Hedge Fund & Private Equity Fund Development

July 17th, 2011

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Hedge Funds & Private Equity Funds

First:

What is a hedge fund? Technically, there is no legal definition of a hedge fund. In a sentence, our basic definition:

A hedge fund is a private investment fund that may consists of various securities, commodities, futures, options, or other investments, whether public or private.

Biggest Hedge Fund Myth:
There has been been much discussion that claim hedge funds are not regulated and they need to be regulated. The facts are that hedge funds are generally structured as private investment funds, and or limited partnerships which have been regulated since 1933 under the Securities and Exchange Act of 1933, Regulation D, including, but not limited to Rules 504, 505, and 506.

General hedge fund facts:

  • Most hedge funds are registered and domiciled outside the USA, however there are a fair number that operate within the USA.
  • There are over 5,000 hedge funds.
  • Hedge funds are prohibited to make general public solicitations to potential investors.

Second:

What is a private equity fund?

A private equity fund is where a group of investors come together to invest as a whole (much like a hedge fund). The main difference might be where these investors seek to place capital into a new, fast growing or a promising business.

What is the difference between a hedge fund and private equity fund?
There is really no major difference between a hedge fund and a private equity fund. The rules for these funds are very similar in regulatory nature and in business structures. The main difference is perhaps their goals. Typically hedge funds invest in the financial markets, where private equity tends to invest in smaller, start up, and fast growing companies. However, hedge funds are not exempt from investing in private companies so long as their charter allows such.

Who can invest in a hedge fund or private equity fund?

  • a bank, insurance company, registered investment company, business development company, or small business investment company;
  • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • a charitable organization, corporation, or partnership with assets exceeding $5 million;
  • a director, executive officer, or general partner of the company selling the securities;
  • a business in which all the equity owners are accredited investors;
  • a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase;
  • a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
  • a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

(Source: SEC.gov, Rule 501 of Regulation D)

Can hedge funds & private equity funds accept non-accredited persons who earn less then $200,000 a year or who don’t meet any one other the other requirements above?
Technically, yes. Under SEC Rule 505, Regulation D (The SEC Act of 1933), managers can accept no more then 35 non-accredited (unaccredited) investors in their private fund. However we STRONGLY advise any hedge fund manager to NOT accept any non-accredited (unaccredited) investors into any hedge fund, private placement, limited partnership or other privately managed fund. If the fund is not operating under Rule 505, and instead operating under say Rule 506, the SEC states that:

“…all non-accredited investors, either alone or with a purchaser representative, must be sophisticated—that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.” (Source: SEC Rule 506 of Regulation D)

The Documents
The most important part of any hedge fund, private equity fund or other private investment fund are the fund documents.  These documents are like gold to some manages as they are the template to allow the business to function. No fund can operate without the proper legal disclosures and proper documents.

Mutual funds are required by law to issue a prospectus (a “485 filing”) to each new investor in a fund. (Source: SEC.gov)

Hedge funds and other private equity or other investment funds are required to issue certain formal documents to all perspective investors PRIOR to investing or sending in any money. If these documents and their execution are not in proper order, there are huge risks to at least the fund manager.

The fund manger must keep track of who has received a copy of the fund documents and when. They must also keep records of the potential clients and note how the perspective clients even qualified to be able to see the fund documents, let alone receiving acceptance and approval to invest money in any private fund. This is called the prospective client screening process and must be handled very diligently. Failure to handle this properly can result in fines, potential litigation risks, and the risk of having the fund shutdown by state and or federal regulators.

There is a lot more to know about hedge funds, private equity funds, structures, regulation, and ongoing compliance.

How We Can Help

  • Assist in finding structure(s) that suits the needs of the opportunity.
  • Develop the structure(s) and integrate modules to control certain risks for the fund manager, AND the investors.
  • Assist in meeting licensing where required and perform regulatory compliance (such as Reg D., the Patriot Act/ Anti-Money-laundering Act, and other areas of compliance) on the state and federal government level.
  • Provide consultation about client screening, dissemination of information, fund client communications, on-going compliance issues, using a prime broker and for other matters.
  • Record keeping.
  • Working with auditors.
  • Control costs and managing fund expenses.
  • Management fee structures.
  • Managing and identifying certain potential fiduciary risks.

We bring in legal experts in this process or you can use your own. We also have tax experts we work with for tax-related questions. We are experienced in developing fund structures, have actual fund management experience, and we are familiar with what kinds of issues managers need to know when operating their fund. Our first fund structure was developed in the year 2000.

For more information on how we may be able to help you start, structure, develop, properly market, and assist in regulatory compliance with a new or existing fund, please contact us.

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Please use this contact form for more information and free initial consultation.

Please note hedge fund, private placement, related services or other consulting is NOT provided by NetAdvisor.org or KMG, Inc. – a non-profit organization.

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