Starting a Small Hedge Fund: A Comprehensive Guide for Family and Friends

Starting a small hedge fund can be an exciting venture, especially when sharing the investments with family and friends. However, it is important to approach this with a clear understanding of the legal and financial considerations involved. This guide aims to provide a step-by-step process and important legal pointers to help you establish a small hedge fund.

Understanding the Legal Framework

The rules for starting a hedge fund vary significantly from country to country. In the United States, for instance, you should engage a lawyer specialized in asset management to draft a partnership agreement between the manager and the investors. This agreement will outline the roles, responsibilities, and conditions under which the fund will operate.

Key Points to Consider:

Powers and Duties of the Manager: Clearly define the manager's authority to invest the assets and their obligation to provide regular reports and timely payouts to the limited partners. Contingency Planning: Include provisions for unforeseen circumstances, such as the sudden death of one of your friends, who might have had a vested interest in the partnership.

Step-by-Step Process

1. Legal and Compliance Basics

Start by ensuring that you comply with all relevant laws and regulations. In the U.S., you should engage a lawyer to draft a comprehensive partnership agreement.

2. Fundraising

Collect funds from your selected investors after clearly explaining the rules and terms. It is essential to maintain strict separations between the hedge fund's assets and your personal or other accounts.

3. Establish a Trading Account

Open a trading account exclusively for the hedge fund. Do not commingle the funds to avoid any legal issues.

4. Start Trading

Begin trading based on the investment strategy and guidelines established in the partnership agreement.

Alternatives and Considerations

If your goal is not to become a professional hedge fund manager, you might consider other options. For instance:

Interactive Brokers Friends and Family Account: This platform can be used for managing small investments with friends and family through a general partnership or an investment club. Fidelity Investments: Another option is to form an investment club and secure the necessary support from a financial services provider.

As long as all investors are accredited or sophisticated, you can start an investment club with fewer than 15 members to avoid federal or state registration. It is crucial to consult a lawyer to ensure that your strategy and investors align with the legal definitions and requirements.

Investment Clubs and Motif Investing

For those looking for a simpler solution, platforms like Motif Investing allow you to build a customized portfolio with your friends and family members. Motif provides exposure to a broader range of companies than you could achieve through individual stock purchases. You can enroll in an investment club or create a mutual fund-like structure funded by your circle of friends and family.

Sizing Up the Scale

To successfully start a small hedge fund, you need significant resources. According to industry standards, you should aim for an initial capital of at least 5 million USD. Additionally, appropriate tools, such as the right hardware and software, and trade information subscriptions, are essential. Bloomberg subscriptions, for example, can cost around 30,000 USD per year.

Regulatory Oversight and Profits

To operate a proper hedge fund, you must obtain a brokerage license, depending on your location. Regular reporting to government regulatory bodies about your holdings, assets, and exposures is also mandatory.

Apart from the financial aspects, you need to charge a management fee. A common structure is a 2-20 fee, which means a 2% service fee and a 20% commission on profits.

Conclusion

Starting a small hedge fund presents both challenges and opportunities. By understanding the legal and financial requirements, and choosing the right platform and tools, you can establish a successful investment structure with family and friends. Always consult with legal and financial professionals to ensure compliance and minimize risks.