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Hedge Fund Marketing & Fund Raising
Hedge Fund Sales, Marketing, Accredited Investor Crowdfunding, Websites & Hedge Fund Side Letter AgreementsWe offer assistance, legal advice and services concerning fund side letters, broker selling agreements, placement agents and finders, fund advertising, Rule 506(c) certifications of Accredited Investors, fund websites, and capital introductions.Contact Us for Assistance
Using Unregistered Brokers To Find Investors The use of individuals not registered as broker-dealers as intermediaries (“finders”) is allowed only if the facts lineup under a narrow exception to the rule. The general rule is sales commissions (i.e., any transaction-based compensation paid to a finder for selling interests in your fund is illegal. The SEC opposes the use of finders and has increased its enforcement actions against unregistered finders and placement agents (i.e., imposing liability). The SEC has increased its enforcement actions against funds using finders in violation of SEC regulations. Contact Us for Help
A Finder's Tale While working as an independent consultant for Ranieri Partners, Stephens actively solicited investors on behalf of private funds managed by Ranieri Partners’ affiliates and, in return, received transaction-based compensation totaling approximately $2.4 million. Stephens’ solicitation efforts included: (1) sending private placement memoranda, subscription documents, and due diligence materials to potential investors; (2) urging at least one investor to consider adjusting its portfolio allocations to accommodate an investment with Ranieri Partners; (3) providing potential investors with his analysis of Ranieri Partners’ funds’ strategy and performance track record; and (4) providing potential investors with confidential information relating to the identity of other investors and their capital commitments. By these actions, Stephens engaged in the business of effecting transactions in securities without first being registered as a broker or dealer or associated with a registered broker or dealer. Ranieri was a "finder" that crossed the line to "solicitor". Read the entire SEC Order
Finding Investors for Reg D Fund The starting point for finding investors is your direct contacts. For Rule 506(b) funds, you can raise capital from investors with whom you have existing relationships. You can also raise capital through intermediaries. When using intermediaries, a Reg D Rule 506(b) fund, you must make sure ensure that intermediaries follow the rules requiring substantive pre-existing relationships with any prospective investors and avoid advertising. The SEC takes the position that the relationship between an intermediary (e.g., broker/dealer, lawyer, or accountant) and the intermediary client can take the place of the issuer/investor relationship. Intermediary violations of securities rules expose you and your fund to the same liabilities as if you and your fund violated the rules. Contact Us For Help
Using RIAs to Find Investors Investment advisers registered with the SEC can sell interests in your hedge fund if the prospective offerees are clients of the adviser and the investment advice provided is suitable for each client.
Broker Dealer Placement Agents Only broker-dealers registered with FINRA can be paid sales commissions (i.e., receive transaction based compensation) for raising capital for your hedge fund. Before a broker-dealer will agree to be your fund's placement agent, it will perform a due diligence review of your fund and you. We can introduce you to sources of capital but have a fund performance report (Sample Performance Report) prepared so that we able to prove your ability to trade. Learn More About Due Diligence and Contact Us For Help
Advertising For hedge funds offered under Reg D Rule 506(b), advertising through television, radio, print, internet advertisements, cold calling (i.e., calling individuals that the issuer or its agents have no prior relationship with), distributing brochures to potential investors, setting up booths at shows, fairs, or other events and soliciting individuals or companies publicly via social media, print materials, email, group seminars and other mean with whom you do not have a pre-existing relationship is prohibited by law.
Hedge Fund Marketing Risks There are significant risks involved in marketing an investment fund, both from a regulatory and investor disclosure perspective. Take care when conducting marketing efforts to avoid running afoul of regulatory restrictions. The performance of the fund is the top consideration when raising capital. The key to marketable performance is showing consistent attractive performance over time (i.e., you cannot be a "one hit wonder"). Care must be taken to comply with regulatory requirements when disclosing fund performance.
