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Starting a Hedge Fund in 2009 Bart Mallon, Esq. www. hedgefundlawblog .com For 40 minute voice presentation with this presentation, please visit website.

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Overview <ul><li>Initial Considerations </li></ul><ul><li>Fund Characteristics </li></ul><ul><li>Basic Structure </li></ul><ul><li>Structural Issues </li></ul><ul><li>Laws </li></ul><ul><li>Regulation D </li></ul><ul><li>Investors </li></ul><ul><li>Registration </li></ul><ul><li>Service Providers </li></ul><ul><li>Timeline </li></ul><ul><li>Offering Documents </li></ul><ul><li>Costs </li></ul><ul><li>Raising Capital </li></ul><ul><li>Other Issues </li></ul><ul><li>Disclaimer </li></ul>© www.hedgefundlawblog.com 2 of 18

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<ul><li>Who will be your investors? </li></ul><ul><li>How will you get to where you want to go? </li></ul>Initial Items to Consider 3 of 18

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Hedge Fund Characteristics <ul><li>Trading Strategies </li></ul><ul><ul><li>Traditional </li></ul></ul><ul><ul><li>Non-Traditional </li></ul></ul><ul><ul><li>Other Pooled Investment Vehicles </li></ul></ul><ul><li>Fees </li></ul><ul><ul><li>2 and 20 </li></ul></ul><ul><li>Taxation </li></ul><ul><ul><li>“ pass-through” taxation </li></ul></ul><ul><ul><li>tax benefit of “allocation” of performance fees </li></ul></ul>4 of 18

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Basic Fund Structure Hedge Fund (LP) (Bank Account) Hedge Fund Investors (Limited Partners) Management Company (LLC) Hedge Fund (LP) (Brokerage Account) <ul><ul><li>Investors make investment in the Fund, payment to the Fund’s bank account* </li></ul></ul><ul><ul><li>Manager wires money to the Fund’s brokerage account* </li></ul></ul><ul><li>Fund is managed by the Management Company </li></ul><ul><li>Fund makes investments </li></ul><ul><li>Fund pays Management Company a management fee (or may be paid from brokerage account)* </li></ul><ul><li>Fund allocates Management Company a performance allocation </li></ul><ul><ul><li>If Investors make withdrawals, the Fund will make a distribution to investors* </li></ul></ul><ul><li>* Indicate where there would likely be wire fees </li></ul>Investments <ul><ul><ul><li>Fees </li></ul></ul></ul><ul><ul><ul><li>Allocations </li></ul></ul></ul><ul><ul><ul><li>Management </li></ul></ul></ul><ul><ul><ul><li>Movement of money </li></ul></ul></ul><ul><ul><ul><li>Withdrawal </li></ul></ul></ul>1. 7. 5. 6. 3. 2. 7. 4. 5 of 18

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Structural Issues <ul><li>Fund structure/ Investors </li></ul><ul><li>Minimum Investments </li></ul><ul><ul><li>Initial, Subsequent, In-kind, Maximum </li></ul></ul><ul><li>Withdrawal and Contribution Periods </li></ul><ul><ul><li>Monthly, Quarterly, Yearly; Lock-up; Gate Provision; In-kind; Distributions </li></ul></ul><ul><li>Fees </li></ul><ul><ul><li>Management and Performance; High Watermark; Hurdle Rate </li></ul></ul><ul><li>Management registration status </li></ul><ul><li>Reports to investors </li></ul><ul><li>Selling commissions </li></ul><ul><li>Expenses </li></ul><ul><li>Asset valuation practices </li></ul>6 of 18

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Hedge Fund Laws <ul><li>Securities Act of 1933 </li></ul><ul><ul><li>Interest in a fund are “securities” </li></ul></ul><ul><ul><li>Regulation D “safe harbor” </li></ul></ul><ul><li>Securities Exchange Act of 1934 </li></ul><ul><ul><li>Funds with 500 investors and $10 million in equity must register </li></ul></ul><ul><li>Investment Company Act of 1940 </li></ul><ul><ul><li>Hedge funds exempted under Section 3(c)(1) and Section 3(c)(7) </li></ul></ul><ul><li>Investment Advisers Act of 1940 </li></ul><ul><ul><li>Requires investment advisers to register with the SEC </li></ul></ul><ul><ul><li>Exemption under Section 203(b)(3) for advisers who have less than 15 clients over a 12 month period </li></ul></ul><ul><li>Commodities Exchange Act </li></ul><ul><ul><li>CPO and CTA Registration </li></ul></ul><ul><li>Other Laws </li></ul><ul><ul><li>Internal Revenue Code of 1986 </li></ul></ul><ul><ul><li>“ Blue Sky” Laws </li></ul></ul>7 of 18

