching the same income level in the current year;

(7) Any trust, with total assets in excess o $5 million, not ormed or the specic purpose o acquiring the

securities oered, whose purchase is directed by a sophisticated person as described in Rule 206(b)(2)(ii); and

(8) Any entity in which all o the equity owners are accredited investors.



here is a limit o 35 nonaccredited investorsthose who do not meet the above deinition o accredited

investor. It is advisable that such nonaccredited investors have an investment advisor. Although Regulation D

does not speciically mandate an investment advisor, it contemplates one with an explicit description o what

one is and its purpose. Such advisors can go a long way toward meeting the burden o demonstrating that the

Regulation D exemption is appropriate.

It is the unds obligation to demonstrate compliance with the requirements o Regulation D, including

a demonstration that the investors are either accredited, have an advisor, or meet the requirements o

sophistication. Accordingly, an investor questionnaire is generally provided to a prospective investor and,

generally, the und requires the investor to ill it out. In other subscription documents, which are usually also

provided and required to be signed, the investor attests that the inormation he or she is providing is truthul,

that he or she has read the oering materials and is not relying on anything other than those materials, and

understands the risks o the oer. It is essential that such a document be provided, illed out, and signed by

investors. Within 15 days o the irst sale, the und must ile the registration materials and a Form D with

the SEC, as well as other documents and ees speciied in blue sky statutes, within the state o residence o

each investor.

Each state has its own securities laws, which must be complied with when selling to residents o that state.

Although each state has dierent requirements that should be researched prior to any actions, the relevant

department o the state government generally requires a iling o Form D, a Uniorm Consent to Service o

Process (or Form U-2), and a iling ee.

> The Advisers Act: investor criteria. Te Advisers Act also identies who can invest in the und, depending

upon the ee structure o the oering. Where there is solely a management ee charged, the prescriptions o

Regulation D are the only investor criteria that apply. However, where there is a perormance ee, a special

allocation ee, or a general ee tied to the perormance o the und, the Advisers Act requires that sales be

made only to a qualied client or investor. As dened in Rule 205-3 o the SEC, a qualied client is:

>(i.) A natural person who or a company that immediately ater entering into the contract has at least$750,000 under the management o the investment adviser;

>(ii.) A natural person who or a company that the investment adviser entering into the contract (and any

person acting on his behal) reasonably believes, immediately prior to entering into the contract, either:

> (ii.) (A) Has a net worth (together, in the case o a natural person, with assets held jointly with a spouse) o

more than $1.5 million at the time the contract is entered into; or

> (ii.) (B) Is a qualied purchaser as dened in Section 2(a)(51)(A) o the Investment Company Act o 1940

at the time the contract is entered into; or

>(iii.) A natural person who immediately prior to entering into the contract is:

> (iii.) (A) An executive ofcer, director, trustee, general partner, or person serving in a similar capacity, o the

investment adviser; or

> (iii.) (B) An employee o the investment adviser (other than an employee perorming solely clerical,

secretarial, or administrative unctions with regard to the investment adviser) who, in connection

with his or her regular unctions or duties, participates in the investment activities o such

investment adviser, provided that such employee has been perorming such unctions and duties

or or on behal o the investment adviser, or substantially similar unctions or duties or or on

behal o another company or at least 12 months.



eRisA Corao

Accordingly, when determining the ee structure, it is vital that you consider the nature o your investors.

Small investors will restrict the ees charged and may make it impossible to oer the und to a potential

investor. Although the und may be marketed to an (IRAs) pension unds and other ERISA pension vehicles

(ERISA unds), there can be substantial issues with accepting more than a small amount o such investors.

ERISA contains an exemption rom its provisions or unds that have less than 25% o their assets as ERISA

unds. I the und exceeds such amounts or more than 14 days, the und must ollow the enhanced duties and

restrictions required by ERISA and the Department o Labor (DOL), the agency charged with enorcing ERISA.

ERISA contains restrictions on the ability o the general partner to receive compensation, engage in transactions,

compensate sister entities, or engage in certain trading activities, such as block trades. Although, the DOL at

one time severely restricted the ability to charge perormance ees, it has taken a more exible approach over the

past two decades. Perormance ees are allowed where:

> Te perormance-based ee ormula takes into account both realized and unrealized gains and losses during a

pre-established measurement period;

> Te decision to enter into the perormance-based ee arrangement is made by an ERISA duciary who isindependent o the investment manager;

> Te ee arrangement complies with the securities laws governing perormance-based compensation arrangements;

> I the clients portolio contains assets or which market quotations are not readily available, the assets are

valued by a person who is independent o the investment manager and who is appointed and, i necessary,

replaced only by the pension plan; and

> he arrangements involve sophisticated investors having aggregate assets o at least $50 million.

Similarly, to the extent that any sister entity is providing services to the und, ERISA prohibits the general

partner or its managing member irm rom receiving any compensation rom the activities o the und. ERISA

also restricts the ability o the und to cross-trade, or move securities rom one und to another. Otherunds are managed by the same investment manager to certain very limited circumstances and transactions

and require no commissions or compensation to be paid in such cross-trades. he DOL also reserves the right

to inspect the operation o the und to ensure compliance with ERISA.

