How to start a U.S.-based hedge fund with less than $25 million?

Hint: It may be easier and more cost-effective than you think!

Starting a U.S.-based fund with assets under $25 million requires a comprehensive understanding of the legal and regulatory framework. Smaller funds face unique challenges, but careful planning and adherence to the law can lay the foundation for long-term success. Our firm has the legal experience necessary to help you establish a compliant and functional investment fund in the United States.

Choosing the Right Fund Structure

The first step in launching a fund is selecting an appropriate legal structure. Most U.S.-based funds operate typically as a Limited Partnerships (LPs). These structures offer operational flexibility and limit liability for investors. The choice of structure depends on the fund’s investment strategy and target investor base.

For funds seeking to attract international investors, a master-feeder structure is common. This arrangement typically includes a domestic master fund and an offshore feeder entity, often established in a jurisdiction like the Cayman Islands. Such structures simplify investments for non-U.S. investors and provide tax advantages.

Funds under $25 million in assets must also comply with the Investment Company Act of 1940. Most smaller funds rely on exemptions under Section 3(c)(1) or Section 3(c)(7). Section 3(c)(1) allows for up to 100 accredited investors, while Section 3(c)(7) permits an unlimited number of qualified purchasers. These exemptions are vital for avoiding the stricter requirements of a registered investment company.

Start a Hedge Fund: Registering and Filing with Regulators

A critical legal requirement for fund managers is registering or making the appropriate filings with the appropriate regulatory bodies. Funds with less than $25 million in assets under management (AUM) are typically exempt from registration with the Securities and Exchange Commission (SEC). However, managers must still file as an Exempt Reporting Adviser (ERA), which involves submitting a Form ADV, which discloses information about the adviser’s business, conflicts of interest, and disciplinary history.

State-level registration may also be required, depending on the fund manager’s location. Each state has its own rules and thresholds for registration. Compliance with these requirements ensures that the fund operates within the legal framework of its jurisdiction.

Additionally, funds that rely on private placement exemptions under Regulation D must file Form D with the SEC. This filing notifies the SEC of the fund’s offering and confirms its adherence to the rules of exempt securities.

Drafting Essential Legal Documents

Proper documentation is crucial for a legally compliant fund. Key documents include the Limited Partnership Agreement (LPA), Investment Manager Operating Agreement, Investment Management Agreement, the Private Placement Memorandum (PPM) and Subscription Agreement.

In summary, the LPA governs the internal operations of the fund, detailing the roles and responsibilities of the general partner, the allocation of profits, and the decision-making process.

The PPM is a disclosure document that outlines the fund’s investment strategy, fee structure, and risks. It serves as the primary communication tool for prospective investors.

The Subscription Agreement is the contract between the fund and its investors, formalizing their commitment to invest and acknowledging the risks involved.

Engaging experienced legal counsel is essential for drafting these documents. Legal experts ensure that the fund’s documentation complies with applicable laws and protects both the manager and investors.

Anti-Money Laundering (AML) and Know Your Customer (KYC) Requirements

U.S.-based funds must implement robust AML and KYC procedures to comply with federal regulations. These measures help prevent money laundering and terrorist financing. Fund managers must verify the identities of investors, monitor transactions for suspicious activity, and maintain detailed records. Failure to comply with AML and KYC rules can result in severe penalties, including fines and reputational damage.

Minimizing Costs While Ensuring Compliance

Operating a fund with under $25 million in AUM requires careful cost management, outsourcing non-core functions such as compliance, accounting, and IT can reduce costs without compromising quality.

Small funds should also consider partnering with service providers that specialize in emerging managers. These firms often offer scalable solutions tailored to the needs of smaller funds.

Navigating Challenges and Scaling the Fund

Launching a small fund presents unique legal and operational challenges. Limited revenue from management fees—typically 2% of AUM—may not cover all expenses, necessitating a lean operational model. Additionally, larger investors often prefer funds with substantial AUM, making it harder for smaller funds to attract capital.

To overcome these obstacles, fund managers should focus on building a strong track record and cultivating relationships with early investors. Transparent reporting and consistent communication can build trust and encourage reinvestment. Over time, a history of strong performance can attract additional investors and facilitate growth.

Soreide Law Group, PLLC ǀ Your Law Firm for Setting-up and Managing a U.S. Fund. 888-760-6552

Establishing a U.S.-based fund with assets under $25 million requires meticulous attention to legal requirements and strategic planning. At Soreide Law Group, PLLC, we can help you select the appropriate fund structure, register or file with regulators, and draft comprehensive legal documents, so that you can operate a compliant and operationally sound fund.