How to start a hedge fund in the US? Any advice?

[muscleman]

thanks for the idea about IB, muscle.

 

As far as the series 7 goes, I don't know if you really need it to manage. It's a license to sale securities so if you've got someone else selling, you probably don't need it (but I could be wrong).

 

Selling securities? So if I run a hedge fund and try to sell some shares of my hedge fund, that would require series 7 right? But for investment advisory, that's probably not needed because I am not selling securities right? I have no plan to become a broker.

[muscleman]

What's the major differences in setting it up via traditional channels vs IB?

 

Someone suggested to me via PM to start as investment advisory instead of a full fledged HF manager. The cost would be much lower and I would only provide services to manage individual accounts. I log into their accounts and trade, instead of asking them to send me their money. This will be much easier to earn trust than asking people to send me money and just trust whatever I do with their money.

IB has an automated feature to support this and it sounds like it can automatically withdraw fees from client's account into my advisory master account.

 

I've considered this, but what bothers me is that the client can see all of the trades being made. What's stopping them from just copying everything you do in real time, while giving only a small amount of money? Also, I fear giving access to real time portfolio value, with all of its ebbs and flows can cause distress to a client, and in turn problems for the portfolio manager. I think this is why Buffett reported account value only once a year, but I might be wrong on that.

 

Hmm..... This is indeed a big concern. I certainly don't want clients to log in everyday and monitor my trades in real time and calling me all the time. That would be very annoying. Is there a way to block clients from viewing their own account in IB?

[oddballstocks]

My impression has always been that a hedge fund is $50k+ in startup costs.  That only makes sense if you're going large from the start.  You mention having a few employees, presumably you have connections to raise capital already. 

 

If you want to run lean go the RIA method.  Seems like there are a lot of paranoid investors here.  If someone is paying you to manage their money why would they be looking over your shoulder hourly?  They probably have better things to do.  If not and they don't trust you fire them as a client, you don't want clients like that.

 

If you're in the A camp I'd just call a lawyer and talk this through with them.  What's an extra grand or two in lawyer fees if you're going to be spending a lot to startup anyways.  Plus then you'll get real advice, not second hand from the internet.  This is good advice, but we don't know what state you're in, your products etc.  Talk to a lawyer.

 

If you're in the B camp then this is probably the best cheapest advice you can find.  But I'd still say talk to a lawyer!

 

Lawyers are expensive until you get sued.  I've surfed the net for business questions, spending hours and at times days looking for a good answer.  I've come to learn that in many cases my lawyer knew the answer and a simple email or call would have done.  If you have someone decent, someone interested in growing with your business they aren't going to nickel and dime you.  That is unless you're wasting a TON of their time.  Ask for all-in quotes on things as well.  I've asked for the price for doing something as a package, not on an hourly basis.  Usually cheaper and better for standard things like a trademark or form filings.

 

This is a forum of DIY people, but I've learned the hard way that professionals are often worth more than their hourly bill rate.  Learn to use them!

[Tim Eriksen]

thanks for the idea about IB, muscle.

 

As far as the series 7 goes, I don't know if you really need it to manage. It's a license to sale securities so if you've got someone else selling, you probably don't need it (but I could be wrong).

 

Selling securities? So if I run a hedge fund and try to sell some shares of my hedge fund, that would require series 7 right? But for investment advisory, that's probably not needed because I am not selling securities right? I have no plan to become a broker.

 

no you would not need the Series 7 to sell interests in your own hedge fund.  Just the 65, and not every state requires that.  WA does.

[constructive]

Lawyers are expensive until you get sued.  I've surfed the net for business questions, spending hours and at times days looking for a good answer.  I've come to learn that in many cases my lawyer knew the answer and a simple email or call would have done.

 

Yes, asking a lawyer for advice is the most efficient path. But I think developing a strong personal understanding of legal issues (not depending entirely on your lawyer) is essential to complying with the law throughout your business practices, and not getting sued in the first place.

[muscleman]

thanks for the idea about IB, muscle.

 

As far as the series 7 goes, I don't know if you really need it to manage. It's a license to sale securities so if you've got someone else selling, you probably don't need it (but I could be wrong).

 

Selling securities? So if I run a hedge fund and try to sell some shares of my hedge fund, that would require series 7 right? But for investment advisory, that's probably not needed because I am not selling securities right? I have no plan to become a broker.