New fund managers will need to rely initially on investors that are contacts of the management team and intermediaries. Typically, the starting point for finding seed investors is: direct contacts of the fund's directors, managers, officers, or employees. These individuals can raise capital from investors with whom they have existing relationships. Do not expect institutional level investors based on exceptional performance alone. While performance is necessary, a fund must also be of a sufficient size to satisfy the risk tolerance of large investors. Seed investor arrangements vary from fund to fund. Some seed investors expect ownership interest in the general partner, while others expect only concessions on fees. After the initial seed capital is raised, many funds find it advantageous to raise capital through a placement agent -- an intermediary that introduces the fund manager to capital. When using a placement agent, a fund must ensure that the placement agent follows the rules requiring substantive pre-existing relationships with any prospective investors, and avoid advertising and solicitation (unless conducting a Rule 506(c) offering, which allows advertising). Intermediary violations of the securities rules and regulations can subject the fund to the same liabilities as if the fund had committed the violations.
Regulation D Rule 506(c) Funds Reg D Rule 506(c) permits advertising but these funds cannot accept any non accredited investors. Learn More About Accredited Investors Rule 506(c) funds must file SEC Form D at least 15 days prior to engaging in advertising and allow the SEC to review their marketing materials in advance of their use with investors. Hedge funds operating under Rule 506(b) can file a Form D with the SEC within 15 after the first sale of the offering. Learn More About Filing SEC Form D
Rule 506(c) Funds Certification of Accredited Investors Under Rule 506(c), your hedge fund is permitted to engage in advertising and solicitation if: all purchasers are accredited investors and you take reasonable steps to verify that investors are accredited. The SEC issued a short list of methods that can be used to verify whether an investor is accredited. You can require your investors to obtain written certification from a licensed attorney, CPA or broker-dealer certifying that the professional has reviewed documentation indicating that the investor meets the accreditation standard; you can review your investors' recent IRS forms and let your investors self-certify their status as accredited or you can review bank and brokerage documents and let your investors self-certify their status as accredited.
Fund Factual Business Information Information not involving an offer of securities may be disseminated widely about a fund without violating Rule 502(c) of Regulation D. For example, factual business information that does not condition the public mind or arouse public interest in your fund is not an offer and may be disseminated widely. Information that involves an offer of securities through any form of general solicitation would contravene Rule 502(c). What constitutes factual business information depends on the facts and circumstances. Factual business information typically is limited to information about the issuer, its business, financial condition, products, services, or advertisement of such products or services, provided the information is not presented in such a manner as to constitute an offer of the issuer’s securities. Factual business information generally does not include: predictions, projections, forecasts or opinions with respect to valuation of a security, nor for a continuously offered fund would it include information about past performance of the fund. See SEC Division of Corporation Finance, “Compliance and Disclosure Interpretations” (August 6, 2015)
Hedge Fund WebsiteRule 502(c) of Regulation D prohibits a fund from offering or selling securities by any form of general solicitation or general advertising. As the SEC stated in Securities Act Release No. 7856 (Apr. 28, 2000), the use of an unrestricted, publicly available website constitutes a general solicitation and is not consistent with the prohibition on general solicitation and advertising in Rule 502(c) if the website contains an offer of securities.
Internet Offers Many countries do not treat information presented on a website as an offer unless it contains both detailed information and a means to subscribe (e.g. a subscription agreement). Other countries treat less detailed information as an offer but do not consider the offer to be made unless the information on the website is targeted at their residents. There are some countries that consider it an offer simply if any information is viewable by their residents. Countries in the latter group are not likely to target the issuer for enforcement activity unless there is evidence that the offer is targeted at their residents in some way. Countries concerned with Internet offerings and enforcement also show interest in the elements of push-pull marketing and volition. If a viewer "pulls" the information from the Internet, the information may not constitute an offer. If the information were "pushed" at the viewer (e.g., through e-mail) the information would treated as an offer.
The Bottom Line You must make sure your marketing activities for a Rule 506(b) fund do not rise to the level of a public offer. In just about any country, the best way to raise capital for your fund is to build on existing relationships. Use direct personal contact to identify prospective purchasers or to establish preexisting business relationships in the legal sense. A preexisting relationship is not an absolute requirement especially in situations where only a very small number of persons will be solicited. In larger offerings, however, if there is a preexisting relationship it is less likely that the larger numbers of offerees will result in an illegal offer.