In general, most unds seek to avoid the strictures o ERISA and stay under the 25% threshold, unless the

intent o the und is speciically tailored to the ERISA unds market and intends to operate under ERISA

provisions under all circumstances, no matter the nature o the investor.

A-Moy larg Compac

You must also comply with anti-money laundering statutes. Under these statutes, the issuer is charged with

having suicient knowledge o the investor to ensure that the customer is not laundering money. Becauseprivate equity unds investments are illiquid, they are considered under the statutes to be low-risk endeavors

or money laundering activity. Nonetheless, the issuer must take steps to ensure that the investors identity is

veriied. In general, some orm o government-issued identiication, such as a drivers license or passport, will

suice to comply with such laws.



Oor F

Funds are requently created in certain oshore locations that have tax and privacy advantages. When setting

up an oshore und, it is important to choose a location that has a suiciently stable government and a

regulatory structure that is rigorous enough to provide comort to investors, yet lexible enough to be able to

operate on a day-to-day basis. It is also important that the location have an adequate amount o inancial and

legal service providers to implement the und. ypical locations include the Cayman Islands, the British

Virgin Islands, and Bermuda; Ireland and the Netherlands Antilles are also used.

he corporate structure o an oshore und somewhat diers rom a U.S. und in that the location statutes

generally avor other corporate orms or do not have the typical U.S. corporate orms at allor example, an

exempted investment company issued in the Cayman Islands or an international business corporation in the

British Virgin Islands. Unlike a U.S. und, an oshore und usually contracts with an investment manager

located in its jurisdiction, who, in turn, typically contracts with a U.S.-based subadvisor to manage the unds

assets. he day-to-day administration o the activities is handled by the oshore investment manager.

Oshore unds may be marketed in the United States, but care must be taken to ensure that the unds

activities, beyond the oering, remain oshore, so as not to trigger U.S. laws beyond Regulation S, whichprovides a sae harbor provided that the securities come to rest outside the United States. Resale is similarly

restricted with Regulation D as discussed earlier.

Each location also has its own anti-money laundering statutes that come into play or unds, most o which

involve the know your customer types o rules. Money laundering issues in the current environment have

taken on a greater lie, and procedures should be in place to be able to discern the nature o the client.

Care must be taken to ensure that corporate structures are ollowed to maintain the unds oshore status.

Oshore unds are primarily o interest to high-net-worth investors who have, or wish to have, assets outside

United States jurisdiction. Frequently, there are tax implications to those who invest in oshore unds, and

the oshore nature o the und must be preserved in order to protect investors and the und. hereore, the

oshore investment manager should be used in all transactions and not be ignored. Failure to ollow proper

procedures could create substantial issues or the und and investor.

F Oprao

he limited partnership agreement deines the unds operation and structure. he procedures set orth in the

operating agreement should be ollowed. ypically, partnership agreements require quarterly reporting o the

unds proitability to the limited partner, as well as a year-end audited report. hese provisions should always

be ollowed. In the event that the general partner wishes to change the unds investment strategy, partnership

agreements generally allow or such a change without approval. However, investors must be inormed o such

a change in order to avoid a claim under the 1933 Act that the oering materials were alse and misleading

with regard to the description o the investment strategy. he und should have a reputable accountant oraccounting irm calculate and maintain the capital accounts o each investor. Such individual account

inormation should be included in the inancial reports. Care must also be taken to ensure that the und

remains below the 25% threshold previously described or ERISA unds. ERISA allows a window o 14 days

to correct an inadvertent crossing o the 25% threshold. Accordingly, it is vital to monitor the percentage o

ERISA unds under management to avoid the ERISA strictures and, i needed, change the investor makeup to

comply. Generally, it is not advisable to cross the 25% threshold. Fees should only be paid in compliance

with both the amount and timing procedures set orth in the limited partnership.



he general partner has a iduciary duty to the und and its investors. hat duty generally requires the general

partner to act in the best interests o the und and its investors, even i it is to its detriment. Investment

advisors and brokers are generally aware o and comortable with this duty, as they owe the same or similar

obligations to their clients.

tax Corao

A number o tax issues relate to the ormation o your hedge und. Some o the general tax considerations are the

selection o the type o entity to be used; state and local tax implications; tax basics; and the taxability and

deductibility o beneits, management compensation, and income allocation. he ollowing inormation regarding

the tax considerations associated with launching your hedge und has been authored by Sasserath & Zoraian LLP.

F srcr

Your attorney will walk you through the choices that exist; however, an early decision you will make is who

you are targeting as investorspeople residing in the United States or residents o oreign countries? his

decision will impact how your und is organized.

> Onshore fund. For investors residing in the United States, an onshore und is usually organized as a limited

partnership. By purchasing an interest in the partnership, an investor becomes a limited partner o the partnership.

> Offshore fund. An oshore und is organized to acilitate investments o capital rom investors residing

outside the United States. Oshore unds are typically organized in two ways:

> Master feeder. Tis structure allows both investors residing in the United States and investors residing

oshore to indirectly invest in the same oshore corporate entity commonly known as the master und.

Onshore and oshore eeders are used to invest assets in the master und.