 

no you would not need the Series 7 to sell interests in your own hedge fund.  Just the 65, and not every state requires that.  WA does.

 

Ok. So my friends will be the main guys trying to get clients and I will mostly be trading and researching. Only I need the series 65 and my friends won't need series 7, is that right? So how can I ensure that my friends talk about the right things and right promises when they tell their clients? Do I have to train them?

 

[muscleman]

My impression has always been that a hedge fund is $50k+ in startup costs.  That only makes sense if you're going large from the start.  You mention having a few employees, presumably you have connections to raise capital already. 

 

If you want to run lean go the RIA method.  Seems like there are a lot of paranoid investors here.  If someone is paying you to manage their money why would they be looking over your shoulder hourly?  They probably have better things to do.  If not and they don't trust you fire them as a client, you don't want clients like that.

 

If you're in the A camp I'd just call a lawyer and talk this through with them.  What's an extra grand or two in lawyer fees if you're going to be spending a lot to startup anyways.  Plus then you'll get real advice, not second hand from the internet.  This is good advice, but we don't know what state you're in, your products etc.  Talk to a lawyer.

 

If you're in the B camp then this is probably the best cheapest advice you can find.  But I'd still say talk to a lawyer!

 

Lawyers are expensive until you get sued.  I've surfed the net for business questions, spending hours and at times days looking for a good answer.  I've come to learn that in many cases my lawyer knew the answer and a simple email or call would have done.  If you have someone decent, someone interested in growing with your business they aren't going to nickel and dime you.  That is unless you're wasting a TON of their time.  Ask for all-in quotes on things as well.  I've asked for the price for doing something as a package, not on an hourly basis.  Usually cheaper and better for standard things like a trademark or form filings.

 

This is a forum of DIY people, but I've learned the hard way that professionals are often worth more than their hourly bill rate.  Learn to use them!

 

Thanks a lot!

I will talk to a lawyer to get started. I should register an LLC first right? And then employ myself from the LLC and get director and officer liability insurance? How much would that cost?

[jawn619]

My impression has always been that a hedge fund is $50k+ in startup costs.  That only makes sense if you're going large from the start.  You mention having a few employees, presumably you have connections to raise capital already. 

 

If you want to run lean go the RIA method.  Seems like there are a lot of paranoid investors here.  If someone is paying you to manage their money why would they be looking over your shoulder hourly?  They probably have better things to do.  If not and they don't trust you fire them as a client, you don't want clients like that.

 

If you're in the A camp I'd just call a lawyer and talk this through with them.  What's an extra grand or two in lawyer fees if you're going to be spending a lot to startup anyways.  Plus then you'll get real advice, not second hand from the internet.  This is good advice, but we don't know what state you're in, your products etc.  Talk to a lawyer.

 

If you're in the B camp then this is probably the best cheapest advice you can find.  But I'd still say talk to a lawyer!

 

Lawyers are expensive until you get sued.  I've surfed the net for business questions, spending hours and at times days looking for a good answer.  I've come to learn that in many cases my lawyer knew the answer and a simple email or call would have done.  If you have someone decent, someone interested in growing with your business they aren't going to nickel and dime you.  That is unless you're wasting a TON of their time.  Ask for all-in quotes on things as well.  I've asked for the price for doing something as a package, not on an hourly basis.  Usually cheaper and better for standard things like a trademark or form filings.

 

This is a forum of DIY people, but I've learned the hard way that professionals are often worth more than their hourly bill rate.  Learn to use them!

 

Thanks a lot!

I will talk to a lawyer to get started. I should register an LLC first right? And then employ myself from the LLC and get director and officer liability insurance? How much would that cost?

 

I don't think you need insurance, and registering as an LLC doesn't take more than $200.

[oddballstocks]

My impression has always been that a hedge fund is $50k+ in startup costs.  That only makes sense if you're going large from the start.  You mention having a few employees, presumably you have connections to raise capital already. 

 

If you want to run lean go the RIA method.  Seems like there are a lot of paranoid investors here.  If someone is paying you to manage their money why would they be looking over your shoulder hourly?  They probably have better things to do.  If not and they don't trust you fire them as a client, you don't want clients like that.

