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Starting a Hedge Fund in Texas: What to Consider First

Recently, Texas has made important changes to how hedge funds are regulated in the state. In this blog, we explain what you need to consider before starting a hedge fund in Texas.

Structuring Your Hedge Fund

A hedge fund’s structure is dependent on tax, regulatory, and financial considerations. In Texas, the structure is usually composed of a limited partnership and one or more LLCs. Limited partnership-based funds are the most commonly used, but LLC-based funds can be appropriate in certain cases.

Due to local taxes, Texas-based hedge fund sponsors often form two separate entities: the investment manager and the general partner. This structure can also help reduce federal payroll taxes and is useful for separation of roles and legal liabilities.

The first LLC, formed in Texas, acts as the fund’s investment manager and is wholly owned by the fund sponsors. The second LLC, which may be formed in a state with low or no corporate income tax, is formed to act as the general partner of the fund.

For the fund to remain exempt from registering under the Investment Company Act, the fund must have:

  • No more than 100 investors.
  • Only “qualified purchasers” as investors in the fund. The definition of qualified purchaser is $5 million net worth for individuals or $25 million for entities.

Offshore & Domestic Structure

A domestic fund is enough if the fund sponsor is only expecting U.S. investors. However, if the sponsor is expecting offshore investors or U.S. tax-exempt investors, they will need an appropriate offshore fund to shield their investors from U.S. tax liabilities. The two most common offshore fund structures are the master-feeder and the parallel structures.

Hedge Fund Offering Documents

  • Private Placement Memorandum: Provides investors with material information about the fund to help them make an informed investment decision. The PPM provides specific information about the terms of the fund, the structure of the investment, background of the managers, and other disclosure issues.
  • Limited Partnership Agreement: Outlines the rights and obligations of the investors and the fund manager. This can be a lengthy and complex legal document.
  • Subscription Documents: Provides investors with a description of the steps needed to purchase limited partnership interests in a fund. It also provides fund managers with eligibility information about the investor. This document requires investors to meet certain eligibility standards, such as being an “accredited investor” or “qualified client.”
  • Investment Management Agreement: Defines the services that a fund manager will provide. It also assigns to the fund manager a power of attorney over the fund’s assets.
  • Management Company Operating Agreement: Specifies how ownership of the fund sponsor is divided among its principals.

Do you have more questions about starting a hedge fund in Texas? Call (888) 252-8277, or contact our Houston securities lawyer to start your case evaluation today.

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