Getting a licence from the FSA
The FSA is an independent group responsible for the financial regulation of the financial services industry in the UK. In order to set up a hedge fund, you must first obtain an FSA licence. This can be achieved by filling out an application, which can be ordered from their site.
To start off, there are a few things that you need, such as money, a lawyer, a prime or introducing broker, an office and an accountant. It would also be an idea to start networking and getting to know some of the more experienced financial services talent. It is also becoming more and more common for brokers, lawyers and accountants to team up to provide a “one-stop shop” approach to launching hedge funds, and most of the correspondence happens via the phone or internet.
The first thing you need to start a fund is capital money. Typically, the first people to ask are friends, family, etc., as it can be difficult to attract institutional investors to a new fund. Friends and family know you and know that they can trust you. It is also worth noting that all hedge funds have at least some of their manager’s own wealth invested into them, after all, if you can’t have faith in your own investment then why expect anyone else to?
Lawyers and legal services
To begin, you will need a planing consultation. Here you, along with your lawyer, will work out issues such as location, management, investment adviser registration, etc. and devise a stronger action plan. Once the fund and management company entities are formed in the appropriate jurisdictions, the fund manager can open bank and brokerage accounts, and begin setting things up on the administrative side of things. The legal team can then collect the information required to form the operating agreements for the entities and the offering documents can be drafted and finalised for distribution to prospective investors.
Once the hedge fund is organised and the offering documents are in order, you can start a relationship with a prime broker (or an introducing broker, who has an agreement with a prime broker to use that firm’s services). The broker will provide marketing and capital introduction services. Hedge funds are not allowed to market themselves in the conventional sense, however, brokers have been developing ways to work around these restrictions. For this reason, it is important to steer clear of retail brokerage firms, as they seldom have the expertise needed to work with hedge funds.
When considering your office space, the single most important factor is high speed internet. Due to the nature of modern technology, and the sheer number of hedge funds, it is perfectly acceptable to work from home. Most of your work can be done over the internet, and it is becoming common for hedge funds to abandon offices all together. Office space should be considered further down the line once the money starts to flow.
Starting the hedge fund
To start a hedge fund, the manager must set up both the hedge fund entity and the management company. Since it’s a start up, the management company should be set up as a limited liability company or corporation, and will function as the fund’s general partner.
It is very important that the lawyer drafts the offering documents. While it can be tempting to do the work yourself, without a strong understanding of securities law it will be obvious to investors that proper legal counsel was absent, which makes the hedge fund manager look bad. For example, potential investors rely heavily on the information provided by the PPM (private placement memorandum). This is an extensive document that features all the basic information about the hedge fund and its manager, and what kind of investments will be made, and how said investments can be justified.
The PPM also provides information about what a prospective investor needs in terms of qualifications and procedures to become a limited partner, as well as information regarding taxation of investing in the fund, expenses, allocations of gains and losses, etc. while other aspects such as the redemption rights and procedures, fund service providers, potential conflicts of interest, disclosure of lock-up periods, etc. can be discussed either briefly or in detail.
The investment policy and strategy portions of the PPM are intended to help investors evaluate the hedge funds in order to determine whether or not it’s an investment opportunity worth considering. Keeping that in mind, PPMs should be written taking accountability into consideration. It is therefore important that terms, such as “capital preservation” and “risk aversion”, are clearly defined and adhered to with future audits taken into consideration.
The process of setting up a hedge fund usually takes around 2-3 months, but if you are planning on registering as an investment adviser, or if there are other delays, then it can take a while longer.