 

If you're in the A camp I'd just call a lawyer and talk this through with them.  What's an extra grand or two in lawyer fees if you're going to be spending a lot to startup anyways.  Plus then you'll get real advice, not second hand from the internet.  This is good advice, but we don't know what state you're in, your products etc.  Talk to a lawyer.

 

If you're in the B camp then this is probably the best cheapest advice you can find.  But I'd still say talk to a lawyer!

 

Lawyers are expensive until you get sued.  I've surfed the net for business questions, spending hours and at times days looking for a good answer.  I've come to learn that in many cases my lawyer knew the answer and a simple email or call would have done.  If you have someone decent, someone interested in growing with your business they aren't going to nickel and dime you.  That is unless you're wasting a TON of their time.  Ask for all-in quotes on things as well.  I've asked for the price for doing something as a package, not on an hourly basis.  Usually cheaper and better for standard things like a trademark or form filings.

 

This is a forum of DIY people, but I've learned the hard way that professionals are often worth more than their hourly bill rate.  Learn to use them!

 

Thanks a lot!

I will talk to a lawyer to get started. I should register an LLC first right? And then employ myself from the LLC and get director and officer liability insurance? How much would that cost?

 

I don't think you need insurance, and registering as an LLC doesn't take more than $200.

 

Depends on the state, $750 is PA. S-corp is only $125.

[Tim Eriksen]

thanks for the idea about IB, muscle.

 

As far as the series 7 goes, I don't know if you really need it to manage. It's a license to sale securities so if you've got someone else selling, you probably don't need it (but I could be wrong).

 

Selling securities? So if I run a hedge fund and try to sell some shares of my hedge fund, that would require series 7 right? But for investment advisory, that's probably not needed because I am not selling securities right? I have no plan to become a broker.

 

no you would not need the Series 7 to sell interests in your own hedge fund.  Just the 65, and not every state requires that.  WA does.

 

Ok. So my friends will be the main guys trying to get clients and I will mostly be trading and researching. Only I need the series 65 and my friends won't need series 7, is that right? So how can I ensure that my friends talk about the right things and right promises when they tell their clients? Do I have to train them?

 

You are getting into complex area with your proposed arrangement.  I recommend finding a good lawyer.  It is my understanding that if your friends are not officers or directors of the LLC or fund they will need to have a Series 7 in order to receive any compensation for bringing in clients.  Even if they are officers or directors their compensation may not be able to based on how much assets they bring in without being considered selling and subject to either a Series 65 or 7, you needing to file U-4's for them, and being responsible for oversight and at risk of being sued if they violate securities laws.   

 

It is another reason why you end up with one man shops. 

[muscleman]

You are getting into complex area with your proposed arrangement.  I recommend finding a good lawyer.  It is my understanding that if your friends are not officers or directors of the LLC or fund they will need to have a Series 7 in order to receive any compensation for bringing in clients.  Even if they are officers or directors their compensation may not be able to based on how much assets they bring in without being considered selling and subject to either a Series 65 or 7, you needing to file U-4's for them, and being responsible for oversight and at risk of being sued if they violate securities laws.   

 

It is another reason why you end up with one man shops.

 

Got it. So regardless of whether they are officers or not in the LLC, they have to pass series 7 in order to bring in clients? One of my friend is not a US person and he is targeting foreign clients, so does he still need the series 7?

It sounds like I do need to get director and officer liability insurance for both me and my friends. I will go talk to a lawyer.

[merkhet]

Yes, definitely go talk to a lawyer. As someone who used to be a lawyer and someone who currently runs a fund, even I get a little turned about with some of the random regulatory requirements for fund formation. A good specialist in fund formation is well worth his or her fee.

[Guest Schwab711]

thanks for the idea about IB, muscle.

 

As far as the series 7 goes, I don't know if you really need it to manage. It's a license to sale securities so if you've got someone else selling, you probably don't need it (but I could be wrong).

 

Selling securities? So if I run a hedge fund and try to sell some shares of my hedge fund, that would require series 7 right? But for investment advisory, that's probably not needed because I am not selling securities right? I have no plan to become a broker.

 

no you would not need the Series 7 to sell interests in your own hedge fund.  Just the 65, and not every state requires that.  WA does.