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Regulation D <ul><li>Rule 506 </li></ul><ul><ul><li>No limit on amount of sales </li></ul></ul><ul><ul><li>Generally only sold to “accredited investors” </li></ul></ul><ul><ul><li>Can have up to 35 non- “accredited investors” </li></ul></ul><ul><li>Definition of “accredited investor” </li></ul><ul><ul><li>$1 Million Net Worth </li></ul></ul><ul><ul><li>$200,000 in income in last 2 years </li></ul></ul><ul><li>No General Advertising </li></ul><ul><ul><li>No newspaper ads </li></ul></ul><ul><ul><li>No radio shows </li></ul></ul><ul><li>File Form D with SEC within 15 days of sale </li></ul>8 of 18

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Hedge Fund Investors <ul><li>Section 3(c)(1) Funds </li></ul><ul><li>Limited to 99 investors </li></ul><ul><li>Accredited Investor </li></ul><ul><li>Qualified Client </li></ul><ul><ul><li>Natural person with a net worth of $1,500,000 </li></ul></ul><ul><ul><li>Note: may be dependant on state law </li></ul></ul><ul><li>Section 3(c)(7) Funds </li></ul><ul><li>Limited to 499 investors </li></ul><ul><li>Qualified Purchaser </li></ul><ul><ul><li>Natural person with a liquid net worth of $5,000,000 </li></ul></ul>9 of 18

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Registration <ul><li>Investment Advisor Registration </li></ul><ul><ul><li>State vs. Federal </li></ul></ul><ul><ul><ul><li>Under $25 million – State only </li></ul></ul></ul><ul><ul><ul><li>$25 - $30 million – SEC or State </li></ul></ul></ul><ul><ul><ul><li>Over $30 million – SEC </li></ul></ul></ul><ul><ul><li>SEC </li></ul></ul><ul><ul><ul><li>Section 203(b)(3) exemption </li></ul></ul></ul><ul><ul><ul><li>Generally 2-4 weeks </li></ul></ul></ul><ul><ul><ul><li>Compliance manual </li></ul></ul></ul><ul><ul><li>State </li></ul></ul><ul><ul><ul><li>Exemption depends on state laws </li></ul></ul></ul><ul><ul><ul><li>Generally 2-8 weeks </li></ul></ul></ul><ul><ul><ul><li>Series 65 </li></ul></ul></ul><ul><ul><ul><li>Potential net capital requirements </li></ul></ul></ul><ul><ul><ul><li>Compliance procedures including potentially a compliance manual </li></ul></ul></ul><ul><li>CTA or CPO Registration </li></ul><ul><ul><li>Registration with CFTC through the NFA </li></ul></ul><ul><ul><li>Potential CTA and CPO Exemptions (but potential state issues) </li></ul></ul><ul><ul><li>Series 3 </li></ul></ul><ul><ul><li>Various compliance requirements </li></ul></ul>10 of 18

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Hedge Fund Service Providers <ul><li>Lawyer </li></ul><ul><ul><li>drafts offering documents; entity formation; registration; strategic and legal advice </li></ul></ul><ul><li>Administrator </li></ul><ul><ul><li>provides fund NAV calculation; fee calculations; investor reporting; etc. </li></ul></ul><ul><li>Auditor/ Accountant </li></ul><ul><ul><li>provides yearly fund audit; prepares tax forms for the manager and investors </li></ul></ul><ul><li>Prime Broker </li></ul><ul><ul><li>provides execution and/or clearing services for trades; custodian of assets </li></ul></ul><ul><li>Consultant </li></ul><ul><ul><li>provides consulting services to management company re: fund raising, marketing, operational guidance etc </li></ul></ul>11 of 18

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Hedge Fund Timeline <ul><li>Week 1 </li></ul><ul><ul><li>discuss fund structure in depth, organize legal entities (management company, fund), begin talking with outside service providers </li></ul></ul><ul><li>Week 2 </li></ul><ul><ul><li>receive draft of offering documents, begin thinking about operational issues which may arise – are your computers ready, is office space secured? </li></ul></ul><ul><li>Week 3 </li></ul><ul><ul><li>discussion and revision of offering documents with attorney, begin finalizing outside service provider contracts, establish bank account, establish brokerage account </li></ul></ul><ul><li>Week 4 </li></ul><ul><ul><li>tie up loose ends, finalize offering documents, begin to get ready for trading or selling interests in your fund </li></ul></ul><ul><li>IA registration and CTA/ CPO registration will affect this timeline – usually add about 2-4 weeks to the schedule assuming that the principals have all required regulatory exams and also provided that there are no prior regulatory actions </li></ul>12 of 18

