Investment funds, hedge funds, alternative investment funds: formation
- John Deane
- Updated: Tue, 25th Oct 2016
Investors increasingly scrutinise investment or hedge funds. This is primarily due to overall underperformance compared to traditional asset classes. However, investment funds permit a risk allocation and access to assets otherwise outside an investors’ traditional portfolio. Thus, hedge or investment funds remain attractive.
We act for investors, funds, and management and advisory entities.
Our investment fund services include
Investment fund structure
First we assess your fund’s prospectus and overall intentions. Fund structures are flexible, which we tailor to meet your requirements.
Initial considerations for every investment fund
Key questions we ask include:
- Is the fund open or closed, i.e.
- Will investors redeem their interests?
- Who markets the fund? and:
- Are administrative functions based in the UK?
- If the fund is UK managed:
- Will a limited liability partnership manage the fund?
- What fees will the fund pay the management entity, and note:
- Often we find the traditional 2/20 model is no longer industry standard;
- Who is the funds’ target investor?
When we understand the issues, we’ll suggest appropriate structures, then discuss their pros and cons. We aim to quickly clarify your decision.
Enabling the selected structure
We create the documentation. For offshore funds, we often use our network of international lawyers. Your fees are lower compared to traditional international law firms. Our regular partners often agree fixed prices.
Documentation for the structure
If we were involved in the selection, we often provide a fixed quote for the documentation. Documentation for each fund differs, but usually includes:
- Trust deed or company incorporation documents;
- Prospectus for investors;
- Management agreement between the fund, its managers and advisors;
- An LP or LLP agreement for the management or advisory entity;
- Side letters giving initial investors preferential rights;
- Equity interest agreement between the fund and management or advisory entity.
LLP agreement or LP agreement
The management or advisory entity usually operates as an LLP or LP. If you have already incorporated the management or advisory entity, then we update the members’ agreements to cover the new fund.
Standalone or original funds require an LLP or LP agreement, signed by the management or advisory members. The agreement covers each members:
- Profit entitlement,
- Linked to the receipt of performance fees;
- Capital entitlement;
- Exit route and associated impacts.
- Bonus pool and allocation of bonus points;
- Terms of carried interests;
If the management/advisory entity operates as an LLP or LP, then the entity is tax transparent. However, disguised remuneration rules may apply. We navigate these complex rules.
It’s common for investment funds to locate offshore to utilise tax breaks. We use our network of international lawyers for the incorporation and management process.
Funds in Ireland and Luxembourg
These day, funds often locate in Ireland and Luxembourg which also gives access to the EU. Funds are subject to these jurisdictions’ rules and procedures. As with management functions undertaken in the UK, managers in these jurisdictions must be authorised by appropriate bodies, e.g. the Central Bank in Ireland.
Hedge funds targeting US investors
If your fund targets US investors, then a feeder structure is usually appropriate. A feeder structure provides “two feeds” into the fund, each with different roles:
- First feed: an offshore company to attract non-US and US tax-exempt investors.
- Second feed: a US registered LLC or LP to attract US taxable investors.
It is an offence to carry on a regulated activity in the UK without the Financial Conduct Authority’s authorisation. The Financial Conduct Authority lists the “regulated activities”. Any involvement with a fund is probably a “regulated activity”.
Usually, an LLP undertakes management or advisory functions, e.g. marketing, arranging, and placing. The LLP must be authorised, as must anyone carrying on regulated activities.
FCA authorisation process
The authorisation process takes from 3 to 9 months, depending on the FCA’s due diligence. The application includes:
- Managers and adviser’s core details;
- Regulatory business plan;
- Scope of permission notice, i.e. the managers and advisers intentions;
- Controllers form;
- Disclosure of significant events; and
- Appointed representatives form.
We can tell you if you require authorisation for your managers/advisers input.
The tax treatment depends on the funds location. If the fund is “offshore” then tax breaks are available. However, you’ll lose offshore tax breaks, if the managers or advisors:
- Are located in a jurisdiction that is “onshore” for tax purposes; and
- Undertake functions that directly manage the fund; and so
- Bring the fund “onshore” for tax purposes.
There are solutions, which we’ll discuss.
Maximise investors’ returns
Every investor has their own investment agenda. Most investors seek a realised certain return for income purposes. However, e.g. a closed end fund can still focus on delivering a capital return on closure. Closure may constitute a fixed three year tie-in period.
UK investors tax & Reporting fund status
There are special considerations for individual fund investors in the UK. Their tax treatment depends on whether HMRC grants the fund “reporting fund” status. We often apply for reporting fund status. Reporting funds enjoy tax advantages, at the cost of a regulatory reporting burden.
Typically, UK investors are taxed on the income they receive from the fund, i.e. in the form of dividend tax. Currently, the dividend tax credit is £5,000.00. The reporting fund status determines the tax position for capital returns. If you don’t meet particular criteria, HMRC taxes capital returns as income, whatever your prospectus or fund documents state.
Investment funds take many forms. Funds differ in size, structure, market, and assets under management. We appreciate the commercial drivers behind the chosen structure.
We do more than just prepare documents to incorporate or register the fund and management entities. Our tax knowledge and commercial experience means we deliver practical advice. Combined with our access to lawyers in offshore jurisdictions, you get the full picture .