Incubator Funds An "incubator" fund provides a low cost way to build a marketable performance record. An incubator fund is a startup hedge fund seeded with the founder's (also called the "sponsor") own money. Nothing teaches capital preservation like having "skin in the game" and future investors like to see that you are personally invested in the success of your own fund. We break down startup costs into a two-step process. There is no redundancy as it costs the same amount for the full fund setup as it does for our two-step process.
No "Friends and Family" Exceptions There is no "friends and family" exception to the law. If you charge fees, or have investors, you are setting up a full hedge fund. We have learned through experience that what many people consider an "incubator" fund to be is a fully functional fund. Click Here to Learn More About Hedge Fund Offering Documents
Incubator Fund Costs The cost to form an incubator fund is lower than the cost to form a fully operational hedge fund. The incubator fund can b(always) be converted to a fully operational fund at any time. Since an incubator fund formation involves much of the same work needed to form a fully operational hedge fund, no money spent to set up the incubator fund needs to be spent again to convert it to a fully operational fund. Contact Us for Incubator Fund Prices
Incubator Fund Administration You do not need a fund administrator to start and run an incubator fund. Postponing the need to hire a fund administrator is another reason to establish an incubator fund first. Once you have outside investors, charge performance and management fees and are fully operational, then consider hiring a fund administrator. Fund administrators provide net asset value calculations, monthly reports, performance tear sheets, performance and management fee calculations, tax preparation services and tax accounting services. There are varying levels of hedge fund administration services available. Your fund administrator can be a real help when it comes to running a hedge fund. Unlike many other countries, the United States does not require you to hire an administrator for a hedge fund. Some states require a fund manager, if he is based (and licensed as an RIA) in that state, to hire a "gate keeper" for a hedge fund but using a "gate keeper" is not the same as having full fund administration services. In the United States, administrator are not required to be licensed. Learn More About Hedge Fund Administration, Taxes and Audit
Already Have a Trading Track Record? We create the hedge fund performance reports and marketing tear sheets you will need to present your hedge fund to investors. Click Here For A Sample Fund Performance Report & Tear Sheet An incubator fund (or your personal trading history) does not need a full financial statement audit prepared by an auditor. What it does need is a performance report or compilation prepared by a licensed accountant. Learn More About Hedge Fund Accounting We offer outstanding hedge fund administration, NAV services, custodial services and tax return filing services. Contact Us for a Free Consultation
Standard Incubator Fund Structure In the United States (only) an incubator fund structure requires a Delaware limited partnership (LP) as the fund entity and a limited liability company (LLC) as the management company entity (i.e., two companies). The LLC is usually based in your home state, but there are other planning options available to you. You will invest in your LP as the initial "seed capital" investor. Both the LLC and LP are the same entities used when the fund is converted to a fully-operational fund. There is no need to create additional companies in the future using this approach.
New Approach Incubator Fund Structure Recently, we have seen the opportunity in the United States to use a Delaware LLC alone as the incubator fund. This approach requires more expense in the future (to convert to a fully operational fund) than the standard incubator fund involving two companies at onset. The reason for this is that the legal work is more difficult See See World's Favorite New Tax Haven Is the United States and Learn More About the Benefits of Delaware Companies
Complex Incubator Fund Structures In some cases we suggest tiering a Delaware LLC above a Florida LLC for regulatory and tax purposes. Ask us about this option. If you live in a high tax state or country you may consider setting up three companies: the hedge fund, the investment management company (i.e., the company where discretionary trading authority and decisions take place) to receive the carried interest share in the future (i.e., the performance allocation) and a management company to receive the management fee in the future (i.e., the company where management of the fund's books and records takes place). We can help you plan complex structures for tax and regulatory purposes. We have learned through experience that what many people consider an "incubator" hedge fund is in fact a fully functional hedge fund. There is no "friends and family" legal exception either to the rules. If you charge fees in the United States, you are not setting up an incubator fund. Contact Hedge Fund Attorney Hannah Terhune for a Free Consult
How are Incubator Hedge Funds Taxed? The U.S. incubator fund is taxed as a pass-through entity. This means that the incubator fund's realized gains and losses are taxed at the investor level. The tax character (i.e., ordinary income or capital gain treatment) of the gains and losses pass through to the investor (i.e.,reported on IRS Form K-1). Learn More About Hedge Fund Taxation Offshore incubator funds are set up as corporations, generally, and with respect to U.S. investors, can work as UBTI blockers.
How much money do I need to seed the incubator fund? There is no minimum investment amount. You are just trying to create a performance percentage based on real time trading. See a Sample Performance Report & Tear Sheet
Hedge Fund Banking and Brokerage Services For either banking or brokerage services, you cannot use your personal account as the hedge fund’s account. The hedge fund needs its own bank and brokerage account. If you are our client, we can introduce you to bankers and brokers who may be interested in working with you and your new hedge fund. Contact Us for Assistance
Can I gather indications of interest from potential investors during the incubation phase? Yes. Performance information about the incubator hedge fund can be provided to preexisting and potential contacts at any point after the fund's inception. You can gather indications of interest through your personal network, friends and family (i.e., persons with whom you have a pre-existing relationship). Learn More About Attracting Investors
Can I operate more than one incubator fund? Yes. Some managers will incubate multiple funds in order to develop track records for different strategies.
Using Personal Performance Data Versus Incubator FundYou can use proprietary trading data to market yourself. However, you cannot use that proprietary trading data to market a new hedge fund. Over the years the SEC has issued rules for performance advertising through a series of enforcement actions, "no-action" letters and interpretive letters. The SEC rules are very difficult to follow. First of all, if you are not a registered investment adviser, you have no business advertising your services as such. You should not be soliciting clients, holding your advisory services out to anyone or marketing your prior performance results. You have no license. Investment adviser advertising, including performance advertising, is governed by Rule 206 of the Investment Advisers Act of 1940. If you are not SEC licensed, you are subject to state investment adviser law. None of the states allow you to advertise your services (i.e., hold them out to others) without state registration as an investment adviser. Learn More About SEC Registration An ad is a written or oral communication addressed to more than one person which offers investment advisor services. It is something communicated to attract or maintain clients. The SEC gives a broad brush to the concept of an ad. It also gives a broad reading to what it considers false, misleading or untrue. This means that if every single sentence of your ad is true but the over-all effect is deceptive and misleading, the SEC views it as fraudulent. Learn More About Hedge Fund Marketing The sniff test for fraud is so subjective that the SEC won't give advice as to whether an ad is misleading. Contact Us for Assistance
Funding the Incubator Fund With very few exceptions, the incubator fund should not accept outside investors. Even investment from close friends and family can run afoul of state and federal securities law, especially if they are non-accredited investors. You should not borrow capital from others to invest in the incubator fund. The regulators look through this arrangement. You should consult with us prior to accepting any outside funds from any source.
Can I add or withdraw money from my incubator fund? Yes. The track record of the fund is measured as the percentage return of assets under management, regardless of the amount of capital contributed to or withdrawn from the fund. Learn More About Hedge Fund Performance Reports
Should I Make a Mark-to-Market Election? Yes, the fund has to qualify by its level of trading activity to be able to make the mark-to-market election. Learn More About Mark-to-Market Election
CALL US FIRST We are experts. Click on any reference below to our leading articles:
Strategic Hedge Fund Planning by Hannah Terhune. Wilmott Magazine Ltd. (Volume 2013, Issue 63, pages 8-11 January 2013).
Trading Foreign Index Contracts? Know the Tax Rules Before You Trade by Hannah M. Terhune and Roger D. Lorence. Stocks, Futures and Options (June 2005).
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