How to start a hedge fund: Steps to make it happen

In 2023, the top 20 hedge fund managers collectively generated $67 billion in profits for their investors. Together, all hedge funds made a total profit of $218 billion, breaking the previous record set in 2021.

Even though launching a hedge fund poses several challenges, it also offers significant advantages. For example, hedge fund managers receive considerable compensation for their performance, and the tax benefits are great for high earners.

How to start a hedge fund business? How to register a hedge fund? What is the cheapest way to start a hedge fund? Find the answers in the article.

Hedge fund definition

A hedge fund is an investment company where the money of private investors is managed by professional hedge fund managers who use complex and risky investment strategies to generate returns. Those strategies include short-selling, derivatives, leverages, and alternative asset classes.

Hedge funds are regarded as risky investment choices in the process of investment banking and require a high minimum investment or net worth and target wealthy private investors.

Hedge funds are often considered as easy-to-establish-and-benefit-from ventures due to the following reasons:

• Hedge funds offer an attractive earning system, often referred to as “2 and 20,” which stands for a 2% management fee and 20% performance fee. It means that a hedge fund manager gets 2% of each investor’s shares and 20% of the profits the investment brings. 

• Hedge funds are less regulated, which makes it easier to start such an investment company if you have enough experience, prospective investors, and capital required for the fund to function. 

Note: If you’re interested in a merger arbitrage as one of the common hedge funds’ strategies, explore how does merger arbitrage work in our dedicated article.

Why start a hedge fund?

Based on our observations, these are the key reasons why you might choose to start a new hedge fund:

1. Potential for significant financial profit. Hedge funds offer flexibility in investment strategies, including leveraging and short-selling, which can potentially result in higher returns compared to traditional investment vehicles.
2. Portfolio diversification. Many hedge funds provide opportunities to spread risk across different asset classes and investment strategies, improving portfolio diversification and potentially reducing overall hedge fund risk.
3. Global investment opportunities. Access to global investment opportunities enables hedge funds to diversify portfolios, capitalize on emerging trends, and hedge against geopolitical risks, currency fluctuations, and market downturns.
4. Prestige. Managing a successful hedge fund can bring prestige and autonomy, give financial freedom, and attract sophisticated investors seeking to establish their presence and reputation in the financial industry.
5. Tax benefits. There are several techniques for tax optimization for hedge funds. Among them are offshore structures, tax-efficient trading strategies, and capital gains deferral. This helps to minimize tax liabilities for investment professionals, enhancing overall profitability.
6. Customization. Hedge funds offer high levels of customization, allowing for investment strategies tailored to specific investor preferences or market conditions.

How much does it cost to start a hedge fund?

Let’s refer to the calculations of Michael Coglianese, a boutique Certified Public Accountant (CPA) firm, and learn how much it costs to open a hedge fund.

Type of expense	Approximate cost	Description
Legal costs	$15K-$50K	Legal costs encompass establishing the hedge fund’s proper business structure, including setting up limited partnerships and any additional entities as required to ensure compliance and operational efficiency. Costs vary based on factors such as the choice of jurisdiction (domestic fund or offshore), the complexity of the structure, and the need for additional entities like master-feeder funds. Costs also include legal counsel who assists in drafting operating documents and investment agreements and addressing potential legal issues.
Administrative costs	$5K-$20K	Administrative costs cover services provided by hedge fund administrators, including portfolio and partnership accounting, compliance guidance, operational support, and managing investor relationship. Costs can vary based on the level of service, technology infrastructure, and support provided.
Investment compliance costs	$5K-$20K	Investment compliance costs involve setting up initial rules and regulations to ensure adherence to regulatory requirements. Compliance experts assist in creating compliance policies and procedures, ensuring compliance with regulatory bodies, and managing registration requirements. Costs may vary based on the complexity of compliance needs and the need for ongoing regulatory updates and monitoring.
Tax and audit costs	$5K-$20K	Tax and audit costs include third-party audit services that ensure compliance with reporting requirements outlined in offering documents or regulatory mandates. Engaging a reputable auditing firm familiar with industry standards helps ensure accurate reporting and adherence to regulatory guidelines. Additionally, tax specialists provide expertise in hedge fund taxation, minimizing tax liabilities, and mitigating legal risks. Costs depend on factors such as fund size, complexity of investments, and accounting accuracy.
Technology costs	Dependent	The cost of technology integration in hedge funds varies depending on the fund’s strategy and technological needs. Core technology essentials include internet connectivity, email hosting, secure data storage, and cybersecurity protocols. Additional costs may arise for automated trading strategies, real-time data access, and regulatory compliance requirements. Hedge funds must balance technology investments with risk management to ensure operational efficiency and mitigate potential disruptions.
Marketing costs	$4K-$20K	Setting a marketing budget allows hedge funds to establish a professional image, communicate their investment process, and reach potential investors effectively. Costs include the design and production of marketing materials, travel expenses for networking, and attendance of investor conferences.

