As you may already know, hedge funds are investment vehicles that pool capital generally from accredited investors, in order to employ on that capital varying strategies upon securities aiming for positive returns. In this article, we answer the question above and delve into the fundamentals of a simple domestic hedge fund structure, shedding light on the key components and documents involved in its formation.
Although a hedge fund can be structured a variety of way, in this article we assume that it is structured as a limited partnership (as it historically has been). Thus, structured as a limited partnership, the domestic hedge fund structure will typically involve the following key players and components:
General Partner (GP): Sitting at the top of the hedge fund structure are the persons who are responsible for managing the fund’s operations and making investment decisions. These two functions may be consolidated into one “general partner” or GP position, or one often sees the functions broken down into a separate GP responsible for managing the fund’s operations and a separate entity acting as the fund’s investment adviser. The reasons behind this will be covered later on. In either case, within the structure of the limited partnership, by statute, a “general partner” is the position with unlimited liability for the fund’s activities, however if an entity is serving as GP (and not an individual) then that entity will still enjoy the statutory limited liability protection provided to it by the relevant statute.
Limited Partners (LP): Then there are the individual or entity investors that put money into the fund, for the GP to manage. They contribute capital to the fund and have limited liability, meaning their losses are confined to the amount of their investment. LPs typically include high-net-worth individuals, institutional investors, and family offices.
Counterparties: the GP and the LP are certainly the two most important players involved in a hedge funds structure. Other than the foregoing, the hedge funds deals with a variety of counterparties that serves its operation, including but not limited to, accountants, auditors, fund administrators, brokers, attorneys, and more.
It is the hedge fund’s attorneys that take the initiative to draft the hedge fund documents. The fund documents are drafted to align with the fund manager’s investment strategy, which has experienced a successful track record over time. The documents involved in Forming a Simple Domestic Hedge Fund include the following:
Private Placement Memorandum (PPM): The PPM is a comprehensive document that outlines the fund’s investment strategy, risks, fees, and other relevant information. It serves as a disclosure document for potential investors, providing them with the necessary information to make informed investment decisions.
Limited Partnership Agreement (LPA): The LPA is a legal document that governs the relationship between the general partner and limited partners. It outlines the rights, responsibilities, and obligations of each party, including profit-sharing arrangements and withdrawal provisions.
Subscription Agreement: Investors commit capital to the fund through a subscription agreement. This document outlines the terms and conditions of the investment, including the amount invested, payment terms, and representations and warranties of the investor.
Formation Documents: The limited partnership and the entity that will be serving as the GP (often an LLC) are formed by filing the appropriate formation document with the Secretary of State of the State selected for formation. If the State is Delaware, then such documents would be called the Certificate of Limited Partnership and the Certificate of Formation respectively.
GP Operating Agreement: For a GP of the above structure that is an entity, the appropriate governing document is put in place for that entity (e.g. an Operating Agreement).
Compliance and Regulatory Documents: Depending on the jurisdiction and nature of the fund, additional documents may be required to comply with regulatory requirements. This may include filings with the Securities and Exchange Commission (e.g., Form D) or state securities regulators.
Conclusion:
Understanding the basics of a simple domestic hedge fund structure and the associated documents is essential for anyone considering forming a hedge fund. Working with experienced professionals, including legal counsel and fund administrators, is crucial to navigate the complexities and ensure compliance with regulatory requirements.
