How To Start Your Own Hedge Fund | Joe Ponzio's F Wall Street

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How To Start Your Own Hedge Fund

December 8, 2008 by Joe Ponzio

What does it take to start a hedge fund? The scary truth is that virtually anyone can start a
hedge fund; and, it can be fairly inexpensive and easy to do. Why is this so scary? Among
other reasons, hedge funds can attract investors while providing very little information; so,
investors may not be able to make well-informed decisions. Then, hedge funds dont need to
provide regular (or audited) information on an ongoing basis. If your manager is a crackpot
and you have to stay invested for the remainder of the year (or quarter or whatever), you
could wind up with very severe losses.
(Prospective investors should choose very carefully.)
Of coursethat wont stop me from telling you how to set up a hedge fund. After all, I get a
kick out of divulging Wall Streets billion dollar secrets for free.

THE HEDGE FUND ENTITY

Hedge Funds are typically structured as:
a limited (or limited liability) partnership, or
a limited liability company, or
a trust.
What structure you choose depends entirely on what you want and the laws in the state in
which you are forming. (Non-U.S. readers should explore the entities in their home countries
as well.)
For the remainder of this article, Ill be referring to the most common hedge fund structure
the Limited Partnership, or LP.
To set up a limited partnership is fairly easy and inexpensive. In Illinois, you answer six
questions on a fill-in-the-blank form, get a cashiers check for $150, and send it to the
secretary of state. How tough are the questions? If you can come up with a name and write
your address, you are in business.
Running Total: $150.00

GETTING THE TAX ID NUMBER

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Youll need to get a tax id (FEIN) number from the IRS. Simple enough go to the IRS
website and get it online in a matter of minutes. Its fast, easy, and free.
Running Total: Still $150.00

BECOMING AN INVESTMENT ADVISER

If you will have 15 or more investors in your hedge fund, youll need to register as an
investment adviser with the SEC. (Note: That doesnt mean youll have to register the hedge
fund. Well get to that in a bit.) If youll have less than 15 investors, you may still have to
register in one or more states. (See Rule 203(b)(3)-2 of the Investment Advisers Act
of 1940.) Id play it safe and register with the SEC. Its not scary theyre actually there to
help you so long as you are not defrauding investors.
To become an investment adviser, youll need to sit for a regulatory exam the Series 65.
The Series 65 is a 3-hour, 140 question exam, of which 130 count towards your final score.
Its not the hardest exam in the world (part of the scary conversation above); but, youll
need to score a 68.5% or better to pass.
The Series 65 doesnt teach you a darn thing about investing. Instead, its a minimum
competency exam designed to test your ethics and understanding of basic securities laws
and practices. A study guide and a few hours of quiet reading can make you a pro.

SCHEDULING YOUR EXAM

Your state will generally sponsor you to take the exam (as opposed to the Series 7, which
requires a firms sponsorship); so, you fill out Form U-10, sign over a check for $120, and
schedule your exam.
Once youve successfully completed the exam, you are now licensed (though not yet
registered) as an investment adviser.
Running Total: $270.00

THE REGISTERED INVESTMENT ADVISOR VS.

INVESTMENT ADVISOR REPRESENTATIVE
At this point, you have a decision to make Do you run your partnership/advisory business
as a sole proprietor (eg., Joe Ponzio Sole Proprietor) or do you (as is more commonly done)

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create an investment advisory company to shield yourself from personal liability (eg., Joe
Ponzio Funds, Inc.)?
To be safe, you create a corporation (or LLC, whatever) to act as general partner of your LP.
(Your investors will be the limited partners). Youre cheap; so, you create your Illinois
corporation for $175 instead of expediting for $300. Once incorporated, youll get a FEIN for
your company as well.
Thus, you will personally be the Investment Advisor Representative (IAR) of your company,
which will act as the Registered Investment Advisor (RIA).
Running Total: $445.00

REGISTERING YOUR RIA AND IAR

Youre just about there. First, you have to register your company as the RIA, which you will
do through the Investment Adviser Registration Depository (IARD). The instructions are on
the IARD site; so, Ill spare you the details. Its not rocket science; but, it will likely take
you a few hours to figure it all out. (When I was starting my firm, I spent the better part of
three months figuring all of this out. Then again, I didnt have an article like this one to
read!)
As of the time of this writing and through July of 2009, it is free to set up your firm on the
IARD system.
Once your firm is set up, youll need to register yourself with your firm by filing a Form
U-4. Coming in at 28 pages, it looks like a beast. (You can also file it electronically.) So long
as you dont have a lot of disclosures (eg., if youre not a criminal), you wont fill in half of
them.
Submit your U-4 with a $30 check
Voila! You are now an investment adviser, running an investment advisory firm
and a hedge fund.
Total Cost: $475.00
I told you that it was scary easy.

SOME THINGS TO CONSIDER

For less than $500, you could technically be in business. Youll need a few things to get

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started:
For Your Investment Advisory Firm:
By-laws
Compliance manual
Code of Ethics
Supervisory Procedures Manual
Investment Adviser/Portfolio Management Agreement
Everything else to run your business (website, business cards, etc.)
For Your Hedge Fund:
A LP agreement
Private Placement Memorandum
A presentation or brochure about your proposed investment style (needed for capital
raising and road shows)
A custodian/brokerage account to house the funds securities
along with checking accounts, etc.
If you are feeling really cheap, you can find a lot of this stuff online, and then tweak it for
your business; or, you can pay a compliance service to provide you with many of these
things.

REGISTERING YOUR HEDGE FUND WITH THE SEC

Hedge funds dont technically register with the SEC. Instead, youll have to register your LP
interests offering (corporations have stock; LPs have interests; LLCs have memberships;
trusts have units of beneficial interest) with the SEC if you are offering the hedge fund to
investors other than friends and family. Soyou dont register your fund; you register your
offering, usually under Rule 506 of Regulation D of the Securities Act of 1933.
Though there is no fee for registering your offering, you will have to get a CIK number from
the SEC and file Form D with the SEC and with each state in which you plan to offer or sell
interests.

OBVIOUSLY
Having gone through a lot of these steps over the years, its a lot easier for me to say than for

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you to do. Though I spent a few months digging around in the dark to get my firm started, I
can now say that it is not all that difficult or expensive if I had to start over again.
As you can see that hedge funds are not as mysterious as Wall Street wants you to believe. In
the end, a hedge fund is a partnership not some special entity that has a general partner
(you or your investment firm) and limited partners (your investors).
Then again, dont mistake this article as advice or compliance help. This is a broad overview
of how to set up a basic hedge fund. The laws, rules, and regulations can change; so, make
sure you are up to speed based on your situation.

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