Example Promotional Mailings A promotional brochure that solicits investors for a proposed Regulation D offering is intended to be mailed to the members of the Thoroughbred Owners and Breeders Association, to be distributed at a sale of horses, and to be run as an advertisement in a trade journal. The fund relies on the exception provided in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act to the definition of "investment company" in Section 3(a) of that Act. Sections 3(c)(1) and 3(c)(7) both require that a fund not make or propose to make a public offering of its securities.
Answer: These activities would constitute a general solicitation in connection with the offer or sale of a security, and therefore would render those aspects of Regulation D subject to Rule 502(c) unavailable. SEC Guidance Jan. 26, 2009
Example Press Releases A reporting company proposes to offer securities under Regulation D. Due to the fact of a large size and price of the offering, a fund feels compelled by Section 10(b) of the Exchange Act to issue a press release discussing the offering. Would such a press release by the issuer constitute general solicitation or general advertising, activities which are not permitted by Rule 502(c) in connection with most Regulation D offerings? The fund relies on the exception provided in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act to the definition of "investment company" in Section 3(a) of that Act. Sections 3(c)(1) and 3(c)(7) both require that a fund not make or propose to make a public offering of its securities.
Answer: The company should refer to the Rule 135c safe harbor for reporting issuers giving notice of proposed unregistered offerings. SEC Guidance Jan. 26, 2009
Example Targeted Solicitation If a solicitation were limited to accredited investors, would it be deemed in compliance with Rule 502(c)? The fund relies on the exception provided in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act to the definition of "investment company" in Section 3(a) of that Act. Sections 3(c)(1) and 3(c)(7) both require that a fund not make or propose to make a public offering of its securities.
Answer: The mere fact that a solicitation is directed only to accredited investors will not mean that the solicitation is in compliance with Rule 502(c). Rule 502(c) relates to the nature of the offering, not the nature of the offerees. SEC Guidance Jan. 26, 2009
Example Issuer Information What information can an issuer widely disseminate about itself without contravening Rule 502(c)? The fund relies on the exception provided in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act to the definition of "investment company" in Section 3(a) of that Act. Sections 3(c)(1) and 3(c)(7) both require that a fund not make or propose to make a public offering of its securities.
Answer: Information not involving an offer of securities may be disseminated widely without violating Rule 502(c). For example; factual business information that does not condition the public mind or arouse public interest in a securities offering is not an offer and may be disseminated widely. Information that involves an offer of securities through any form of general solicitation would contravene Rule 502(c). SEC Guidance Jan. 26, 2009
Side Letter Agreements Most offering documents allow the management team to negotiate special terms (side letter agreements) that are not applicable to other investors. Often the special arrangement involves better economic terms, such as reduced management or performance fees, or more convenient withdrawal terms. Care must be taken, however, not to allow side letters to prejudice other investors. For example; side letters that provide additional information rights or preferential liquidity treatment should be avoided.
We drafts side letter agreements and add the appropriate language to your offering documents authorizing side letter agreements! We also sell side letter agreement templates if you prefer to draft your own document. Contact Us For Help
The proliferation of side letter agreements has further complicated matters for both funds and potential and existing investors. Aside from the risk of side letter arrangements being held void from the beginning, grounds for challenge from other shareholders may exist if a side letter creates enhanced class rights that are detrimental to their own share holdings. The scope for litigation in the event of a dispute is also widened by the existence of a side letter, especially if it contains a choice of law clause. As a matter of good practice, the following conditions are crucial for the drafting of side letters.
A side letter agreement should: satisfy the relevant requirements and formalities needed for any contractual agreement to be binding; and be drafted so as to be governed by the same law as the memorandum and articles of association and formation. With respect to offshore funds, a review of the actual terms of a custodian/nominee agreement should be conducted in order to ensure that an agreement between the beneficial owner and the fund does not conflict with the original subscription agreement and the articles of association such that would render it ineffective. It is also necessary to ensure that parties to a side agreement have the necessary authority to enter into binding agreements; that a side letter does not conflict with the main contract (the memorandum and articles of association of the company); and the memorandum and the articles reference the validity and legal effect of any side letter.
