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HEDGE FUNDS, PRIVATE EQUITY FUNDS, & VENTURE CAPITAL FUNDS

Investment fund sponsors with profitable investment ideas often desire to establish a private investment fund to raise capital and pursue their investment strategy.

Part of the discussion often revolves around what type of fund that the new fund will be. Almost all funds can be described as a hedge fund, private equity fund, or venture capital fund. (Real estate funds are discussed separately here) Each of these fund types is discussed below.

  • A hedge fund is a portfolio of stock and/or commodities that the fund manager purchases, often using leverage (borrowed funds using the securities purchased as collateral for the loan). Most hedge funds focus on active trading and providing returns in the short term. Many hedge funds provide for the fund manager to be paid a management fee plus a performance fee equal to a percentage of the fund’s gains.
  • A private equity fund is a broad term used to describe a fund that invests in other companies for long-term gains. The term private equity fund encompasses leveraged buyout funds, which raise equity and borrow money to buy companies, to more passive funds that have a broad portfolio of holdings which the fund manager expects to increase in value. In some private equity funds, the investors may not invest all of their monies upfront; rather, they may commit to making capital contributions as needed. This capital commitment structure is more prevalent in buyout funds than more passive funds. Private equity funds almost always provide for the fund manager to be paid a management fee plus a performance fee equal to a percentage of the fund’s gains. In addition, the fund sponsor (which may be an affiliate of the fund manager) may receive compensation for additional services, which may or may not be credited against the fund manager’s fees.
  • A venture capital fund invests in debt and equity of private companies. The fund manager selects private companies that it believes will provide superior returns over the long term (5 to 10 years). A venture capital fund will usually seek to exit its investment through an initial public offering of the portfolio company or via a buyout of the portfolio company. Like the other funds discussed above, the fund manager is usually compensated via a management fee plus a performance fee.

Sometimes, a fund can be a hybrid fund that straddles more than one of these categories. For instance, a private equity fund could invest 90% of its assets in “safe” stocks and devote 10% of its portfolio to riskier, venture capital-type investments. In addition, the above types of funds are by definition private (i.e. not offered to the general public or traded on a national securities exchange); however, the same strategies can be undertaken through a public company structure, thereby making them a public equity fund.

If you need help in forming your investment fund, contact a Houston business lawyer from Whitley LLP Attorneys at Law today. We will help you in all aspects of starting your hedge fund, private equity fund, or venture capital fund.

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