British Virgin Islands: How To Start A Hedge Fund In The US 2018: The Offshore Dimension

Eric Flaye, of Conyers, shines a light on the BVI hedge fund structuring options for US sponsors.

Many of the initial questions US counsel will have for a sponsor looking to launch a new hedge fund will be about the anticipated investor base, as that factor is fundamental in determining the appropriate fund structure.

The three key categories of investors are: (i) taxable US investors; (ii) tax-exempt US investors; and (iii) non-US investors.

If the anticipated investor base will principally be comprised of taxable US investors, as a general proposition the US sponsor may rely exclusively on domestic jurisdictions (such as Delaware) for all of its potential structuring needs.

However, if the anticipated investor base also includes tax-exempt US investors and/or non-US investors, and such investors represent a material source of prospective subscription capital, the US sponsor may need to include an off shore fund within the broader structure to cater to the particular tax considerations of such investors. This is where the British Virgin Islands (the BVI) – with its unique set of well-regarded, innovative and cost-competitive hedge fund products – comes to the fore.

TAX CONSIDERATIONS OF THE INVESTOR BASE

Taxable US investors: such investors generally prefer to invest in domestic US hedge funds classified as partnerships for US tax purposes (most commonly Delaware limited partnerships or limited liability companies).

Tax-exempt US investors: such investors include certain US pension plans, foundations, endowments and other charitable organisations, and are a material source of hedge fund capital. Passive investment income earned by such investors is generally exempt from US federal income tax; however, this exemption does not extend to 'unrelated business taxable income' (UBTI). In the context of hedge funds, the key potential source of UBTI is earnings arising from debt financed investment activities (i.e. trading on margin). If a tax-transparent entity such as a typical domestic hedge fund earns any UBTI, its investors shall be treated as though they earned such UBTI themselves, which may result in US tax liabilities for those otherwise tax-exempt US investors who invest in the domestic fund.

In contrast, off shore entities (such as a typical BVI fund) classified as corporations for US tax purposes can effectively 'block' any such attribution of UBTI as they are not tax-transparent vehicles. If the BVI fund earns any UBTI, the character of that income is not passed through or otherwise attributed to its investors. Th is 'blocking' effect is the principal reason tax-exempt US investors generally prefer to invest in off shore funds.

Non-US investors: such investors generally prefer to invest in off shore funds classified as corporations for US tax purposes so as to keep out of the US tax net (and avoid any attendant requirement to file US tax returns).

IS AN OFFSHORE FUND MERITED?

Having identified potential tax-exempt US investors and/or non-US investors within the anticipated investor base, the sponsor will then have to determine whether an off shore fund is warranted from a cost-benefit perspective, taking into account: (i) the potential capital to be raised from such investors; (ii) the preferred timing of such capital contributions (e.g. are such investors important seed/anchor investors, or can they instead be courted and the off shore fund established at a later stage once fund AuM hits critical mass?); and (iii) the incremental formation and maintenance costs of the off shore structure and their expected impact on the fund's performance returns and track record.

The BVI is oft en regarded as the leading blue-chip jurisdiction from the perspective of this value equation as it is a comparatively quick, painless and cost-competitive domicile in which to establish off shore hedge funds.

OFFSHORE HEDGE FUND STRUCTURES

There are three principal structuring options for an off-shore hedge fund. The appropriate structure will depend primarily on the particular trading strategy, investment and tax considerations of the investor base, and preferred tax treatment of the investment manager's performance compensation.

Side-by-side structure: taxable US investors invest directly in a domestic fund which in turn invests in an underlying portfolio of securities. Tax-exempt US investors and non-US investors invest directly in an off shore fund which in turn invests in a separate underlying portfolio comprised of the same or substantially similar securities as the domestic fund. This structure necessitates at least two new fund entities, which are separate but operate in parallel under common management.

A side-by-side structure affords the manager flexibility to implement different trading strategies for the domestic and offshore funds, which may be beneficial if onshore and offshore investors have different investment and/or tax considerations. Side-by-side structures are often comparatively cheap to establish and simple to administer from an accounting perspective; however, they can require duplicative trading (or splitting of trade tickets) and administration work and result in different performance results between the domestic and offshore funds, and may not be appropriate or efficient for funds with trading-intensive strategies. Side-by-side structures are often used for fund-of-funds strategies but are otherwise relatively uncommon.