Working with a Broker to Find Investors? Selling efforts by registered broker dealers with pre-existing, substantive relationships with prospective investors is allowed. If you use a broker to market and distribute your fund, obtain investors certifications to make sure that they qualify for investment in your fund, and that the statements in the subscription agreement are accurate. Procedures such as those outlined by the SEC should be established to limit delivery of the memorandum to persons who are qualified to invest in your fund. Either one person or a limited number of persons should control access to your fund's offering documents and keep records as to who has received your offering documents.
Create a Paper Trail Use questionnaires to establish or determine preexisting relationship, accredited investor status, sophistication, business experience, and/or prior investment with issuer. Questionnaires are helpful in terms of proving general marketing did not take place. SEC guidance indicates that a pre-existing, substantive relationship with the prospective investor can be established through a purchaser questionnaire providing sufficient information to evaluate the offeree's sophistication as an investor and financial situation. You must maintain adequate records of the number and names of the persons contacted in connection with your offering and of the nature and extent of your relationships with them. The goal here is to be ready to demonstrate that a solicitation was controlled, private, and not indiscriminate.
Selling Agreements Registered brokers can distribute information about your fund to their own customers even though the fund itself has no pre-existing relationship with the broker's customers. Brokers enter into selling agreements with fund managers to find investors for their funds as well as assist with strategy and market positioning. Brokers can identify prospective investors, arrange meetings to pre-qualify prospective investors in terms of overall suitability, accompany managers to investor presentations, prepare marketing materials, follow up with prospective investors, and act as client liaison throughout the investment period.
If you are considering whether to sign a selling agreement, there are a variety of issues to consider. The most important issue for sales in the U.S. market is whether the placement agent is licensed as a broker with the SEC and in the various states in which it intends to solicit investors. The placement agent will be selling securities (your fund) and getting paid and needs to have a license. The reason you can sell interests in your own fund without a sales license to investors is because you are covered by issuer exemption. Note that your staff cannot receive separate compensation for their sales efforts under the issuer exemption.
We can draft a purchaser questionnaire and disclosure if you use a placement agent or broker dealer to sell interests in your fund. Need a selling agreement? Contact Us for help.
Pre-Existing Substantive Relationships A “pre-existing” relationship is one that you as the issuer formed with an offeree prior to the commencement of the securities offering or, alternatively, that was established through either a registered broker-dealer or investment adviser prior to the registered broker-dealer or investment adviser participation in the offering. See, e.g., the E.F. Hutton & Co. letter (Dec. 3, 1985). A “substantive” relationship is one in which you have enough information to evaluate (and do, in fact, evaluate) a prospects financial circumstances and sophistication. Self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a “substantive” relationship.
If you share information about your hedge fund with members of a pre-existing informal, personal network of individuals with experience investing in hedge funds, this fact may allow you to establish a reasonable belief that the offerees in the network are financially sophisticated and such communications would not be illegal. The existence of such a pre-existing, substantive relationship is one means, but not the exclusive means, of demonstrating the absence of a general solicitation in a Regulation D offering. See Securities Act Release No. 6825 (Mar. 15, 1989), at fn. 12. Accordingly, an offer of the issuer’s securities to the person with whom the issuer, or a person acting on its behalf, has such a relationship would not constitute a general solicitation and, therefore, would not be in contravention of Rule 502(c).
Example Angel Investors & Networks There are circumstances under which an issuer, or a person acting on the issuer’s behalf, can communicate information about an offering to persons with whom it does not have a pre-existing, substantive relationship without having that information deemed a general solicitation. Selling practices exist where issuers and persons acting on their behalf are introduced to prospective investors who are members of an informal personal network of individuals with experience investing in private offerings.
