February 14, 2017 | Fund Forum

ABCs of Fund Formation

4 min

So you want to form a fund – everybody's doing it, right? More and more entrepreneurs are exploring whether to form a fund to fulfill their business objectives. On the one hand, launching a fund is not brain surgery. On the other hand, to do it correctly and successfully requires careful planning and flawless execution.

Here are some critical questions to answer in anticipation of launching a fund:

  1. What type of fund are you launching (e.g., hedge, private equity, venture)?
  2. What is the fund's strategy (e.g., infrastructure, telecom, commodities, long-short)?
  3. How much capital do you intend to raise, and how often?
  4. What type of investors will be targeted (e.g., institutional, foreign, pension, high net worth, individual)?
  5. Will investors be located in the U.S., internationally, or both?
  6. Will investments be located in the U.S., internationally, or both?
  7. Do you envision allowing your investors to exit the fund at certain designated times (e.g., quarterly)?

Among other things, the answers to these questions will drive the structure, tax planning, and regulatory requirements of the fund.

For most funds, the following elements should be considered and/or implemented to ensure a successful fund launch:

  • Draft a Business Plan. Draft a detailed business plan. A good business plan can become the basis for your offering document, if one is required.
  • Identify Potential Investor Pool. Identifying the potential investors and their investment profile, background, and characteristics will save you time and effort in terms of the other elements of your launch plan.
  • Identify Advisers. Identify and engage critical advisers. Lawyers, accountants, tax advisers, bankers, administrators, custodians, prime brokers, and clearing agents may all be relevant to your fund.
  • Create a Checklist. Create a detailed checklist mapping out action items, deliverables, and timeline for launch. Fund launches can easily take 6-12 months, depending on complexity.
  • Create a Budget. Create a detailed budget. Many sponsors, particularly those launching their first fund, underestimate the total cost of the effort.
  • Identify Regulatory Requirements. Identify and evaluate applicable regulatory requirements, including (i) filings, (ii) offering and marketing requirements and restrictions, (iii) compliance programs, (iv) training, and (v) record-keeping.
  • Registration. Determine whether registration of an investment adviser and/or the fund will be required, and, if so, in which jurisdictions. This can be a technical and nuanced analysis.
  • Tax Planning. Proper and sophisticated tax planning affects many aspects of fund formation, including the economics for sponsors and investors, as well as applicable tax and regulatory requirements. For example, do you need an offshore feeder fund, and, if so, is Cayman or elsewhere the best foreign jurisdiction for formation purposes? Or are your potential investors familiar with the myriad of tax and regulatory disclosures and reporting requirements often applicable to an investment in a fund?
  • Compliance. Full compliance with regulatory requirements for registered investment advisers is required upon the effective date of the adviser's registration. Even advisers not registered with the SEC are required to comply with the anti-fraud rules under the Investment Advisers Act of 1940 and broader federal requirements such as anti-money laundering. Timely and effective implementation of the applicable compliance infrastructure is a critical element in launching and managing a fund.

Assuming you have successfully navigated the fund launch, the hard work truly begins with execution of the fund's strategy, sourcing deals, and managing investments. However, building a good foundation during the launch sequence greatly helps managers once operations begin. Moreover, careful planning during a fund launch also promotes a positive firm culture, which, in turn, is good preparation for managing communications with investors and oversight from auditors and regulators.

Managing the fund life cycle throughout launch, registration, fundraising, investing, compliance, examination, and, ultimately, exit requires many skills and resources. Fund formation is a nuanced and time-intensive process, the complexities of which are often underestimated. Poor planning wastes resources, ends up costing more, and potentially results in regulatory fines and penalties. On the other hand, careful planning maximizes the potential for success and the return on investment for all stakeholders.