How to create a hedge fund in seven steps

Starting a hedge fund should always begin with defining a viable and profitable fund’s investment strategy that is clear to your potential investors. Then, you’ll need to follow several regulatory steps to legally register your new investment company. 

Thanks to our practical knowledge, we have outlined seven regulatory steps on how to launch a hedge fund in the United States. 

1. File the articles of incorporation for your own hedge fund

To start a hedge fund in the US, you’ll need to create two business entities: one for the hedge fund itself, and the other for the hedge fund’s investment manager. The second entity will be your investment advisory company.

As a rule, hedge funds are registered as limited partnerships (LPs) or limited liability companies (LLCs). Contact the secretary of your state to get more details on what are the legal requirements for registering a hedge fund. 

At this stage, you’ll also need to come up with the fund’s name to complete all the necessary legal paperwork.

Additionally, you’ll need to apply for a Federal Employer Identification Number (FEIN) with the Internal Revenue Service — it’s free. You can do it online or by filling out the IRS Form SS-4. 

With this information, finalize filling out the articles of incorporation and wait for the company to be legally formed (usually, it’s pretty fast).

2. Create your corporate bylaws

To move to the incorporation of your company and register a hedge fund with the Securities Exchange Commission (SEC) and other regulatory agencies in the state, you’ll need to create your corporate bylaws.

The bylaws solely depend on a particular hedge fund manager, but usually include:

• Manual for supervisory procedures
• Ethical code of conduct
• Compliance manual
• Advisor’s portfolio-management agreement

3. Register your investment company as an investment adviser

To make the partnership legal, you need to register your company as an investment advisor. You can do it online on the Investment Advisor Registration Depository (IARD) website.

By obtaining the status of a Registered Investment Advisor (RIA), you get the right to advise high-net-worth clients on their investments as well as administer their portfolios.

4. Register your company representatives as investment advisors

After legally registering your fund as an investment advisor, you’ll need to register yourself (and all the hedge fund managers of your company) as the Registered Investment Advisor Representative (RIAR). 

You can do it online on the same website and take the Financial Industry Regulatory Authority (FINRA) Series 65 exam.

5. Write offering documents

Writing offering documents is one of the important starting hedge fund requirements to attract prospective investors. Offering documents explains your fund’s strategy and fund regulations.

Regulatory bodies require offering documents, and their range depends on the state where you’re registering your hedge fund—consult professional lawyers to make sure you prepare all the necessary documentation.

6. Register the hedge fund offering with the Securities and Exchange Commission

You’ll need to register the offering of the limited partnership with the SEC. For this, complete the SEC Form D in each state where your hedge fund will be operating.

This offering will have all the names of the key fund’s partners and large hedge fund investors, as well as provide a detailed hedge fund investment strategy.

7. Promote your hedge fund

Here’s the last step on how to open a hedge fund.

Without proper marketing, you won’t be able to attract wealthy investors. Make sure you have a viable and effective marketing strategy or at least are acquainted with enough prospective investors to form a seed capital.

It’s worth mentioning that due to the light regulations of hedge funds, they are more flexible when it comes to promotion. You can legally market your hedge fund to all the investors who satisfy the requirements.

Tips on setting up a hedge fund

To make the hedge fund start process even more efficient, keep the following recommendations in mind:

• Conduct thorough competitor research

If you want to make your hedge fund profitable, you have to ensure you have a competitive model and terms for potential investors. Study what the best hedge funds in your market have to offer before creating a strategy.

• Define your competitive advantage

Offering something that makes you stand out among other hedge funds improves your chances of being noticed by wealthy investors. It can be a marketing advantage of knowing lots of potential accredited investors who could establish your fund’s capital, or a trading advantage of having a unique investment strategy — pick something you’re good at and promote it.

• Determine a viable strategy

The accredited investors you want to attract to your hedge fund want to see a clear and viable strategy that will bring returns from their investments. Mind that strategies that were not used in the market before might discourage investors from investing money in your fund, as there is no evidence of its profitability.

• Develop a strong marketing plan

Developing a strong marketing plan is essential for attracting investors to your hedge fund. This includes crafting compelling messaging, targeting potential investors through various channels, and establishing a strong online presence.

• Get seed capital

Considering the fact that hedge fund managers work with wealthy clients, you’ll need seed capital sourcing to establish the capital of your new investment company. To find a seed-capital provider, you’ll probably need to have a strong network and a good professional reputation among investors.

• Ensure you have a professional lawyer

Having a good lawyer is a kind of investment when starting a hedge fund. With such a person on the team, you can rest assured that all the regulatory-required documentation is in place and that there are no pitfalls on your way.

