What you need to do before you can legally operate a hedge fund

Opening a hedge fund requires registering with the Securities and Exchange Commission (SEC), forming a legal entity, and obtaining the licenses your firm's employees will need. The SEC does not issue a "hedge fund license" — instead, you register as an investment adviser under the Investment Advisers Act of 1940, and your firm must comply with specific rules about how you manage money, what you disclose to investors, and how you handle their funds. The timeline from formation to accepting your first investor typically runs four to eight months, depending on how quickly you complete paperwork and how complex your investment strategy is.

You cannot operate without this registration. Running an unregistered investment operation — even a small one with a handful of investors — is a federal violation that can result in civil penalties, criminal charges, and orders to return all investor money plus damages.

Key Takeaways

  • You must register with the SEC as an investment adviser before you can manage money for others, and this registration requires Form ADV and proof of compliance infrastructure.
  • Your firm needs a legal structure (usually an LLC or corporation), a compliance officer, written policies on conflicts of interest and trading, and a custodian to hold investor assets.
  • You and any employee who advises clients or handles trades must hold a Series 65 license (or Series 7 plus Series 66), obtained through your firm's broker-dealer sponsor.
  • Hedge funds typically require a minimum investment of $100,000 to $1 million per investor and must file Form PF with the SEC if assets under management exceed $150 million.
  • You will need a prime broker (a large financial institution that provides trading, financing, and custody services) and a separate administrator to handle accounting and investor reporting.

Forming your legal entity and basic structure

Start by forming a business entity in your state — most hedge funds use a limited liability company (LLC) or a corporation. An LLC is simpler for tax purposes and is standard in the industry. You will need an Employer Identification Number (EIN) from the IRS, which takes minutes to obtain online. Register the business name with your state's Secretary of State office and open a business bank account in the fund's name, not your personal name.

Next, decide on your fund's basic terms: the investment strategy (long/short equities, macro, event-driven, etc.), the minimum investment per investor, the fee structure (typically 2% management fee plus 20% performance fee), and the lock-up period (how long investors' money stays in the fund before they can withdraw). These terms go into your offering documents, which you will draft with a securities attorney. Do not skip this step — offering documents must comply with securities law and clearly disclose risks and fees to investors.

You will also need a compliance officer — either you, if you have compliance experience, or a hire. This person oversees adherence to SEC rules, maintains records, and responds to regulatory inquiries. Many small funds contract this role to a compliance consultant rather than hiring full-time.

SEC registration as an investment adviser

File Form ADV with the SEC through the Investment Adviser Registration Depository (IARD). Form ADV has two parts: Part 1A covers your firm's basic information, ownership, and regulatory history; Part 1B covers each employee who gives investment advice or supervises others who do. Part 2A is your brochure — a plain-language document describing your services, fees, conflicts of interest, and investment approach. Part 2B lists the background and disciplinary history of your advisory personnel.

The SEC reviews your Form ADV for completeness and compliance. If information is missing or raises questions, they will issue a deficiency letter asking you to clarify or revise. Once approved, you receive a Central Registration Depository (CRD) number and appear in the SEC's Investment Adviser Public Disclosure database. Registration is not permanent — you must update Form ADV within 90 days of any material change (new employees, fee changes, strategy changes) and file an annual amendment.

If your fund will manage less than $100 million in assets, you may register with your state instead of the SEC. State registration is simpler but limits your ability to market to out-of-state investors. Most new funds start with state registration and move to SEC registration once they cross the $100 million threshold.

Licensing requirements for you and your team

Anyone at your firm who gives investment advice or supervises trading must hold a securities license. The standard license for hedge fund managers is the Series 65 (Uniform Investment Adviser Law Exam), which covers investment adviser regulations, fiduciary duty, and compliance. Alternatively, you can hold a Series 7 (General Securities Representative Exam) plus a Series 66 (Uniform Combined State Law Exam), which covers the same ground but requires passing two exams instead of one.

To sit for either exam, you must be sponsored by a broker-dealer or investment adviser firm. Most new hedge fund managers use a "introducing broker" — a small broker-dealer that sponsors licenses for a fee (typically $1,000 to $3,000 per person per year). You cannot sit for the exam on your own; the sponsoring firm registers you with FINRA (Financial Industry Regulatory Authority) and submits your exam application.

Exam preparation typically takes four to six weeks of study. The Series 65 covers 130 topics and has a 73% pass rate. Once you pass, your license is active as long as you remain sponsored by a broker-dealer or investment adviser firm and maintain your registration.

Setting up custody, prime brokerage, and administration

Investor assets cannot sit in your firm's bank account. You must use a custodian — a bank or broker-dealer that holds the money and securities on behalf of the fund. The custodian executes trades, settles transactions, and provides monthly statements. Large custodians include Fidelity, Charles Schwab, and Pershing. The custodian charges a fee (usually 0.05% to 0.15% of assets annually) and provides the audit trail and record-keeping the SEC requires.