For example, “angel investors,” share information about offerings through their network and members who have a relationship with a particular issuer may introduce that issuer to other members. Issuers that contact one or more experienced, sophisticated members of the group through this type of referral may be able to rely on those members’ network to establish a reasonable belief that other offerees in the network have the necessary financial experience and sophistication. Whether there has been a general solicitation is a fact-specific determination. In general, the greater the number of persons without financial experience, sophistication or any prior personal or business relationship with the issuer that are contacted by an issuer or persons acting on its behalf through impersonal, non-selective means of communication, the more likely the communications are part of a general solicitation. See SEC Guidance August 6, 2015
Example Special Situations Generally, the SEC allows “pre-existing, substantive relationship” to exist as a result of limited procedures established by broker-dealers in connection with their customers. This is because traditional broker-dealer relationships require that a broker-dealer deal fairly with, and make suitable recommendations to, customers, and, thus, implies that a substantive relationship exists between the broker-dealer and its customers. The SEC also has recognized instances where issuers have developed pre-existing, substantive relationships with prospective offerees. See, i.e., the Woodtrails — Seattle, Ltd. Letter (Aug. 9, 1982). However, in the absence of a prior business relationship or a recognized legal duty to offerees, the SEC believes it is likely more difficult for an issuer to establish a pre-existing, substantive relationship, especially when contemplating or engaged in an offering over the Internet. Issuers would have to consider not only whether they have sufficient information about particular offerees, but also whether they in fact use that information appropriately to evaluate the financial circumstances and sophistication of the prospective offerees prior to commencing the offering. Issuers may therefore wish to consider whether conducting the offering under Rule 506(c) would provide greater certainty that an exemption may be available for the offering.
Fund Demo Days & Venture Fairs Whether a demo day or venture fair constitutes a general solicitation for purposes of Rule 502(c) is a facts and circumstances determination. If a presentation by the issuer does not involve an offer of a security, then the requirements of the Securities Act are not implicated. Where a presentation by the issuer involves an offer of a security, the presentation at a demo day or venture fair may not constitute a general solicitation if, for example, attendance at the demo day or venture fair is limited to persons with whom the issuer or the organizer of the event has a pre-existing, substantive relationship, or have been contacted through an informal, personal network. If potential investors are invited to the presentation by the issuer or a person acting on its behalf by means of a general solicitation and the presentation involves the offer of a security, Rule 506(c) may be available if the issuer takes reasonable steps to verify that any purchaser is an accredited investor and the purchasers in the offering are limited to accredited investors.
Hedge Fund Seeding Arrangements Revenue sharing is a common hedge fund seeding arrangement. In this scenario, the seeder invests in the fund as an investor and the fund manager agrees to share a percentage of the fund’s revenues with the seed investor for an agreed period of time or in perpetuity, depending on the arrangement. Another hedge fund seeding arrangement is called the "equity stake". With the equity stake approach, the seeder acquires a percentage of the fund's general partner and exercise influence over the hedge fund operations. This arrangement is accomplished sometimes through a hedge fund platform where the fund becomes a sub-fund. Another hedge fund seeding model is “first-loss capital” approach. In this case, the seeder allocates capital into a separate managed account along with the hedge fund manager who matches capital with the seeder up 10 to 20 percent of the total managed account value. Trading losses, if any, are allocated to the manager before any are allocated to the seeder. Profits recuperated, if any, are allocated the manager until the losses are recovered. If the trading ends profitably, profits are split between the manager and seeder in accordance with their performance fee arrangement.
Building a Track Record & Seed Capital One option is to become a sub-adviser to a well-established hedge fund manager. At times, established investment manager are looking for new ideas and provide seed capital to a new money. As a sub-adviser, one works under the investment manager and builds a track record with the goal of starting a fund in the future. A second option is to create seeder share class in your fund. This requires that you offer discounted fees to initial investors your hedge fund for either a period of time or until the fund reaches a pre-defined amount of assets under management. Rather than the usual 2/20 fee structure, investors in the seeder share class are offered reduced performance and management fees (and this is a better approach than using a side agreement to reduce). Once the hedge fund reaches the pre-defined limits for the seed share class the seed share class is closed.
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