It is much easier than you
think
Want to Build
an Investment Fund?
Recently, an increasing number of customers have asked us to help them make an investment fund, such as a hedge fund, an offshore fund or a private equity fund.
They are not only
financial institutions intending to build an investment company. Many of them are individuals and small
businesses. Some of them ask
irrelevant questions, which could be avoided if they knew about fundamentals of
the process of investment fund creation.
In this article,
we make a brief picture of how to build an investment fund so that people
intending to create a fund may focus fundamental matters at the very first
stage.
First of all, we
must ask you a very basic question.
There are various types of investment funds, such as (1) hedge funds,
(2) mutual funds or (3) exchange-traded funds (ETFs). If you are interested in making an investment fund, you are
expected to know the difference among them. Then, can you tell which of the three is the easiest to
create? Which one is the most
difficult to launch?
Among theses three
types, obviously the mutual funds are most familiar. Compared with them, “hedge funds” may sound like the other
side of the world. You cannot buy
hedge funds from banks, securities firms or stock exchanges. Hedge funds sounds very private and
closed, and may be difficult to approach.
However, if you
are a fund manager and want to launch your own investment fund, “hedge fund” is
the easiest to create. Hedge funds
or any other types of private equity funds are so designed that their business
can be operated under the least government regulations. On the other hand, investment funds
available to the public (such as mutual funds or ETFs) are strictly regulated
and must require very difficult and complicated formalities.
Now you know hedge
funds are the easiest to create.
Hedge funds are a type of private equity firm and the procedures for
forming a hedge fund is basically the same as those for other types of private
equity funds. So, the procedures
described in this article should be useful for those who are considering of
creation of other private equity investment funds than hedge funds.
If you intend to
create and launch an investment fund, it is needless to say that you are
starting a new business. Then, you
must start with clarification of your image of prospected customers who may
invest in your fund.
One of the most
important factors is the number of the customers. In case of private equity funds, the number of the investors
must be small enough for avoiding undesirable financial regulations of the government
(such as Investment Company Act of 1940 of the U.S.A.). To get enough volume of investments
from limited customers, you may need to approach corporate or institutional
investors.
Then, you must
think how much money you need for creating a fund. In the United States, for example, it is said you need
approximately 50,000 to 100,000 dollars to launch a hedge fund. This may sound small, to be sure, but
it is not for investing. It is
just a cost for creation and launch.
For investing, you need millions of dollars to be managed, but it does
not necessarily have to be your money.
In most cases,
however, you are not lucky enough to find sufficient amount of investments
before launching your fund. Then,
you must invest your own money in your fund to show prospective investors how
nice it is to invest in your fund.
Your prospective investors may usually decide to invest after seeing the
actual performance of your fund.
In general, fund
managers of hedge funds, buyout funds or other private equity funds invest a
considerable amount of money at their own risks. In most cases, they started the business by investing their
own money. In other words, they
cannot get started until they invest their own.
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To get started,
when you have clarified your target customers and have enough capital to launch
your fund, you must contact service providers, such as
(1) Law firms,
(2) Financial institutions,
(3) Accountants,
(4) Administrators.
Among such service
providers, you should probably contact with a financial institution first. If you need to borrow stocks or a loan
for leverage, you must contact with such institutions as a bank offering prime
brokerage services. However, very
few banks or institutions take such a risk as offering such services for
newborn funds. You should rather
find a small bank, which offers basic services for fund mangers such as opening
a custody account in the location where your fund is to be registered, rather
than seeking for possible prime brokers.
You need at least two separate bank accounts. One is for investments. The other is for operating costs for your fund. Those two accounts must be separated in
a strict manner.
Such banks may
provide you with information of local law firms, accountants and administrators
suitable for newborn funds. Then,
the next service provider you should contact is a law firm. If you are in New York, there are lots
of law firms specializing in the hedge fund business, but it should be easier
if the bank of your fund introduces you to the local firms. For example, in the Cayman Islands, a
lot of lawyers have expertise in hedge fund or other private equity fund
business and their fees may be cheaper than those of the lawyers in big
cities. Law firms will help you to
elaborate the legal structure of your fund and prepare an offering memorandum
or prospectus for it. The fees for
lawyers must be a major part of the initial cost of your business, but such
legal documents will protect you from lawsuits.
Based on the fund
structure, the law firm will also take care of formation of companies, trusts
and/or limited partnerships that constitute a legal entity of your fund. In many cases, hedge funds or other
private equity funds need a number of such entities for managing, operation,
advisory or selling in different jurisdictions to constitute the entire
scheme.
In most cases, the
main body of the fund, whether it is a corporation or a limited partnership,
should be established and registered in an offshore financial center such as
the Cayman Islands, the British Virgin Islands or Guernsey. Especially if you are targeting at
nonprofit organizations of the United States, such as foundations or the
university investment funds, they will require that your fund should be an
offshore corporation. Even if your
prospected customers (investors) have no such requirements, still offshore
financial centers must be the best jurisdiction for registration of your
fund. Such jurisdictions were
competing with one another in making better legal systems and business
environments for investment funds and fund managers.
Among all of them,
however, the Cayman Islands is said to be the best jurisdiction in
general. In addition to its
advanced legislation such as mutual funds law, limited partnerships law and
companies law, the time zone of the Cayman Islands makes it possible for the
fund managers to do their business in the same time zone as the New York Stock
Exchange. For such reasons, the
Cayman Islands has become an international standard as a jurisdiction for the
business of hedge funds and other private equity funds.
When you have (1)
transferred your money to an account with a bank providing services for fund
managers, and (2) established legal entities in accordance with the legal
structure, all you have to do for launching your funds is to choose an
accountant and an administrator.
Probably your Cayman bank has information of good local accountants and
administrators.
As you can see
above, it is not difficult to make and launch a hedge fund, if you can manage
to cover the initial cost. Today, it
is said that there are tens of thousands of hedge funds or other private equity
funds in the world. It is partly
because it is easy to build and launch.
However, the question is: how can you continue the business
successfully? Most of the hedge
funds are only a small business.
Only a few of them can grow big.
Probably, the biggest issue is not to grow your investments in the
fluctuating financial market, but to get customers, especially institutional
customers (investors), such as foundations, university funds or pension
funds. Such institutional
investors, rather than wealthy individuals, will lead your funds to
success.
What do you
think? Sounds easier than you
thought? Anyway, when you have
done the steps described in this article, you are on the start line to grow big
to success.
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