Emerging managers face various challenges in their pursuit to start hedge funds. There are a multitude of issues to consider, from planning how to raise capital to choosing service providers to support the business. With a limited history to rely on, managers need to demonstrate an ability to generate returns for potential investors whilst meeting the ever-changing demands of the regulatory environment.
Raising start-up capital
Capital raising has drastically changed over the years and is proving to be increasingly challenging for emerging managers. Although attracting investors and raising substantial amounts of capital may seem like an overwhelming process, there are various alternatives to explore.
Starting A Hedge Fund: Hedge fund type
Under the Investment Company Act of 1940, private funds, which are excluded from the standard registration requirements of the SEC, are commonly categorized under two sections of the Act: sections 3(c)(1) and 3(c)(7) (“3C1” and “3C7” funds). Initially, since an emerging manager tends to attract friends and family to their fund, they generally set up a 3C1 onshore fund. As a 3C1 fund grows, the manager can form a 3C7 fund and transfer those partners that qualify to the 3C7 fund so the total number of investors is able to grow.
As tax-exempt and offshore investors are attracted to the fund, the manager would then consider opening an offshore fund (either 3C1 or 3C7). U.S. tax-exempt investors typically subscribe to an offshore fund, as the corporate form of the offshore fund enables the blocking of any unrelated business taxable income (UBTI) from flowing through to the tax-exempt investors. A fund manager may then consider opening a master fund and have both the onshore and offshore funds as feeder funds as each begins to mature, which would eliminate the need for two separate investment portfolios.
Via: EisnerAmper