 

Ok. So my friends will be the main guys trying to get clients and I will mostly be trading and researching. Only I need the series 65 and my friends won't need series 7, is that right? So how can I ensure that my friends talk about the right things and right promises when they tell their clients? Do I have to train them?

 

You are getting into complex area with your proposed arrangement.  I recommend finding a good lawyer.  It is my understanding that if your friends are not officers or directors of the LLC or fund they will need to have a Series 7 in order to receive any compensation for bringing in clients.  Even if they are officers or directors their compensation may not be able to based on how much assets they bring in without being considered selling and subject to either a Series 65 or 7, you needing to file U-4's for them, and being responsible for oversight and at risk of being sued if they violate securities laws.   

 

It is another reason why you end up with one man shops.

 

Tim's right, you are heading towards lawyer territory fast.

 

Series 7: General Securities Rep (Allows you to talk to clients on behalf of the company; as a non-director/officer!)

Series 65: Investment Advisor/Registered Investment Advisor (Rep) - Sell security advice

Series 6: Represent an Investment Company and sell variable contract products

Series 66: covers 6/65 together

 

I do not know what you need for this hypothetical situation.

 

http://www.finra.org/industry/series6

http://www.sec.gov/answers/mfinvco.htm

 

As Tim mentioned, once you have any "non-partner" employees, things get messy. In addition to his response, you must ensure they are fully approved/registered (tests passed/reg submitted; YOU are responsible for them) and you must submit forms for payroll taxes and the like. It's worth getting a 3p payment processor at that point (PAYX). You'll also want insurance at this point (since you cannot fully control all of your liabilities).

 

To cover employees taking the series 6/7, you need to be a registered IC or B/D. They cannot take this test on their own and they require sponsorship. You need the 7 to start the company to sponsor folks so this is probably a requirement. They are always watching for shell-corps that just sponsor folks so you will likely be watched for the first few years. Either way, it's a LONG process to get approved as a 1940 Act company or B/D; this is not small potatoes. You want to be a HF so you'd probably go with IC (1940 Act). There are all sorts of state/fed registration (depending on size), advertising rules, fees for registration, min capital requirements (you will have custody of client $), and you need to register the securities of your company (you're an IC after all; they call them 1940 Act Companies and that designation is not fun). You will want checklists to make sure you are prepared or $ to pay good lawyers to prepare for you.

 

If you have more than one partner than registering your company is also a little more involved. Are you a partnership or S-Corp? Do you want to pass-through profits/losses? Are they registered/licensed?

 

Finally, HFs (as we all think of them) are a private investment vehicle meant for exempt investors (qualified investors) such as institutional investors (pensions, insurance companies, banks, other asset managers, businesses) with >$5m net wealth and individuals/couples with $200k/$250k income and [sometimes or] $750k/$1m net wealth. Double check these numbers. You are restricted on how/where you advertise and what you can say in an advertisement, so it's easier if they are knocking your door down to start. General rule of thumb is advertise one person at a time and only say things you can comprehensively prove (e.g. be careful talking about past returns unless they are audited, cannot mention successful investments unless you discuss ALL investments made, obviously no guarantees or alluding to a possible guarantee (past returns do not guarantee future profits), ect). The gov takes a lot of the fun out of managing money :).

 

It may not be ideal, but there's a reason most small managers (on this site and in general) have gone with the separately managed accounts setup (using a 1-man shop other than admins to help out). You should have a list of everything you need to cover (this thread includes nearly everything you need to start - just determine what is relevant for your situation and make sure your list is comprehensive).

 

One of the best pieces of advice I ever took was orientation of my first job. The CEO said the most important thing with a biz is to get a good accountant and lawyer. Oddball mentioned it the other day but I want to second it. TAKE THE BEST PROFESSIONAL HELP NECESSARY FOR WHAT YOU NEED. Whether it is an accountant, lawyer, doctor, or hooker; go for the best you can afford, once you know what you need/want. It's almost always a great value/worth the money.

[Jurgis]

Whether it is an accountant, lawyer, doctor, or hooker; go for the best you can afford, once you know what you need/want.

 

I did not know that you needed a hooker to start a HF.

Now I have additional motivation to go pro!  8)  ;D

[stahleyp]

for the folks who recently started a hedge fund or are thinking about it, how long have you guys been managing money? if you care to share, i'd be interested in knowing your performance too.

