So you want to start a hedge fund. These alternative investments used pooled funds and a variety of strategies to achieve returns for investors. They are generally formed to identify and take advantage of specific opportunities—many of which come with a lot of risk—in the market. But how do you go about setting yourself up to become a hedge fund mogul?

Legally forming a hedge fund is a little bit more challenging than forming a corporation or limited liability company (LLC) for a private business. It involves navigating 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 the country and state in which you do business. They may also differ—sometimes drastically—based on where your potential investors are located, how you contact new investor leads, what you are investing in, and how many investors you are working with in total. 

Having said that, if you're still looking to jump into the game, we've listed some of the ins and outs of forming your own hedge fund legally.

Key Takeaways

  • Forming a hedge fund is a time consuming and costly venture.
  • Make sure you do your research, choose a name for your fund, and determine which business structure is best suited for your needs.
  • Expect to spend anywhere between $15,000 to $50,000 in initial costs.
  • Additional costs and considerations include raising capital, hiring an attorney, filing the paperwork.
  • You may consider using an incubation or emerging manager solution, or a hedge fund formation service which can save you a lot of time and money.

The Basics

Before you go and put all your hard earned money into the venture, it's important to do some basic due diligence. After all, this is a very costly and very time consuming process, so you want to make sure you've fully thought this through.

First things first: Do your research and try to become an expert. This isn't like jumping into the stock or bond market. It's much more complicated with very nuanced steps that you'll have to take. And there is, of course, a great amount of risk. Read up on hedge funds, how they operate, and talk to experts in the field so you, yourself, become an expert.

You'll also want to choose a name for your fund—one that best describes your investment style and and your strategy. This may be more difficult than it seems. But remember, you want to attract investors, and your name may help draw them to you.

Determine how you're going to do business. Are you going to set yourself up as an LLC, a trust, or perhaps a limited liability partnership (LLP)? The latter is generally the most popular option.

Initial Costs

Hedge funds are traditionally very expensive ventures with burdensome startup costs that often reached the six-figure range. Some funds went well beyond that, costing millions. Most hedge fund managers, though, start their businesses with anywhere $15,000 to $50,000. But, remember: That's just the cost to start up your fund, meaning additional costs mount up fast. You will probably have to shell out money to recruit another team member—maybe even an expert who can help you raise capital to get you to the next level.

Hedge funds are traditionally very expensive ventures that have hefty startup costs.

You’ll want to secure a significant amount of capital to manage and make running a hedge fund worth your while. Raising capital is one of the biggest challenges for hedge fund startups, as potential investors want to see that you have a significant amount of assets under management (AUM) before entrusting you with their money. While there's no real prescribed target, you should aim to have at least $5 million in AUM to be successful, while $20 million will make you noticeable to investors. Having $100 million will get you noticed by institutional investors.

You may find one or all of the following good sources to go to first to tap into for capital:

  • Your own savings
  • Family and friends
  • Colleagues
  • Hedge fund seeders
  • Endowments or foundations

Getting the Law On Your Side

Now that you've secured the capital, you'll have to work through the legalities of setting up your fund. If you're going to give out investment advice, you'll have to pass a test and register with the Securities and Exchange Commission (SEC). Although you may not be required to do so—you'll have to if you have 15 or more investors—it's probably still a good idea to go ahead and register, as future investors will see this as a positive sign. You'll also need to set yourself up with the Internal Revenue Service (IRS) to get an employer identification number.

You may consider hiring an experienced hedge fund attorney to help you sort through all the paperwork as it can be tedious and cumbersome. It will also save you from making any costly mistakes like misfiling a form or forgetting one altogether. Granted, this is the most expensive option. For many hedge funds, doing so means they have less capital available to recruit experienced team members or invest in software.

When working with an experienced hedge fund attorney, expect to spend as little as $20,000 and as high as $100,000 just for the legal formation of your fund. Experienced attorneys naturally come with a long list of client recommendations and good reputations. The drawback to working with a leading law firm is that, in many cases, you will pay top dollar for work that is mostly completed using legal document templates and junior level staff. While a senior partner will probably review and sign off on everything, large law firms with prestigious partners are very busy, so they won't be working on your startup paperwork.

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How To Legally Form A Hedge Fund

Alternative Methods

Another option is to try to find a hedge fund incubation or emerging manager platform solution instead of fully forming your own hedge fund. These platforms seem to always be coming and going in the industry. One important benefit, thought, is that the emerging manager platform's business model 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.

Hedge Funds by the Numbers

The final option is to use a hedge fund formation template service, which will cut costs and reduce your startup expenses by 60% to 90%. These services allow you to use the same legal templates all those high-end attorneys use—eliminating the need to take up their time and, therefore, those hefty bills. 

Hedge fund formation templates can be purchased for $5,000 to $7,000, and give you the freedom—and responsibility—to establish your fund in a hands-on fashion. Of course, don't discount the fact that you may need 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. But you may be able to afford it at a later date since you saved so much money 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.

The Bottom Line

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.