Additional tip: It is also helpful to be ready with investment banking interview questions that you may need during the hiring process.

Extra details about starting a hedge fund: Structure, strategies, and challenges

Below are the basics of structure, strategies, and challenges of hedge funds described in brief.

Structure

The structure of hedge funds can be different, but let’s distinguish the following two types:

• Domestic

This type of hedge fund’s structure corresponds to the local regulations of the country where the hedge fund is registered and might be more interesting to its residents.

• Offshore

Offshore hedge funds typically serve the needs of foreign investors and adhere to foreign laws.

Strategies

There’s a broad variety of investment strategies used by hedge fund managers, but let’s define the three most common ones that depend on the investment goals: 

• Long or short equity

According to this strategy, investors go short and long on two competing companies that operate in the same industry.

• Fixed-income arbitrage

This strategy guarantees investors stable returns and targets capital preservation in taking short and long positions in fixed-income securities.

• Event-driven

This strategy takes advantage of temporary volatility in stock prices that is caused by such events as mergers and acquisitions, bankruptcy, takeovers, or restructuring.

Other important aspects of hedge fund strategies include:

• Scaling the hedge fund

The process of scaling a hedge fund may include attracting new investors, raising additional capital, expanding investment strategies or markets, and hiring additional staff. Effective scaling requires careful consideration of factors such as risk management, liquidity, regulatory compliance, and investor relations to ensure growth and long-term success.

• Exploring new markets

Hedge fund managers may seek new opportunities in emerging markets, niche industries, or alternative asset classes to capitalize on unique market dynamics, inefficiencies, or trends. For example, Bridgewater Associates was among the first to start investing in emerging markets, even despite concerns about political instability and economic uncertainty.

• Adapting to changing market conditions in 2024

Hedge fund managers should stay informed about macroeconomic trends, regulatory developments, technological advancements, and geopolitical events that may impact financial markets. For example, in 2024, they are advised to incorporate environmental and social metrics in their investments.

Challenges

Investors who want to establish their own funds face several common challenges on the way: 

• Raising capital

For the emerging hedge fund manager, it can be difficult to raise starting capital for their investment company to become attractive to potential investors. One of the solutions for this is a strong marketing strategy that will help your fund get noticed by high-net-worth individuals. Also, building a strong network among wealthy individuals is essential, as personal connections can significantly aid in attracting investment.

• Forming a strong hedge fund strategy

A viable and clear strategy is a cornerstone for any hedge fund. An emerging hedge fund manager should dedicate a lot of time to competitor research that will help define the most efficient investment strategy.

• Attracting institutional investors

By having a mix of characteristics that satisfy the requirements of institutional investors, your hedge fund will be an institutional quality hedge fund. This allows for attracting large sums of money to your fund.

• No experience

Lack of experience in the hedge fund industry can be a big challenge for new fund managers. Without a track record or credibility, it’s hard to attract early investors. Institutional investors prefer managers with proven expertise, so it’s important for new managers to get experience before starting their own business.

Key takeaways

Let’s sum up the basics of the information on hedge funds you’ve learned from the article.

• Hedge funds are investment organizations where investors’ money is managed by professional hedge fund managers who use rather risky strategies to bring returns.

• Starting a hedge fund, you need to contact the authorities of your country to get detailed instructions on what documentation to prepare.

• The overall cost of starting a hedge fund typically ranges from $40,000 to $140,000. Expenses include legal structure, compliance needs, technology requirements, and marketing strategies.

• The key reasons to start a hedge fund include the potential for significant financial profit, portfolio diversification, global investment opportunities, prestige, and customization.

• A viable strategy, strong marketing plan, and substantial seed capital are crucial when setting up a hedge fund.

• There are many types of hedge fund structures, but the most commonly defined are domestic and offshore.

• The strategy of the hedge fund usually depends on the investment goals, such as long/short equity, fixed-income arbitrage, and event driving. 

• The typical challenges an emerging hedge fund manager can face are capital raising, attracting institutional investors, and forming a viable strategy. 

Note: If you want to learn more about quantitative funds, read our dedicated articles.

FAQ

How to start a hedge fund with no money?

This is impossible to do due to the “nature” of the hedge fund. To attract high-net-worth investors to your fund, you’ll need to present it as a solid and reliable organization. And obviously, that requires a certain amount of money to invest. Some of the starting a hedge fund costs include marketing costs, tax and audit costs, back office costs, and technology costs.

How much money to start a hedge fund do you need?

The sum will solely depend on your hedge fund’s size and structure, but be ready to spend somewhere from $10,000 to $100,000 on marketing, software, taxes and audit, back office, and legal services.

What are the key service providers of the hedge fund?

The team of key service providers of your hedge fund should at least include a prime broker, independent third-party fund administrator, attorney, custodian, and public accountant.