Selecting the right fund structure is a crucial step in investment management. This choice impacts how the fund operates, its regulatory requirements, tax considerations, and its appeal to potential investors. This article offers a concise but detailed look into both traditional and emerging fund structures, specifically focusing on Venture Capital (VC), Hedge Funds, and Private Equity (PE) funds. Designed for fund managers and informed investors, this guide aims to clarify the complexities involved in fund formation.

Let’s first compare how these types of funds differ in the table below:

‍

Hedge Funds

Known for their diverse range of assets, hedge funds often employ short-term investment strategies. Hedge funds usually do not limit their term of existence, allow investors to come and go within limitations in the fund’s documentation.

Venture Capital Funds

Primarily focused on early-stage companies, offers high-risk and high-reward investment opportunities. Usually, investors are not free to leave closed-ended funds and are required to provide capital upon capital calls, as defined in the fund’s founding documents.

Private Equity Funds

These funds commonly invest in mature companies and typically have a long-term investment horizon. However, they may lean towards a VC or a hedge fund structure, depending on their objectives.

We provide details as to how these differences may influence the choice of structure below.

Traditional Structure

The Limited Partnership (LP) or Limited Liability Company (LLC) forms are commonly used across all three types of funds. The key difference here is that LLCs can have a single member, and LPs have to have at least one general and one limited partner.

‍

Fund

‍In this form, a fund is a structure that brings together investors. Commonly, this is an LP or LLC for pass-through taxation purposes. Generally, funds are not structured as corporations because profits are taxed at a corporate level, thus reducing the effective return on investment.

Investors

The fund's investors are typically high-net-worth individuals, family offices, institutional investors, or other funds. If the fund is created in the form of a partnership, then investors in such a fund are usually called “limited partners” or “LPs,” and “members” if the fund is an LLC.

Investment Adviser

The fund is managed by a separate legal entity – an investment adviser (aka an investment manager, management company, etc.). Relations between the fund and the investment adviser (IA) are regulated in the Investment Management Agreement (IMA). The IA usually is a “General Partner” or a “Managing Member” of the fund, depending on the type of entity. The IA is responsible for managing the Fund’s portfolio and making investment decisions. In return, IAs receive a management fee (e.g., 2% annually of the Fund’s net asset value) and carried interest (e.g., 20% of the profit on each investment).

Series LLCs

The Series LLC model consists of a master series and multiple series, each being a separate legal entity.

‍

Master LLC

‍Here, Fund is organized as a series LLC, a type of entity that consists of a Master LLC and typically unlimited number of series. The Fund acts as an umbrella for multiple segregated series, holding different assets. Series may be managed by the same or a different manager and have different investors. A Master Fund has limited control over the series’ day-to-day activities, and each series acts as a separate smaller fund.

Investors

‍Investors invest in a portfolio company (companies) through a series that owns the securities of the portfolio company. Different series have different subscription documents and vary by the minimum investment amount, terms, amount or risk, etc.

Series

‍Series have segregated assets and can help the Fund separate conservative assets from riskier ones. Let’s say the Fund’s IA is ready to use leveraged transactions with cryptocurrencies, which might bring a great return but also can wipe out the whole account. Series can help since a negative return on a particular series will not affect the performance of others.

Investment Adviser

Same as with other types of funds, a Series LLC fund is managed by an IA. The IA signs IMA with Master LLC but is allowed to advise series in accordance with terms of the IMA.

Master-Feeder Structure

Master-feeder structures are commonly used in the investment world, especially for funds that aim to pool capital from both U.S. and non-U.S. investors. Here's a brief overview:

‍

Basics of Master-Feeder

In this structure, there are typically two "feeder" funds (one for U.S. taxable investors and another for non-U.S. and U.S. tax-exempt investors) that both invest into a single "Master" fund, where actual trading and investment activities are made.

Investors

‍While the investor’s profile here is the same as in other structures, investors are segregated by their tax residency. For investors who are US tax residents (“US investors” or U.S. taxable investors), direct ownership of shares / interests in a “passive foreign investment company” (PFIC) may entail significant negative tax consequences. Most funds fall under the definition of PFIC. To avoid negative tax consequences, a separate structure (feeder) is created in the form of a limited partnership in the United States, which accepts deposits from American investors and transfers them (feeds into) to the main (master) fund offshore. Hence, the name of the structure - master-feeder fund.

For investors who (i) are exempt from US taxes (U.S. tax-exempt investors) or who (ii) are not US tax residents (non-U.S. investors), it remains more profitable to invest in a master fund through an offshore feeder fund.

Investment Adviser

Here, an IA generally advises only the Master fund, while Feeder funds invest in the Master fund by default.

*     *     *

Choosing the right fund structure is vital for meeting investment goals, managing risk, and optimizing management style. Whether you're looking at VC, Hedge, or PE funds, understanding the pros and cons of each structure can guide you in making an informed decision. Sometimes, you need to deviate from the aforementioned structures and create a custom-built structure that fits your particular project and goals. We can help you draft and launch your fund with the required documentation. We offer services to support your company’s incorporation and the full scale evolution of your fund’s operations. We welcome you to contact us at any stage in your fund formation at info@buzko.legal.