What to Know About Legal Formation of an Investment Fund

Proper legal formation of an investment fund is an important step toward success. A word of caution: Do not use someone else’s or a prior fund’s set of legal documents and “tailor” them for your new fund! Besides the fact that those formation documents were created by a law firm that you are now plagiarizing from, the disclosure requirements and laws change on a regular basis. Even a six-month difference in timing will require you to make new disclosures. It’s not what’s in those older fund documents, it’s what’s not in them.

You may think that you have the same strategy and contemplated structure as the fund the old documents were written for, but it is very unlikely that they are the same. Moreover, there are probably many things you can build into your new fund that the industry hadn’t thought of previously; why miss the opportunity to build a better mousetrap?

Your fund offering documents are the “law” when it comes to how you run your fund, what your investing program is, and most importantly, the rules for how your investors are to be treated and how they should expect to be treated. Follow the letter of the “law” and you have done right by your investors. If you do not follow the fund documents and something goes wrong with the fund, the investors could be eligible to have all their invested capital returned to them. Yes, even if their account went down to zero because of the market and there was no negligence on your part, if you did or did not do something in accordance with the fund documents (even in good faith), investors can recover their invested capital from you. Are you ready to write that check?

You don’t have to spend a small fortune on creating your legal documents and structures, but these pieces of paper are ultimately what you will rely on to protect yourself and your investors. No fund strategy has ever failed because of the fund documents, but if something does go wrong (or even without something going wrong), you should have solid legal documents to stand behind.

Many new fund managers have built their careers at large banks, brokerage firms or money managers with deep pockets, and large institutional investors used to seeing big-ticket law firms’ names on all the documents. These are great law firms and they do have the capabilities to build fund structures that span the global markets and can ensure that investment strategies are legally structured for optimal tax efficiencies and global regulators. For 99% or more of new managers, this is not needed at all. With fund launches of $25 million dollars being major industry news, your new funds are not of a size that must deal with complex investment structures and multi-jurisdictional regulatory regimes that mandate the use of these large law firms. Instead, use one of the many excellent law groups that cater to the emerging fund manager. You can find a well-recognized firm in this industry that will construct a great fund for you for a fraction of the cost of the large firms’ fees. We commonly see these firms charge under $20,000 for all legal documents and filings, compared to the large firms’ services starting at five to ten times that amount. This is for a basic fund structure; if you have any complexities, prepare for the meter to be rolling with the large firms.

Many attorneys in the US will be large enough to have an office in offshore jurisdictions in order to finalize offshore fund structures. Others will have a relationship with law firms in offshore jurisdictions that can serve as the attorney of record for the fund.

In both situations, it is very common for the US attorney to draft all US and offshore fund documents and then send them to the offshore attorneys for review and comments. Expect to have a nominal offshore attorney fee added to your legal costs. This fee can be anywhere from $5,000 to $10,000 for the review and filing by the offshore attorneys.

Also note, most fund documents allow the investment manager to be reimbursed by fund for legal formation costs.  You can read more about that here:  The Fund Manager Gets Off Cheap When Starting Their Businesses!

In conclusion Key takeaways from this post:

  1. Do not use fund documents from other entities to start your fund
  2. Find a well qualified attorney that understands the fund structure and investment strategy
  3. You do not have to spend a ton of money on big name law firms


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