Hedge Funds | Launching a Fund

A prospect who had worked at a successful hedge fund was looking to start his own. After our first meeting with him, we learned that caring for his family, which included three children, was very important to him.

We discussed a window of opportunity, available during the initial stages of a new fund, to transfer wealth off his personal balance sheet and to his heirs in a tax-efficient manner. Together, we reviewed several techniques that revolved around the same principle: transferring assets at relatively low value into a trust to preserve greater wealth for him and his family as the value of the trust’s assets grow over time.

Owning your business

One technique required less cash, which can be a potential option during the start-up phase when significant funds are needed to cover operating expenses. This approach involves giving shares up to the gift tax exclusion amount. The law effectively requires gifting shares of general and limited partnership interests if both exist – a so-called “vertical slice.”1 Gifting a vertical slice would allow his interest to grow, free of transfer tax, over the life of the fund, thereby reducing his overall estate tax.

Appreciation transfers

Another technique involved the creation of a grantor retained annuity trust (GRAT), an irrevocable trust that typically lasts anywhere from two to ten years and allows for the transfer of assets’ future appreciation, free of gift tax, to the next generation. As the principal, he could transfer general partnership and limited partnership interests as well as cash to a relatively long-term GRAT (e.g., seven years). The cash would be used to make the required annuity payments back to the grantor for the first few years, after which time a successful fund should be generating enough cash to cover the annuity payments. GRATs are often seen as a way to transfer significant wealth to the next generation without incurring gift tax; however care must be given to ensure funding of the required distributions.

Wider range of strategies

Because the founder was interested in preserving as much working capital as possible, he found the first approach preferable after weighing both alternatives carefully. These strategies are only a sampling of the range of customized strategies we offer not only for the launch of a new fund, but also for existing funds starting a new strategy.

1Treas. Reg. §25.2701-1(c)(4).

We look forward to speaking with you on how the Financial Institutions Group’s advice and insight can help fulfill your vision.

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This material is intended to help you understand the financial consequences of the concepts and strategies discussed here in very general terms. The strategies discussed often involve complex tax and legal issues.

JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal and accounting advice. Your own attorney and other tax advisors can help you consider whether the ideas illustrated here are appropriate for your individual circumstances.

All case studies are shown for illustrative purposes only and should not be relied upon as advice or interpreted as a recommendation. Results shown are not meant to be representative of actual results. Information and outcome is not a guarantee of future results.

Investors should be cautious when holding a highly concentrated stock position, which is typically defined as any individual holding that constitutes more than 30% of overall investment holdings. Tax consequences, including the avoidance of capital gains through selling, do not eliminate the risks of overexposure to a particular company or business sector.

Hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.

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