[Tim Eriksen]

A couple of books that I found helpful back in 2006 when I launched my fund:

 

US Regulation of Hedge Funds by Shartsis Friese LLP (law firm) about $100  it was updated in 2014.  Explains how to avoid registering as a broker/dealer or Investment Company, private offering exemptions, blue sky laws, etc.

 

THE RIA's Compliance Solution Book by Demby about $60 and looks like most recent is from 2006 but it walks you through a lot of rules and Form ADV filings should you do them yourself. 

 

[muscleman]

A couple of books that I found helpful back in 2006 when I launched my fund:

 

US Regulation of Hedge Funds by Shartsis Friese LLP (law firm) about $100  it was updated in 2014.  Explains how to avoid registering as a broker/dealer or Investment Company, private offering exemptions, blue sky laws, etc.

 

THE RIA's Compliance Solution Book by Demby about $60 and looks like most recent is from 2006 but it walks you through a lot of rules and Form ADV filings should you do them yourself.

 

Thanks a lot! I'd like to start as RIA first and then after a few years convert to a hedge fund or preferrably permanent vehicle.

[Ham Hockers]

Why do you want to start a hedge fund? Serious question.

[muscleman]

Why do you want to start a hedge fund? Serious question.

 

I like investing a lot more than my current job as a software engineer. The whole reason that I chose computer science was because I wanted to join a quant fund after graduation, but that's impossible in 2008. Then I got into Microsoft and got stuck as a green card slave until now.

But after learning investing for so many years, I am more interested in doing it on my own instead of joining a hedge fund and work for them.

[Mephistopheles]

 

But after learning investing for so many years, I am more interested in doing it on my own instead of joining a hedge fund and work for them.

 

I'm the opposite. I'm in the healthcare field and would love to manage money professionally. But I'd rather join another fund first. My returns are good and I think can handle running my own fund, I also have quite a few people interested in investing with me, without even marketing to them or telling them of my idea. But I want the satisfaction of having the proper training to build models and understand the knitty gritty of financial statements, which I know most on this board will say is not as important to know about, but it's more for personal satisfaction than anything.

[merkhet]

I'm the opposite. I'm in the healthcare field and would love to manage money professionally. But I'd rather join another fund first. My returns are good and I think can handle running my own fund, I also have quite a few people interested in investing with me, without even marketing to them or telling them of my idea. But I want the satisfaction of having the proper training to build models and understand the knitty gritty of financial statements, which I know most on this board will say is not as important to know about, but it's more for personal satisfaction than anything.

 

The first half will likely make you a worse investor, and the latter half will likely make you a better one. Perhaps the two will cancel out. :)

[Guest Schwab711]

I'm the opposite. I'm in the healthcare field and would love to manage money professionally. But I'd rather join another fund first. My returns are good and I think can handle running my own fund, I also have quite a few people interested in investing with me, without even marketing to them or telling them of my idea. But I want the satisfaction of having the proper training to build models and understand the knitty gritty of financial statements, which I know most on this board will say is not as important to know about, but it's more for personal satisfaction than anything.

 

The first half will likely make you a worse investor, and the latter half will likely make you a better one. Perhaps the two will cancel out. :)

 

I disagree on modeling, but I get why you say it :). I think there's a lot of value in building models since it helps an investor get a general conversion of growth/discount to P/FCF or P/E. It also provides a check of whether assumptions are realistic (can a niche company really grow at 20% for 10 years). I agree that models can be an investing crutch really quickly if decisions are made solely based on the output of one. Creating an intricate model should ultimately be just a map of how money moves around the financial statements and what the effects of potential improvements/downturns are. I don't use models as much lately but I have built a lot of generic and company/sector specific ones from over the years.

 

I always read Buffett's statement "that he doesn't model his investment decisions" as the result of experience. I bet he generally knows what the model will spit out at this point. It only happened from modeling so many companies.

 

I choose not to work on the sell-side because I didn't want to become a worse investor :). I hate that they force you to have a positive opinion [or even an opinion] so often. I think I would have taken a buy-side position over starting a fund so early if the

opportunity had been present.