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Offering Documents <ul><li>Private Placement Memorandum (PPM) </li></ul><ul><ul><li>Similar to mutual fund prospectus </li></ul></ul><ul><ul><li>Discussion of important structural terms </li></ul></ul><ul><ul><li>Discussion of investment program </li></ul></ul><ul><ul><li>Information on management company and managers </li></ul></ul><ul><li>Limited Partnership Agreement (LPA) </li></ul><ul><ul><li>Governing legal document </li></ul></ul><ul><li>Subscription Documents </li></ul><ul><ul><li>Subscription agreement </li></ul></ul><ul><ul><li>Investor suitability questions </li></ul></ul>13 of 18

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Costs to Start a Fund <ul><li>Lawyer </li></ul><ul><ul><li>Range from $15,000 (boutique) to $30,000 (BigLaw) for a basic domestic long-short fund; registration extra </li></ul></ul><ul><ul><li>My firm will be about $10,000 for a basic domestic long-short fund; registration from $2,000 if necessary </li></ul></ul><ul><li>Administration </li></ul><ul><ul><li>Range from $750 - $1,500 per month; Initial one time set-up fees range from $500 - $1,500 </li></ul></ul><ul><ul><li>Larger funds may also pay a fee (x bps) on AUM </li></ul></ul><ul><li>Audit </li></ul><ul><ul><li>Audit: $5,000 – 15,000 depending on a number of factors including Audit firm </li></ul></ul><ul><ul><li>Tax Prep: $4,000 - $10,000 depending on a number of factors including number of investors and the Audit firm </li></ul></ul><ul><li>Prime Broker </li></ul><ul><ul><li>Varies depending on strategy, investments, trading volume </li></ul></ul><ul><li>Business Expenses – office rent, compliance costs, telephones, computers and IT, office equipment, staff salary, etc. </li></ul>14 of 18

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Raising Capital <ul><li>Must be done pursuant to Regulation D </li></ul><ul><li>Who </li></ul><ul><ul><li>Friends and Family </li></ul></ul><ul><ul><li>Institutional Investors </li></ul></ul><ul><li>Marketing Materials </li></ul><ul><ul><li>Powerpoint Pitchbooks </li></ul></ul><ul><ul><li>One Page Tearsheets </li></ul></ul><ul><ul><li>Appropriate Disclosures/ Disclaimers </li></ul></ul><ul><li>Outside Marketing </li></ul><ul><ul><li>Hedge Fund Databases </li></ul></ul><ul><ul><li>Hedge Fund Industry Events </li></ul></ul><ul><ul><li>Capital Introduction Services </li></ul></ul><ul><ul><li>Third Party Marketers </li></ul></ul>15 of 18

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Other Issues <ul><li>“ Incubator” hedge funds </li></ul><ul><li>Offshore hedge funds </li></ul><ul><li>Taxation </li></ul><ul><li>ERISA and IRA investments </li></ul><ul><li>“ New Issues” Rule </li></ul><ul><li>Soft Dollars </li></ul><ul><li>Side Letters </li></ul><ul><li>Due Diligence </li></ul><ul><li>Blue Sky Filings </li></ul>16 of 18

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Disclaimer <ul><li>This presentation was made for informational purposes only. </li></ul><ul><li>I am not providing legal advice to any user. </li></ul><ul><li>I am not providing tax advice. Presentation is subject to the Circular 230 Notice on the disclaimer portion of my blog. </li></ul><ul><li>This presentation does not establish an attorney-client relationship between myself and the user. </li></ul><ul><li>Any discussion herein is not a substitute for seeking actual legal advice from a licensed attorney with knowledge of the rules and regulations governing the industry. </li></ul><ul><li>I make no representations, guarantees, or warranties as to the accuracy, completeness, currency, or suitability of the information provided via this presentation. </li></ul><ul><li>This may be considered to be “attorney advertising” in some jurisdictions. </li></ul>17 of 18

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For Voice Presentation, please see: www. hedgefundlawblog .com Please send questions, comments or suggestions to Bart Mallon at bartmallon@gmail.com © www.hedgefundlawblog.com