A number of factors contribute to long-term success for hedge funds, starting with high-quality investment performance. Hedge funds are all about alpha.
However, to attain business success and a stellar track record, hedge funds must also raise capital and attract and retain exceptionally talented professionals. This article examines how to strengthen the latter ingredient by using advanced planning to help incentivize experts at the fund.
The management company is the operating entity that hires the fund’s professional and administrative staff. It pays their salaries and provides various benefits programs. Very often, astute general partners use their management companies to deliver programs and advanced planning solutions that nurture and retain key talent. It’s also through the management company that the general partners usually structure continuation plans.
A number of different advanced planning solutions are attractive to general partners:
• Defined benefit plans.
• Asset protection plans.
• Contingency plans.
Let’s look at each of these solutions.
Defined Benefit Plans
One of the main advantages of defined benefit is the ability to put money aside for the general partners and key employees that grows tax deferred. These qualified plans can be useful in helping to attract and retain key employees.
Two types of defined benefit plans that are particularly appropriate for hedge fund managers are cash balance plans and benefit-focused plans because they permit large contributions—and thus large income tax deductions—and they can be structured to favor selected employees.
In a cash balance plan, each participant has an account into which monies are contributed and an interest credit with a guaranteed return that’s independent of investment performance.
A benefit-focused plan permits the largest income tax deductions of all qualified plans. It can also be used creatively in succession and estate planning.
Asset Protection Plans
More than ever before, the wealthy—including those who might not be wealthy but are generally perceived to be rich, such as hedge fund managers—are confronted with what can be considered frivolous and baseless lawsuits. The way to best address this potential problem is with an asset protection plan.
Asset protection planning is pre-litigation planning. It incorporates financial products and legal strategies to mitigate the loss of wealth due to lawsuits. A good starting point is for hedge fund managers to ensure they have the appropriate personal and professional insurance coverage. Then they should consider legal strategies and solutions, from the use of corporate structures to trusts to captive insurance companies.
It’s important to remember that asset protection planning needs to be implemented before it’s needed. For example, if a hedge fund manager were sued, the asset protection plan would have to be already in place for it to have value. Moving assets around after the fact would be considered fraudulent conveyance and would likely be negated by the courts.
Contingency Plans
Many investors have become quite concerned about continuity at hedge funds. The solution to this is to develop and implement contingency plans and explain them to investors.
Well-constructed contingency plans have two main components: financial considerations, which ensure money is available for smooth transitions, and operational matters, including personnel issues such as determining who’s in charge of making certain that talent is retained or acquired.
The death of a general partner is usually best addressed through key person insurance and buy/sell arrangements. This can also be applied in another area that’s often overlooked: the potential disability of a general partner. Not having a contingency plan for these situations can have destructive consequences.
Conclusion
Hedge fund general partners typically spend most of their professional time focused on making their funds successful. This means investing well and building an enviable performance track record. This sometimes leads to overlooked advanced planning opportunities, such as the ones discussed here.
By capitalizing on defined benefit plans, general partners are able to lower their income taxes, sometimes appreciably (by $1 million or more), as well as create a pool of safe money growing tax-deferred. Asset protection planning is wise because anyone can be the victim of lawsuits. Also, it’s wise to have solid contingency plans to protect the hedge fund and its general partners.
Frank W. Seneco is an advanced planning life insurance specialist. He is the president of Seneco & Associates Inc., a boutique advanced planning firm in Connecticut. He can be reached at [email protected].
Evan Jehle is a principal in Rothstein Kass’ Family Office Group in New York. His clients include family offices, celebrities and hedge fund general partners. He can be reached at [email protected].