[muscleman]

I'm the opposite. I'm in the healthcare field and would love to manage money professionally. But I'd rather join another fund first. My returns are good and I think can handle running my own fund, I also have quite a few people interested in investing with me, without even marketing to them or telling them of my idea. But I want the satisfaction of having the proper training to build models and understand the knitty gritty of financial statements, which I know most on this board will say is not as important to know about, but it's more for personal satisfaction than anything.

 

The first half will likely make you a worse investor, and the latter half will likely make you a better one. Perhaps the two will cancel out. :)

 

I disagree on modeling, but I get why you say it :). I think there's a lot of value in building models since it helps an investor get a general conversion of growth/discount to P/FCF or P/E. It also provides a check of whether assumptions are realistic (can a niche company really grow at 20% for 10 years). I agree that models can be an investing crutch really quickly if decisions are made solely based on the output of one. Creating an intricate model should ultimately be just a map of how money moves around the financial statements and what the effects of potential improvements/downturns are. I don't use models as much lately but I have built a lot of generic and company/sector specific ones from over the years.

 

I always read Buffett's statement "that he doesn't model his investment decisions" as the result of experience. I bet he generally knows what the model will spit out at this point. It only happened from modeling so many companies.

 

I choose not to work on the sell-side because I didn't want to become a worse investor :). I hate that they force you to have a positive opinion [or even an opinion] so often. I think I would have taken a buy-side position over starting a fund so early if the

opportunity had been present.

 

Same feeling here. Regarding the knitty gritty of the financial statements, you can learn by reading some great books like:

1. Quality of Earnings.

2. Financial Shenanigans.

3. What's behind the number

 

I have a friend in the PE industry and I have also contacted a few funds, pretending that I am interested in investing with them and then pointed to their largest position and said, oh I am scared of this one. This one has xxx problems so why are you buying it? Their answers are mostly unsatisfactory to me.

 

Personally I don't think they understand a lot of the quality of earnings and other accounting tricks. They look at models and they have the institutional imperative to buy whatever other funds buy.

 

[Ham Hockers]

I'm the opposite. I'm in the healthcare field and would love to manage money professionally. But I'd rather join another fund first. My returns are good and I think can handle running my own fund, I also have quite a few people interested in investing with me, without even marketing to them or telling them of my idea. But I want the satisfaction of having the proper training to build models and understand the knitty gritty of financial statements, which I know most on this board will say is not as important to know about, but it's more for personal satisfaction than anything.

 

The first half will likely make you a worse investor, and the latter half will likely make you a better one. Perhaps the two will cancel out. :)

 

I disagree on modeling, but I get why you say it :). I think there's a lot of value in building models since it helps an investor get a general conversion of growth/discount to P/FCF or P/E. It also provides a check of whether assumptions are realistic (can a niche company really grow at 20% for 10 years). I agree that models can be an investing crutch really quickly if decisions are made solely based on the output of one. Creating an intricate model should ultimately be just a map of how money moves around the financial statements and what the effects of potential improvements/downturns are. I don't use models as much lately but I have built a lot of generic and company/sector specific ones from over the years.

 

I always read Buffett's statement "that he doesn't model his investment decisions" as the result of experience. I bet he generally knows what the model will spit out at this point. It only happened from modeling so many companies.

 

I choose not to work on the sell-side because I didn't want to become a worse investor :). I hate that they force you to have a positive opinion [or even an opinion] so often. I think I would have taken a buy-side position over starting a fund so early if the

opportunity had been present.

 

Same feeling here. Regarding the knitty gritty of the financial statements, you can learn by reading some great books like:

1. Quality of Earnings.

2. Financial Shenanigans.

3. What's behind the number

 

I have a friend in the PE industry and I have also contacted a few funds, pretending that I am interested in investing with them and then pointed to their largest position and said, oh I am scared of this one. This one has xxx problems so why are you buying it? Their answers are mostly unsatisfactory to me.

 

Personally I don't think they understand a lot of the quality of earnings and other accounting tricks. They look at models and they have the institutional imperative to buy whatever other funds buy.

 

What is your break even AUM?

 

 

[Ham Hockers]

 

But after learning investing for so many years, I am more interested in doing it on my own instead of joining a hedge fund and work for them.

 

But I'd rather join another fund first.

 

This is 100% the way to go in my opinion. If you have no professional experience, just about any place where you can practice and learn about finance (yes even a sell side shop!) will be better than jumping immediately into your own start up hedge fund. We're not all Michael Burry.