Hedge Fund Structures Explained

Summary

In this video, Frank Nagy explains the key hedge fund structures, focusing on U.S. entities like the Limited Liability Company (LLC) and Limited Partnership (LP), both offering liability protection and tax benefits. He also discusses offshore fund structures, particularly in tax-free jurisdictions like the British Virgin Islands. The video covers how U.S. and offshore investors can invest in hedge funds through side-by-side or master-feeder structures. Frank emphasizes the importance of hiring a hedge fund consultant and highlights his book, 'The Ultimate Hedge Fund Guide,' for more information.

Takeaways

• 😀 Before starting a hedge fund, it's important to understand the various setup structures available.
• 😀 The two most common U.S. hedge fund structures are the Limited Liability Company (LLC) and the Limited Partnership (LP).
• 😀 Both LLCs and LPs provide limited liability, which is crucial for fund managers who are directly involved in day-to-day operations.
• 😀 In an LLC, liability can be adjusted based on the management structure, with managers bearing the greatest liability.
• 😀 In a Limited Partnership, the general partner has full liability, while limited partners have minimal liability if they are not involved in the management.
• 😀 Both LLCs and LPs are pass-through entities for tax purposes, meaning earnings and losses pass through to individual partners or members, who report them on their personal tax returns.
• 😀 Offshore funds are ideal for international investors, with tax-free jurisdictions like the British Virgin Islands (BVI) being popular for this purpose.
• 😀 BVI funds typically qualify as professional funds, requiring accredited investors and a minimum investment of $100,000.
• 😀 Offshore funds are often structured using side-by-side or master-feeder structures, depending on where the investors are located.
• 😀 In a side-by-side structure, U.S. investors invest in a U.S. limited partnership, while offshore investors invest in an offshore corporation, each with separate trading accounts.
• 😀 The master-feeder structure allows both U.S. and offshore investors to invest in feeder funds, with all trades conducted at the master fund level and reported to the separate feeder funds.
• 😀 Consulting with an experienced hedge fund advisor can simplify the process of setting up a hedge fund, ensuring access to the right service providers.

Q & A

What are the most common U.S. structures for managing a hedge fund?

The two most common U.S. structures for managing a hedge fund are the Limited Liability Company (LLC) and the Limited Partnership (LP). Both structures offer liability protection, tax benefits, and control features.

What is the main benefit of an LLC structure for a hedge fund?

The LLC structure provides liability protection, which is particularly important for fund managers who are directly involved in the day-to-day operations of the fund. It also allows flexibility in determining who runs the company.

How does liability work in an LLC compared to a Limited Partnership?

In an LLC, the liability of members (investors) is limited to their investment, and liability can be adjusted based on who is managing the company. In a Limited Partnership, general partners bear the full liability due to their involvement in management, while limited partners have minimal liability, as long as they do not participate in the management.

How are taxes handled in an LLC and a Limited Partnership?

Both LLCs and Limited Partnerships have pass-through taxation, meaning that the entity itself does not pay taxes. Instead, each member or partner receives a K1 form detailing their share of the profits or losses, which they report on their personal tax return (Schedule E of Form 1040).

What is the advantage of setting up a hedge fund in an offshore jurisdiction?

Setting up a hedge fund in an offshore jurisdiction, such as the British Virgin Islands (BVI), is beneficial if the investors are international, as these jurisdictions often offer tax-free benefits, which can be attractive for investors outside the U.S.

What are the legal requirements for a professional fund in the British Virgin Islands (BVI)?

To qualify as a professional fund in the BVI, the fund must only offer shares to accredited or professional investors, with a minimum investment of no less than $100,000 USD. Additionally, the fund must have an administrator, an auditor (optional but recommended), a custodial bank, and at least two directors.

What is the difference between a side-by-side structure and a master-feeder structure in a hedge fund?

In a side-by-side structure, U.S. investors invest in a U.S. limited partnership, while offshore investors invest in an offshore corporation. In a master-feeder structure, both U.S. and offshore investors invest through separate feeder funds, but all trades are conducted at the master fund level, typically located offshore.

What are the responsibilities of a fund manager in a hedge fund structure?

The fund manager is responsible for the day-to-day management of the hedge fund, including making investment decisions, managing trades, and ensuring compliance with legal and regulatory requirements.

What is the role of a general partner in a Limited Partnership structure?

In a Limited Partnership structure, the general partner is responsible for the management of the fund and assumes full liability for the fund’s operations, as they are directly involved in the day-to-day management.

How does hiring a hedge fund consultant benefit a new fund manager?

Hiring an experienced hedge fund consultant, such as Frank Nagy Financial Services, helps reduce the complexities of setting up a hedge fund. The consultant can provide guidance on legal structure, tax considerations, and introduce the right service providers to meet the hedge fund’s needs.