> Side-by-side. In a side-by-side structure, U.S. investors typically invest in a limited partnership organized

in the United States and oshore investors invest in an oshore corporation. Te prime broker typicallyallocates trade tickets between the domestic und and the oshore und.

ey sco

he entities that are normally ormed to start a hedge und are the entity or the investment vehicle and the

entity(ies) or the management company(ies). hese entities may be organized as a limited liability company,

a C corporation, an S corporation, a general partnership, or a limited partnership.

In order to choose which entity will work best or your unds investment vehicle and which entity will work

best or the management company(ies), you must irst understand the characteristics o each type o entity.

he section below highlights some o the characteristics o each type o entity:

> Limited Liability Company (LLC)

> Limited liability or all members

> Single level o taxation

> No limitation on number o owners

> No limitation as to type o owners (i.e., entity or individual permitted) or citizenship o owners

> Income and loss allocation exibility (i.e., special allocations as dened below are permitted)



> Sel-employment (payroll) tax on the distributive share o ordinary income applicable to active members

> No single class o membership requirement

> ax-ree distribution o appreciated property (subject to certain limitations)

> ax-ree liquidations (subject to certain limitations)

> C Corporation

> Limited liability or all shareholders

> wo levels o taxation



> No income or loss allocations to owners

> Payroll taxes applicable to shareholders and employees that receive salaries

> No single class o stock requirement

> axable distribution o appreciated property at the corporate and individual levels

> axable liquidations

> S Corporation

> Limited liability or all shareholders

> Generally a single level o taxation

> 100-shareholder ownership limitation

> Ownership limit to U.S. citizens, resident aliens, or certain types o estates or trusts

> Limitations on income and loss allocations and distributions, which must be in proportion to each

shareholders interest in the S corporation (i.e., special allocations as dened below are not permitted)

> Payroll taxes applicable to shareholders and employees that receive salaries

> Single class o stock requirement

> axable distribution o appreciated property at the corporate and individual levels

> axable liquidations

> General Partnership

> Unlimited liability or all members





> Sel-employment (payroll) tax on the distributive share o ordinary income applicable to active members

> No single class o ownership requirement





> Limited Partnership

> Unlimited liability or general partners, limited liability or limited partners





> Sel-employment (payroll) tax on the distributive share o ordinary income applicable to general partners

> No single class o ownership requirement



Generally, state and local taxation rules ollow ederal taxation rules, except in New York City, which does not

recognize low-through entities. Accordingly, i the management o your hedge und is located in New York

City, there are separate planning ideas to minimize local entity taxes. hese are discussed in more detail below.

Entities with a single level o taxation generally have no tax liability at the entity level. All o the income, loss,

deduction, and credit items low through the owners o the entity either in their ownership percentage or, i

permitted and agreed to within the entity operating agreement, in a percentage other than their ownership

percentage, also known as a special allocation.

With a single level o taxation, low-through income retains its character at the entity level. Accordingly, i there

is a long-term capital gain at the entity level, such a gain will be reported to the owners as a long-term capital

gain. he rule also applies to ordinary income, short-term capital gain, and investment interest expense.

Beneits paid by the management company(ies) to the owner and employee are treated similarly to the

beneits paid by any company to their owners or employees. Accordingly, retirement plans, health insurance

plans, and other beneit plans paid by the management company(ies) must comply with IRS and DOL rules

and regulations. Generally, as long as the plan covers all employees o the management company(ies), a

deduction will be permitted at the entity level and the owner and employee will not have to pay taxes on

beneits. Owners and employees may be limited in the beneits they are permitted to receive rom a plan

depending on the type o plan.

Investment vehicles are typically organized as limited partnerships or the single level o taxation, limited

liability or the limited partners, no limitation as to the type or citizenship o the partners, and permission ospecial allocations. he only other permissible entity that could accommodate all o these characteristics is the

LLC, though it is not normally chosen.



In a situation in which there are one or more management companies, separate entities are typically set up to

receive the management ee and the incentive reallocation. For the most part, ederal or state tax beneits

cannot be gained rom orming separate companies or the management and incentive reallocations. However,

because New York City generally does not recognize low-through entities, there is a local tax beneit to

having separate entities or management companies that are doing business in New York City.

Management companies are typically organized as LLCs or the single level o taxation, limited liability to the

members, no limitation as to the type or citizenship o owners, permission o special allocations, and no single class

o membership requirement. Additionally, in the event that, in the uture, the members o the company(ies) decide

to change rom this entity, the liquidation o this entity is tax-ree, though subject to certain limitations.

While some o the attributes stated above may be eected by using other entities, there are drawbacks to

doing so. For example, i a C corporation was ormed as the management company, special allocations

could be eected by adjusting the salaries o the shareholders and employees. However, the IRS could deem

such salary adjustments as excessive salaries.

As mentioned above, manager compensation takes two orms: the management ee and the incentive

reallocation. he management ee is a ee paid to a management company, typically 1%2% o the assetscalculated on a monthly or quarterly basis. his ee is used by the management company to cover normal

operating expenses.

Incentive reallocation is not a ee, it is a reallocation o the proits rom the investment vehicle. Accordingly,

the items o income, loss, deduction, and credit retain their character. his incentive reallocation is typically

20% o the proits derived rom the investment vehicle and is reallocated to the general partner o the

investment vehicle. his treatment is generally advantageous to both the investor and general partner.

Neither the Internal Revenue Code (IRC) nor its regulations mandate a speciic method or hedge unds to

allocate proits or losses to their investors. Generally, any reasonable approach that is consistent with the

partnership rules is permitted. However, once an approach is adopted, your und should be consistent withthe allocation methodology rom year to year.

he aorementioned are the tax considerations that all hedge unds ace. Below is a discussion o other

considerations that your particular hedge und may or may not need to address.

Or tax Corao

> IRC Section 475: election. It may be advantageous or certain hedge unds to make an election under IRC

Section 475. Such an election causes all gains and losses rom securities and securities held at year-end to be

marked to market, and gain or loss, as ordinary. Funds that could beneit rom this election are unds that

do not expect to generate much in the way o long-term capital gains. Also, volatile unds would generate

ordinary losses in the years in which they created a loss, rather than capital losses that may or may not beable to be deducted by partners.

> Offshore funds: entity choice. With oshore unds, the choice o entity question is more complex

depending on whether there are taxable or tax-exempt U.S. persons involved. In this case, your und would

most likely be a oreign corporate vehicle or oshore investors that require anonymity and reedom rom

making U.S. tax ilings.



Cck lga a tax Ovrvw

Evaluate whether you have enough capital to sustain you through the unds start-up phase.

Create a timeline o events leading up to the launch o the und.

Identiy your strategy and target investors.

Have an attorney drat your legal documents.

Have your accountant review the documents prepared by your attorney.

tcoogy Corao

Establishing a reliable, available, and secure technology core is essential or a hedge und to become successul.

he speciic technology required or a irm varies depending on the applications used, what the und does,

and how it operates. here are a ew basic technology requirements that all unds must consider when starting

up: inrastructure, data protection, voice services, and archiving.

A solid network inrastructure must be created in order to carry the valuable inormation that a und uses ona daily basis. A business continuity plan and a corresponding disaster recovery system have become essential

in todays marketplace, with investors looking or unds to demonstrate how they will be able to maintain

operations regardless o external events. A voice communications system must be created to support the

valuable communication that takes place within the und. Finally, email and instant message archiving to

guard against loss o inormation are both required rom a legal standpoint. Having transactions archived will

make it possible to reer back to what speciically took place and answer any questions that might arise. o

meet this need, many unds lease space in collocation data centers, which host their hardware and sotware in

an osite acility, providing necessary bandwidth and increased protection.

irarcr

Security is undamental when considering a unds technology setup and network inrastructure. A multi-

tiered security approach is essential to protecting the critical inormation that passes through the system every

day. I outsourcing I, the manager should veriy that the provider is considering the security o its data

center and hosting environment. he site should maintain physical security, cages, and 24/7 monitoring, as

well as technical security, cameras, and digital monitoring. he data center needs suicient redundancy and

availability. An N+1 inrastructure should be developed through multi-entry iber paths and power grids,

multi-day uel supply onsite, and multiple network providers. Managers should also inquire about the

requency o system and application monitoring to ensure that nothing goes wrong with the security in place.

tcommcao

elecommunications has three key categories to consider: Internet service, phone and voicemail, and market

data services. Most irms view the Internet as a critical means o collecting and distributing market data, as

well as communicating through the use o email. hree Internet options are typically available: cable modems,

DSL, or a -1 line. Cable modems and DSL oer high speeds and are relatively inexpensive, but their

reliability is low, especially when compared with a -1 line. Internet -1s are generally considered high in

reliability and oer eicient speeds. When selecting an Internet service provider, you should look or a



company that bundles proactive monitoring and security eatures to achieve high levels o availability. o help

ensure superior reliability, a irm should consider having two providers and a router to establish automatic

ailover i one o the providers goes down.

For phone and voicemail services, a irm typically purchases a phone switch, or PBX, which is installed in the

data center. A PBX provides many options or routing calls and storing voicemails, as well as caller ID, anauto-attendant, and integration with ring-down lines to various brokers. When reviewing your options, it is

important to consider the number o users and required unctionality o the system, including redundancy,

voicemail to email setup, branch oice, call accounting system, and call recording system.

Some irms may also consider implementing a Voice over Internet Protocol (VoIP) system. VoIP services can

be a relatively inexpensive option or irms lacking upront capital or the back oice. However, these systems

should be careully selected and tested, as poor call quality is not uncommon with this technology.

Ideally, your I service provider will have strategic partnerships in place with trusted telecommunications

companies and will help you select the appropriate system or your und. Bear in mind that your inal costs

will be dependent both on the number o end users on the system, as well as on additional unctions you

may require.

For example, small- to medium-size irms with less than 40 people can expect to pay roughly $20,000

to $40,000 or a solution that includes centralized call processes and solutions, such as voicemail and

administration. Many hedge unds require and expect more advanced eatures rom their voice solution,

including modular messaging, advanced mobility capabilities, and integration with trading systems. hese

eatures, as well as having more users, may increase the costs into the range o $30,000 to $80,000.

Selecting a market data vendor is based on the market and product coverage a irm requires, as well as cost,

speed, reliability, and client service. he cost o services is determined by the oering mix, the number o

users, the remote access method, and the real-time pricing requirements. Key market data providers include

Bloomberg, homson, Reuters, and Dow Jones.

daa Proco

Investors are becoming increasingly stringent in vetting a irms business and I practices. hey expect irms

to have comprehensive, tested plans and procedures in place and oten request to see them documented

during routine, pre-investment due diligence audits.

It is important to understand the dierence between a business continuity plan and a disaster recovery plan,

as they deliver complementary, yet unique, capabilities to a und. A disaster recovery plan encompasses the

steps taken to implement and support the inrastructure (hardware, sotware, and sites) necessary to make

possible the recovery o mission-critical services and applications (e.g., email, trading, voice, ile, accounting).

he steps to access up-to-date inormation and applications are established with a disaster recovery plan. Abusiness continuity plan makes use o the inrastructure addressed in the disaster recovery plan, but ocuses

on business operations. It asks the questions whose answers are crucial to business unctionality: what are the

mission-critical processes, who are the key personnel, how are they going to be notiied o an emergency, and

where or how will they continue to operate?



Developing both a business continuity plan and a disaster recovery plan that will be eective takes

approximately two to three months and:

> Supplies an understanding o what processes and personnel are essential, and

>Addresses documenting, planning, implementing, testing, and maintaining the policies, procedures, and

inrastructure to ensure that these mission-critical processes and people can continue to operate or quicklyreturn to operations ater an unexpected outage.

When dealing with business continuity and disaster recovery plans, it is important to keep in mind that some

practices may seem appropriate to a und manager, but are, in act, ineective. Some o these ineective

methods include relying solely on physical tapes or backup or hosting a disaster recovery site at an employees

home. he many requirements, such as redundant power, HVAC systems, ire suppression systems, and diesel

generators make running a disaster recovery server out o a home impractical. Another ineective method is

hosting a disaster recovery site in the same geographic region as the irms primary oice. his approach

does not protect the data rom regional outages, such as looding or power outages, which would likely aect

both locations.

Eective practices include having actions based on business and application availability. Firms must determinethe acceptable level o downtime or an application and then design the disaster recovery system to achieve

that level o availability. Firms should also back up all essential documents and data osite in an electronic

ormat at least daily, i not in near-real time. Establishing a means to access critical inormation and

applications in a remote manner will prove useul when an outage occurs by reducing downtime and enabling

a business to remain running near its ull capacity. Finally, irms must regularly test and update plans and

systems to ensure that all personnel know their roles and that the technology is suicient. his will guarantee

that when the time comes, a irms systems will work and its employees will know how to get the business

back up and running.

Coocao

More and more, irms are relying on collocation data centers to host their hardware and sotware in an osite

acility, which provides necessary bandwidth and increased protection. A number o actors, primarily

in-house acility limitations, motivate irms to rely on collocation services or storage and support. As small-

or medium-size businesses begin to grow, so does the supporting technology. I this technology grows at

a rate aster than the businesses can accommodate, they oten decide to host their equipment osite.

Communication rooms (comm. rooms) can be diicult, as well as expensive, to expand. Based on a irms

size, a certain level o power is needed and it can oten be diicult to generate onsite. Firms must also take

into consideration their ability to control heat and humidity levels, which can seriously aect the perormance

o most hardware.

he need or redundancy is another reason why irms are becoming more reliant on collocation data centers orhosting. As with general size and space limitations, an onsite acility might not be able to accommodate the

levels o redundancy that a irm requires to operate suiciently. Also, disaster recovery and business continuity

planning are increasingly being sought out by businesses that understand the realistic need to prepare or a

potential outage. Collocation can be the solution, as equipment is stored away rom the production environment

at locations built rom the ground up, with multiple levels o redundancy, lessening the likelihood o ailure.



Another signiicant advantage to using collocation services is the security they provide, with most data centers

secured and manned 24/7. hey oten provide surveillance and monitoringservices you could potentially

get on your own but most likely at a higher cost. At a data center, your security comes with the package.

Additionally, construction and moving operations are never a concern. Building or expanding a comm. room

on your own will most likely take weeks; whereas a data center could potentially oer you additional storage

in hours. I your business ever needs to move operations to a new production environment, you will not needto worry about transporting all o your hardware.

I you choose to host your irms hardware in a data center, consider application compatibility. First, you

must understand the necessary bandwidth you need in order to process inormation rom your work and

production environment to your data center. I you do not have enough bandwidth, latency will quickly

become an issue. he data center you choose must be able to install redundant connections. Next, be sure

that the unctions o your current applications, as well as those o any uture applications you may be

interested in, are compatible with running out o a collocation center. Remember that every 60 miles you

are rom your data center equals a millisecond o response time or your applications.

A inal driving actor or the use o collocation is the lexibility a data center oers its tenants. I a launching

or relocating irm attempts to store equipment in house and the accommodations are not suitable, the lie-

span o the hardware will ultimately be shortened, costing the irm even more money. here is never a cause

or concern over space at a data center; you simply rent out the space you need, and, i your equipment

expands or increases, you rent more. With a data center you pay or what you get, without having to worry

about spending thousands o dollars expanding your own acilities.