You will also need a prime broker — a large investment bank or broker-dealer that provides trading execution, financing (margin and short-selling), and securities lending. Prime brokers include Goldman Sachs, Morgan Stanley, and Citadel Securities. They charge commissions on trades and interest on borrowed funds. Most hedge funds use one prime broker, though some use two for redundancy. Prime brokers typically require a minimum of $5 million to $25 million in assets under management before they will open an account.

A separate administrator handles accounting, investor reporting, and NAV (net asset value) calculations. The administrator reconciles trades with the custodian, calculates the fund's daily value, prepares monthly and annual statements for investors, and handles subscriptions and redemptions. Administrators include Citco, Intramark, and Apex. They charge a flat fee or a percentage of assets (typically 0.10% to 0.25% annually). Many new funds use an administrator because it separates the fund's accounting from the manager's operations and satisfies investor due diligence requirements.

Creating compliance policies and investor documentation

Before you accept money, you must have written policies on conflicts of interest, trading practices, and information security. The SEC expects to see a Code of Ethics (covering personal trading by employees), a Cybersecurity Policy, an Anti-Money Laundering (AML) Policy, and a Business Continuity Plan. These are not optional — the SEC reviews them during examinations and violations can result in fines or loss of registration.

You will also need a Private Placement Memorandum (PPM) — a legal document that describes the fund, its strategy, fees, risks, and terms. The PPM is the contract between you and investors; it discloses conflicts of interest, lock-up periods, redemption terms, and what happens if the fund closes. A securities attorney drafts the PPM based on your fund's structure and strategy. Expect to pay $5,000 to $15,000 for a PPM from an experienced attorney.

Investors must sign a subscription agreement (agreeing to the fund's terms), provide proof of accredited investor status (net worth over $1 million or income over $200,000 for individuals), and complete AML documentation (name, address, source of funds). You must keep these documents for at least six years.

Capital requirements and initial funding

The SEC does not mandate a minimum amount of capital to start a hedge fund, but practical constraints apply. You need enough money to cover setup costs: legal fees for the PPM and compliance documents ($10,000 to $25,000), registration fees ($2,500 to $5,000), accounting and compliance software ($5,000 to $15,000 annually), and prime broker and administrator fees (typically $50,000 to $200,000 in the first year). Most new managers invest their own money — $250,000 to $1 million — to cover these costs and demonstrate commitment to investors.

Your fund's minimum investment per investor is your choice, but most hedge funds require $100,000 to $1 million per investor. A lower minimum attracts more investors but increases administrative work. A higher minimum reduces the number of investors you must manage but requires you to find larger investors.

Ongoing regulatory obligations after launch

Once you are registered and operating, you must file Form PF (Private Fund Information) with the SEC if your fund manages more than $150 million in assets. Form PF collects data on your portfolio, leverage, liquidity, and counterparty risk. You file annually within 120 days of your fiscal year-end.

You must also maintain a detailed record of all trades, communications with investors, and compliance decisions. The SEC conducts examinations of investment advisers on a rotating basis — expect an examination every three to five years. During an examination, SEC staff review your books, interview your compliance officer, and test your adherence to regulations. Violations can result in warning letters, fines, or suspension of your registration.

You must update Form ADV within 90 days of any material change and file an annual amendment. If you hire a new portfolio manager, change your fee structure, or move to a new office, you must update Form ADV. Failure to update is a violation and can be cited during an examination.

Frequently Asked Questions

Can I start a hedge fund part-time while working another job?

Technically yes, but it is impractical. The SEC expects your compliance and trading systems to operate during market hours, and you cannot manage money responsibly while employed full-time elsewhere. Most hedge funds require the manager to be full-time. If you are employed by another investment firm, your employment agreement likely prohibits you from managing outside money without written consent.

What is the difference between a hedge fund and a mutual fund?

Hedge funds are lightly regulated private investments with high minimum investments ($100,000+), flexible strategies (including short-selling and leverage), and higher fees (2% management plus 20% performance). Mutual funds are regulated by the Investment Company Act of 1940, have lower minimums ($1,000 to $10,000), restricted strategies, and lower fees (0.5% to 2% annually). Hedge funds can only market to accredited investors; mutual funds can market to anyone.

Do I need a Series 7 license or just a Series 65?

For a hedge fund, the Series 65 is sufficient. The Series 7 is required if you want to sell securities (stocks, bonds, mutual funds) to clients directly. Hedge fund managers advise on investments but do not sell securities — the custodian and prime broker handle execution. If you plan to offer other services (like brokerage), you would need the Series 7 as well.

How much does it cost to start a hedge fund?

Setup costs typically run $50,000 to $250,000 in the first year, including legal fees, registration, compliance software, and the first year of prime broker and administrator fees. Ongoing annual costs (compliance, custody, administration, licenses) run $100,000 to $500,000 depending on assets under management. Most managers cover these costs from their own capital or from a seed investor who commits money upfront.

What happens if I close my hedge fund?

You must notify the SEC, return all investor money, and file a final Form ADV amendment. You must keep all records for six years after closing. If you owe investors money (due to losses or fees), you must settle those claims before closing. Once closed, your registration is terminated and you no longer appear in the SEC database.