How to legally form a hedge fund

Legally forming a hedge fund if is a bit more difficult than forming a corporation or an LLC for a private business. It involves a lot of navigation of various investment compliance laws, and you could get in trouble if you don't seek professional help along the way. The laws surrounding and governing your business change entirely based on what country and state you are in. They also may be drastically different based on where geographically you are seeking investors, how you are contacting new investor leads, what you are investing in and how many investors you are working with in total. 

Don't be mistaken by those who say you only need a small amount of money to get everything in place and start a hedge fund, as many funds spend over $1 million in their early stages. Others may start a fund with only $10,000, but the additional costs mount up fast: There is always another team member to recruit, resources to obtain or capital-raising expert who can help you get to the next level. As a reference point, most hedge fund managers start their businesses with $15,000-$50,000. Of course, there are plenty of exceptions who spend up to $350,000 in startup costs.

Of course, before getting the legal paperwork in order, you’ll already want to have secured a significant amount of capital to manage in order to make running a hedge fund worth your while. Securing enough capital is one of the biggest challenges for hedge fund startups, as potential investors want to see a significant amount of assets under management (AUM) before entrusting you with their money. One should aim to have at least $5 million in AUM to be successful, with $20 million making you noticeable to investors, and $100 million needed to be noticed by institutional investors.

The first step is to hire an experienced hedge fund attorney. This would be the most expensive option, and for many hedge funds doing so means that they have less capital available to recruit experienced team members or invest in software.

When working with an experienced hedge fund attorney, you are going to be looking at $20,000-$80,000 just for the legal formation of your fund, and nothing else. Naturally, experienced attorneys come with a long list of client recommendations and good reputations. The bad thing about working with a leading law firm is that you will be paying top dollar for work that is mostly completed using legal document templates and junior level staff, in many cases. Yes, a senior partner will probably review and sign off on everything, but large law firms with prestigious partners are very busy, and they will not be working on your startup paperwork, in most cases.

Another option would be to not fully form your hedge fund, and instead try to find a hedge fund incubation or emerging manager platform solution. These platforms seem to always be coming and going in the industry, but the business model here is that the emerging manager platform allows you to start trading in your hedge fund and seeking investors while building an audited track record within its larger legal structure.

This method significantly cuts down your startup expenses, and allows you to spend more money on talent, systems and other service providers, such as fund administrators, prime brokers, auditors and third-party marketers.

The final option is to use a hedge fund formation template service, to cut costs and reduce your startup expenses by 60%-90%. These services allow you to use the same legal templates that those high-end attorneys use, thus not taking up their time – and racking up those pricey billable hours. Hedge fund formation templates can be purchased for $5,000-$7,000, and give you the freedom (and responsibility) to establish your fund in a hands-on fashion. Of course, you may well further legal representation down the road. You still have the option of retaining a full-blown, high-end attorney as your ongoing compliance and legal counsel – especially since you have saved so much money in forming your fund.

This option is growing in popularity, as there are a large number of demands on the startup capital of a hedge fund, and as long as the fund is formed correctly, there is often a better payback by investing in operations, advisors, hedge fund training, etc.

It is wise to have a complete plan for starting up your hedge fund before you take any action. Know whom you will work with, what will be charged and what you are getting for your money in each case. You have to act like an investor in starting your own hedge fund, in order to make sure you are getting the best return on investment possible while setting up your account, and re-invest in it after the launch.