Funds can expect to spend roughly $1,800 to $3,500 per month on collocation space. he exact cost will

depend upon a ew actors, including the city in which the data center is located and how much closet space a

und needs to house its equipment. Funds can reserve space within a cabinet, a hal-cabinet, a ull cabinet, or

multiple cabinets in which to store their data. Your I service provider will assess your needs and provide

guidance on how much space is necessary or your und.

Arcvg

Email and instant message (IM) archiving is essential to proving compliance with the many rules and

regulations to which hedge unds are subjected. he Federal Rules o Civil Procedure relating to electronically

stored inormation requires hedge unds to be able to supply things such as emails, IMs, Bloomberg Mail and

IMs, documents, spreadsheets, and PDFs i requested. Email and IM data should be saved or the amount o

time prescribed by law. Data should be stored in WORM (Write Once, Read Many) ormat so that nothing

can be changed or deleted. Records need to be indexed in searchable iles to aid in providing only the

inormation that is requested. he best way to store data is on its own osite server, accessible via the Internet.

Commo Mak a how o Avo tm

It may seem challenging to run your own business, particularly i you have become accustomed to the

standards and methods o analyzing and processing your work through proprietary technology systems as an

employee o a large irm. When conronted with the vast number o choices or your own irm, it is easy to

become overwhelmed and end up with a less than optimal technology choice. Below are ive common

mistakes that managers make and what you can do to avoid them.



> Looking for the perfect solution. During the planning phase o your new und, the idea that there may be

one or more solutions that can meet 100% o your technology requirements can be an appealing thought.

Some vendors are attempting to develop a turnkey platorm to deliver on this promise. However, unless

your business is narrowly ocused, the chances that a single vendor will meet every aspect o your needs

are very slim. Realistically, you will likely need to negotiate, purchase, and deploy systems rom multiple

vendors and service providers. Generally, the more sophisticated your business, the more vendors you willneed. Many o the vendor irms oering an all-inclusive solution are rather small and new and, i you go

with a single vendor, by relying on it to be around in the years ahead, you may be assuming more business

risk than you are willing to accept.

> Insufficient planning for the future.Without envisioning how your practice will look over the longer

termin three or ive yearsyou may be setting yoursel up or some short-sighted solutions. Despite your

intense ocus on completing the immediate tasks o launching your und, understanding what your irm

will look like in the uture is important as well. I your und grows signiicantly, will you have the necessary

technological systems to support that larger business?

>Failing to understand how much you rely on technology today. hink about the work you currentlydo today and write down some notes on what systems you use to complete that work (email, reports,

phones, quote eeds, etc.). Now, think about the work that will need to be done in your new hedge und

and what systems you will require to complete it. More than likely, you will need most, i not all, o the

same systems, including additional ones. Use this list as a shopping guide when building out your

technology platorm.

> Overestimating your capacity to manage technology. Managing technology is a proession unto itsel.

Unless you spend most o your ree time building servers and managing networks, you will need help in

managing technology at your new irm. For project-related work (one-and-done jobs), you can use

consultants and contractors. For ongoing interaction and maintenance o technology, you can contract

with a third party; however, you should consider hiring support or administrative personnel that is skilled

with technology.

> Shortchanging the training options and resources. Once you have all o your new systems lined up, you

need to learn how to use them. Many, i not all, vendors provide some sort o onsite or web-based training.

I it is reasonably priced, you will most likely want to take advantage o it. Oten, the vendors proessional

services arms know all the quirks o the sotware package so well that many important details are glossed

over during the sales process. hey can help you develop the correct worklow to maximize your

investment, as well as get you past some o the inevitable challenges. Also, ask the vendor i there are any

established users groups or their sotware and systems. Oten, these can be invaluable resources or getting

up and running quicker and with less rustration. Avoid rushing the installation in order to make a set

deadline and ignore subsequent issues that may arise.

here is an immense amount o advice and inormation regarding how technology can be applied in a hedge

und. Using the ramework outlined above, you should eel conident in your ability to ultimately select the

most useul and eective technology solutions or your unique business.



Cck tcoogy Corao

Office space requirements for both current needs and future growth:

Visit and secure space.

Design ofce conguration with an architect and a designer.

Select a contractor or build-out.

Determine electrical needs.

Arrange or technology equipment room.

Schedule move-in date.

Website:

Determine website and email host.

Register website domain name.

Email:

Create email addresses.

Veriy that email addresses are working.

Telecommunications:

Determine telecommunication needs (dial-up, leased, ax, Internet connectivity), order equipment, and

schedule delivery and installation.

Note existing wiring and cable congurations and determine any additional requirements.

Determine phone numbers or main ofce and individual lines.

Install telecommunication lines.

Computer hardware:

Order desktop computers, monitors, and laptops.

Order servers.

Order printers.

Determine wireless and LAN capabilities.

Software:

Perorm due diligence and select an operating system.

Perorm due diligence and select trading and order management sotware.

Perorm due diligence and select accounting sotware.

Arrange or sotware installation, maintenance, and upgrades.

Install an accounting system and provide training.

Create and review a disaster recovery plan.



Market data and research:

Perorm due diligence and select a market data vendor; establish installation time rame.

Perorm due diligence and select a research vendor(s).

Perorm due diligence and select an analytic tool vendor(s).

Install market data, research, and analytic tool systems.

est trading system and research vendor inormation and accounting system.

scg Yor srvc Provr

With initial plans determined, the irst step to ormulating a new hedge und is selecting your service providers.

Generally, the irst outside party involved is a lawyer. Many individuals contemplating a hedge und launch have

pre-existing relationships with one or more o the our main service providers previously mentioned, and requently

these service providers can recommend others who may it well with your new business. You will be heavily relying

on these third parties to meet the needs o your business and partner with you as your hedge und grows.

> Lawyer. Legal counsel will inorm you about the various regulatory aspects o operating a hedge und and

the registration requirements and will help you determine the appropriate und structure. A lawyer will also

prepare the legal documents necessary to orm, operate, and market your hedge und. Tese documents1

include, but may not be limited to, the ollowing:

> Limited partnership agreement

> Operating agreement

> Subscription agreement

> Private placement memorandum

> Oering memoranda

>Accountant. Te numbers your rm generates are extremely important, and their accuracy is critical to your

success. In addition to providing you with audit services and K-1 preparation or the unds partners once the

und is launched, your accountants can help you review the initial documents drated by your lawyer beore

they are nalized. In their review, they can oer advice on the tax implications associated with entity selection

and manager compensation.2 Additionally, i you choose an accountant with hedge und experience, the

accountant should also be able to coordinate with your administrator, prime broker, and internal accountant.

> O particular signiicance and importance is the annual audit, which will be perormed by your accountant.

During the audit, your accountant will review your inancial statements and the capital accounts o the

investors (partners) o the und. In this review, your accountant will be assessing the controls in place to

ensure that accurate accounting, operations, and trading procedures are ollowed. As part o this process,

your accountant will provide a statement o account to each o the investors, as well as conduct a review othe partnership agreement to determine the partnership percentages.

1 For more inormation on each o these documents, please review the section on the legal landscape provided by Stark & Stark, Attorneys at Law, which begins on

page 7.

2 A section on the tax considerations associated with launching your und has been authored by Sasserath & Zoraian LLP, which can be ound on page 5.



> Prime broker. Your prime broker provides the undamental services o custody o assets and access to

inancing and securities lending. Other services that are central to the oering o a prime broker include

executing orders and portolio reporting. he suite o services oered by prime brokers has greatly

expanded in recent years beyond the core services they oer. Start-up assistance, technology and support

services, capital introduction, operational support, and even oice space are some o the areas where prime

brokers can assist you. As much or as little support as a manager needs is generally available with the goalo allowing you to ocus on the core concerns o your business.

>Administrator. A third-party administrator is not required to successully operate a hedge und; however,

they can relieve a signiicant amount o the burden rom the manager and improve the consistency with

which certain tasks are handled. Many managers use administrators to serve their investors and eectively

act as their outsourced accounting department. Monthly accounting and net asset value (NAV) calculations,

perormance ee calculations, record keeping o investors, and management ee calculations are the services

typically used. While these unctions can certainly be done internally, it can be time consuming or the

manager to do them and costly i sta is hired to perorm themparticularly in the early days o a und.

In every instance, your reputation can be helped or hindered by the providers listed above, and cost is not always anaccurate indicator o the quality o service and support you will receive. echnical skill, responsiveness, trust, and

expense should all be considered when evaluating your providers. It will be necessary or you and your operations

personnel to coordinate the operating unctions among your accountant, prime broker, and administrator.

Here are some things to consider when selecting your providers:

> Counterparty risk. Tis is the risk that your service provider will not be able to live up to its obligations. A

providers ailure to perorm can be a result o poor management or assuming too much credit risk, raud, or

other bad business practices that oten result in lawsuitsall o which can lead to poor service (or no service

at all i the company ails). Given the recent turmoil at nancial institutions o the largest, as well as o the

smallest, scale, counterparty risk has never been a more relevant consideration. In evaluating potential service

providers, you need to be able to ascertain the reliability o the ongoing service they can provide, as it is anextension o the service you provide to your own clients.

>Ability to serve you as both a start-up hedge fund and a large, well-established one. As a start-up und,

you have speciic needs. While many o the processes and procedures will remain the same as the und

grows, the level o interaction will likely increase. Additionally, your needs may become more complex over

time and selecting providers that can support you now, as well as in the uture, may keep you rom

outgrowing the services and support they can provide.

> Support provided. Support services may be particularly important during the initial phase o launching

your und. Many providers have additional services speciically targeted to start-up unds to help them plan,

prepare, and successully launch their und. Additionally, because you will be interacing with some o your

service providers on a daily basis, you will need them to be responsive when problems arise. Questionsabout how problems and other issues are resolved and how long resolutions typically take are good ways to

assess the responsiveness o the support provided.

>Additional capabilities. Are any additional services or capabilities currently in development, and does the

service provider have a reputation o being an innovator? he hedge und industry is always in a state o

evolution and having providers who see emerging trends and plan or your uture needs can be an extra

beneit or you.