Master-feeder structure: taxable US investors invest directly in a domestic feeder fund which in turn invests all its assets in an offshore master fund. Tax-exempt US investors and non-US investors invest directly in an offshore feeder fund which in turn invests all its assets in the same offshore master fund. The offshore master fund then invests in one common underlying portfolio of securities. This structure necessitates at least three new fund entities.

A master-feeder structure results in one common trading strategy and common performance results, and avoids duplicative trading and administration work. While such structures are commonly used by the more established hedge funds, they are comparatively complex and expensive to establish and may not be appropriate if onshore and offshore investors have different investment and/or tax considerations.

Mini-master structure: taxable US investors invest directly in a domestic master fund. Tax-exempt US investors and non-US investors invest directly in an offshore feeder fund which in turn invests all its assets in the same domestic master fund. The domestic master fund then invests in one common underlying portfolio of securities. This structure necessitates at least two new fund entities.

A mini-master structure results in one common trading strategy and common performance results and is cheaper to establish than a master-feeder structure. The key downside is that if any US regulatory restrictions apply on the maximum number of investors in the domestic master fund, the number of investors in the offshore feeder fund will also be counted towards this threshold. In contrast, no such investor look-through applies to master-feeder structures.

BVI HEDGE FUND PRODUCTS

A typical BVI hedge fund will be open-ended in nature – by virtue of providing its investors the right to withdraw capital at periodic intervals by reference to the net asset value of the fund – and therefore will be subject to regulation by the BVI Financial Services Commission. In contrast, a typical private equity or venture capital fund is closed-ended and therefore generally not subject to direct regulation in the BVI.

BVI funds may be incorporated as business companies or formed as limited partnerships or unit trusts. The business company, being a corporate vehicle, is by far the most common structure for BVI hedge funds.

BVI regulated fund products potentially suitable for use as offshore hedge funds include Professional Funds, Private Funds, Approved Funds and Incubator Funds. The following table outlines some of their key characteristics.

BVI HEDGE FUND PRODUCTS

Professional Fund Private Fund Approved Fund Incubator Fund
Suitability Suitable for a full-fledged hedge Fund Suitable for significant 'friends and family' type offerings Each suitable for start-up/emerging managers looking to prove their investment strategy and establish a track record in the most cost-efficient manner
Popular for 'friends and family' type private offerings and managed account structures
Maximum AuM Uncapped Uncapped US$100 million US$20 million
Maximum Number of Investors Uncapped 50 (or potentially uncapped provided the offer is made on a "private basis") 20 20
Investor Qualification Requirements "professional investors" only None None "sophisticated private investors" only
Minimum Initial Investment per Investor US$100,000 (subject to exemptions for certain service providers of the fund and employees of the investment manager) None None US$20,000
Maximum Term/Duration Unlimited Unlimited Unlimited 2 years (with an extension of up to 12 months available with permission from the BVI FSC), upon expiry of which the fund must be converted into a Professional Fund, Private Fund or Approved Fund or otherwise be wound up
Service Providers
Investment Manager Mandatory? Yes Yes No No
Auditor Mandatory? Yes Yes No No
A local audit sign-off by a BVI-based auditor is not required
Custodian Mandatory? Yes Yes No No
A Professional Fund or Private Fund may in certain circumstances apply to be exempted from the requirement to appoint an investment manager, auditor and/or custodian
Administrator Mandatory? Yes Yes Yes No
Foreign Service Providers Permitted? Yes – the U.S. is a "Recognised Jurisdiction" for the purposes of applicable BVI financial services legislation and therefore a U.S. sponsor may appoint its usual U.S. service providers as service providers to the BVI hedge fund
Directors Minimum of two directors (at least one of whom must be an individual; the other may be a corporate director); neither director need be a BVI-resident
Realistic Timeframe for Launch 3-6 weeks 3-6 weeks 1-2 weeks 1-2 weeks

As illustrated above, the BVI offers a diverse set of offshore hedge fund products, suitable for the full gamut of sponsors from start-ups all the way up to institutional managers with established track records and significant assets under management, and is the logical choice for those sponsors who wish to signal to their investor base commitment to quality as well as costs-discipline.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions