It has been a tough year for many managers and there are many funds that will be shutting their doors before the end of the year.  Funds may decide to close their door for many reasons which might range from poor performance to large amounts of investor withdrawals.  While many of the managers and traders at these funds will go on to work for other firms, many of these managers and traders will start new hedge funds and potentially with some of the same investors.

In either case, there are a few things that a hedge fund manager will need to do in order to ensure the orderly liquidation and winding down of the hedge fund.

Liquidation pursuant to the offering documents

The hedge fund limited partnership agreement or LLC agreement (part of the hedge fund offering documents) will set out the manner in which the dissolution and liquidation of the fund will proceed.  Generally there will be some sort of liquidation and then final accounting.  The timing of these will be determined by the offering documents.

Talk with the hedge fund service providers

A manager should first contact his hedge fund attorney to inform him of the plans to close down the fund.  The lawyer will be able to help guide the manager through the process and will be able to help with any issues which may arise.  The auditor, broker and administrator should also be contacted so that these service providers can begin their own processes for winding the fund down.  During the wind down process, the manager should expect to talk with each of the service providers a few times.

Inform your investors

A manager will need to inform the investors that the fund will be winding down.  The manager will probably want to do this through some sort of letter.  After the manager has discussed the wind down with the attorney, the attorney can help the manager draft the letter.  The letter should inform the investors that the fund will be closing and also let the investors know what steps are being taken before the final liquidation is complete.  The manager may also ask the investor how the final proceeds should be sent to the investor – either through wire or through a check.  Additionally, if the manager is going to be starting a new hedge fund, he may want to mention this in the letter.  (However, the manager will need to be careful that the mention of the new fund does not rise to the level of a public offering – the attorney can discuss this with the manager.)

During this time, it is critical for the manager to keep the lines of communication with the investor open.  During a wind down when emotions are high, investors may be looking for any reason to complain or create a reason for a suit against the general partner.  It is most important to be honest during these times.

Make the final wind down and distributions

The final wind down is the process of liquidating all of the fund’s positions to cash and then transferring the fund’s assets to the fund’s bank account.  From the bank account, the manager will then be able to distribute the assets to the investors pursuant to the final accounting by the administrator and/or auditor.

Provide the final audit

The auditor will provide final audited financial statements to the manager who will then provide these statements to all of the investors in the fund.  Usually the final audit will be completed prior to the actual distribution of the assets to the investors in the fund.

Close down the entities

After the final audit and distribution to the investors, the manager will want to close down, or cancel, the fund entity.  To do this the attorney will:

1. Submit articles of cancellation to the Delaware Secretary of State to close down the entity.  The filing fees for this are typically $200-$300 dollars payable to Delaware.
2. Pay any outstanding Delaware franchise taxes.  Generally these are going to be less than $200, but it will depend on the fund.  The attorney will be able to contact Delaware to determine the amount of the taxes owed.
3. Provide the manager with an explanation of how to contact the IRS about the canceled entity.
4. Contact the registered agent in Delaware to cancel registered agent services with them.

The above is a rough outline of the steps involved in closing a Delaware entity and will usually be completed by a paralegal in a few hours.  There are more steps involved with the process of closing down an offshore entity which will depend on the jurisdiction of the fund.  Generally the wind down process for each offshore entity will range in cost from $800 $3,000 or more depending on the circumstances of the wind down.

Additionally, the hedge fund manager should also decide whether the hedge fund management company will also need to be wound down.  In many cases, the entity will be kept alive in order to serve a future purpose for the manager; in some cases the management company will serve as the general partner to a new hedge fund.

Potential roll over issues

For mangers who are simultaneously closing one hedge fund and starting another, a common practice is to simply roll the assets from the old fund to the new fund.  In such instances the manager will definitely need to have close contact with all of the service providers to ensure a smooth transition.  Additionally, there may be some issues which the manager will need to discuss with counsel if there are tax-exempt entities in the old fund.

If you have any questions on the process, please feel free to contact us at any time.