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Structuring a tax-efficient hedge fund

When embarking on any new business, it's important that one not only engages professionals with deep industry knowledge but also commercial knowledge to support the various stages of business growth. For anyone establishing a hedge fund, their needs are going to change as their business evolves from launch to maturity.

"If a manager launches with USD10 million, their tax situation maybe far different compared to some point in the future if the fund's assets have risen to USD200m. If a manager derives profit from their management fee, proper structuring of the management entity may reduce self-employment tax," explains Ron Geffner (pictured), partner at Sadis & Goldberg LLP, one of New York's leading financial services-focused law firms.

Geffner heads up the Financial Services Group, comprised of 13 attorneys that have each spent a significant amount of their career practicing in the private fund space, providing a compelling roster of seasoned legal advisers. 

They routinely handle a diverse range of enquiries providing legal counsel to over 800 funds including domestic and international financial institutions, family offices, hedge funds, private equity funds, venture capital funds, real estate funds and commodity pools. 

Geffner says that the majority of hedge fund launches in the United States launch a domestic fund and that the majority of domestic funds are organised as a Delaware limited partnership. "Nonetheless, a significant number of our clients establish an offshore Cayman master feeder structure at launch. In this instance, the Cayman master fund is established as an exempted corporation for US non-taxable investors (i.e. public pension funds) and non-US investors. Deciding on whether to go offshore will often be dictated by the perceived level of assets available to the manager." 

Whilst the manager will be taxed accordingly based on the profits derived from the management fee, there are different considerations in respect to the performance allocation fee. Receiving a percentage of the profits as an allocation or a fee is also driven by tax considerations, which are primarily driven by the portfolio construction and harvesting of profits. 

When selecting legal counsel to structure the fund entity, managers should consider making it as viable a commercial proposition to prospective investors as possible. Last year, for example, Sadis & Goldberg launched approximately 80 new funds. 

"The work we do ranges from structuring the fund product to make it viable to prospective investors and guiding Sadis & Goldberg clients in respect of regulatory, tax and corporate related issues. The offering documents should reflect a structure that matches the intended investment strategy and management, as well as terms regarding liquidity fees, valuation and expenses, to name a few, that conform to commercial standards. Based upon the number of hedge funds which we represent, we have the commercial experience to guide managers on these issues," explains Geffner. 

He adds that the appointed legal counsel should establish a "close rapport" so that the client can appreciate the practical guidance they are providing. "A lot of professionals in this industry have lost touch with their clients. What makes Sadis & Goldberg unique is that we've had considerable experience working with start-up managers, middle market managers and large, established managers," concludes Geffner.

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