It is always important to evaluate multiple service providers to get an understanding o the capabilities they

have, evaluate pricing, and gain additional perspective on your needs. When selecting any providerwhether

it is your lawyer or one o the other providers discussed in this guidebookask them or recommendations

on your other providers. Having worked with many hedge unds, it is likely that they will be able to give you

valuable advice and potentially shorten your search. I you do not have an existing relationship with any

service providers, you should begin your search by evaluating and selecting an attorney, and proceed with theothers rom there.

Cck scg Yor srvc Provr

Create a list o the service providers you will need.

Evaluate and select your service providers, asking or reerrals rom providers you select.

hma Rorc Corao

Hedge und managers have varying backgrounds, but many have spent at least a part o their careers working or

a large, ull service irm. As a business owner, you will no longer be provided with resources like compliance,

marketing materials and support, research, and technology sotware and systemsyou must ind them on your

own or perorm tasks yoursel. he ability to tailor your in-house capabilities is one o the most signiicant

attractions to owning your own irm, but can also seem overwhelming to create and implement. One o the

biggest challenges or some new managers is to determine staing.

When you start your own irm, the idea o building a network o both processes and people may seem

daunting, but this is an opportunity to design your own staing model to it the needs o your business.

Depending on your approach to the business, your irm will require a combination o dierent sta.

Tere are two types o sta discussed in this guidebook:

> Front-office employees who design and implement the investment and business management strategies othe rm, and

> Operations support and administrative staffwho have the primary unction o supporting the various

operational aspects o the business.

Dedicated ront-oice employees are the individuals with responsibility or developing, designing, and

implementing the irms strategies in terms o business and investment management. he senior investment

proessionals, such as chie investment oicers, portolio mangers, analysts, and traders, are included in this

classiication, along with the irm management: chie executives, inancial, compliance, and operating oicers.

Operations support and administrative sta include any individual who supports the ront-oice employees

or the business itsel. o the extent necessary, operations support sta members also coordinate thecompliance, operations, cashiering, and trading unctions to ensure that the transactions are settled in a timely

and appropriate manner. Receptionists, administrative assistants, and oice managers provide administrative

support by perorming secretarial and clerical duties, such as screening and routing telephone calls, scheduling

appointments, and typing correspondence.



scg Rg sag or Yor Frm

How complex should the stafng structure be in your new rm? What positions do you need to ll and how

many individuals will occupy those positions? o a large degree, the answers to those questions depend on the

initial size o your rm. Many managers who are just starting out do it alone without any sta. However, i you

will have multiple people working in your rm rom day one, it is helpul to answer the ollowing questions:

> How many investors and how much capital will your und have when it is launched? (I you will be serving

a large number o clients at the time o launch, you will likely need a more robust organizational structure

to ensure that you can deliver what you promise.)

>Which unctions do you think you will enjoy, want to do, and be eective at? Which aspects o your job

would you want to delegate to others?

> Do you enjoy working independently or would you rather work in a team-oriented environment?

>What are the essential unctions at your rm? What would be complementary but not strictly necessary?

>What are the values and culture that you want or your irm?

Most new unds are operated by the managers alone. In these cases, managers are required to perorm every

unction within the irm (research, trading, management, etc.). But as a irm grows in size and scale, so does

the scale o the unctions being perormed. Where the research, compliance, general oice management, and

marketing unctions were at one time easily perormed by a single individual, a irms growth increases the

scale o each job to a point where another individual may be needed to spread the workload.

With the management and inancial responsibility o irst inding and hiring all levels o sta, and then

compensating them in salary, bonuses, and beneits, it may be wise to begin with a lean organizational

structure to minimize compensation expenses. his is the common mentality o most hedge und managers,

regardless o the size and scale o the und. It is particularly common among start-up managers who oten do

not draw a salary in the months that immediately ollow the launch o their und. Any expenses will lower the

perormance o your und and will likely have to come out o your own pocket. Conversely, you may beinclined to add sta rom the beginning as an investment expense, which will ensure suicient capacity or

uture growth.

Certain positions are mandatory. For example, any hedge und that is not exempt rom the Advisers Act is

required by the SEC to have a designated chie compliance oicer. You may ill this role as you set up your

irm. I, however, your irm will start as a more complex organization with a large number o sta, you may

need either to have an outside proessional assist you with the responsibilities o the role (in which case you

would still be the designated chie compliance oicer), or hire an individual to work exclusively as the chie

compliance oicer and assume the title or SEC purposes. he chie compliance oicer ensures the saety o

client data, enorces adherence to ederal, state, and sel-regulatory organization securities regulations, and

creates and supervises the irms code o ethics, polices, and procedures. Many technology service providershave created compliance packages and solutions to assist you with developing and implementing a compliance

system at your own irm, but this does not eliminate the need or a chie compliance oicer at your own irm.



emag Co o Yor Frm sag srcr

Each position has an associated cost. Initially, you might estimate those expenses as the cost o laborsalary and

beneits, with perhaps some bonus or incentiveand end the inancial consideration there. However, a number

o ailiated costs accompany each sta position. In this section, we separately examine each o the costs.

Compao Co

Calculating the inancial expense o compensation is airly straightorward. Cash compensation is composed o

an individuals salary and bonus (incentive pay). When seeking candidates qualiied or these positions, bear in

mind that adjustments are alway

a guide to establishing a hedge fund 2009

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