According to the U.S. Securities and Exchange Commission, $30.9 trillion is spread across 109,000 private funds as of 2024. Behind every one of those funds is a founder who started with an idea and the conviction to build something. Fund formation is a complex, months-long process; from the first structuring decision to the final close, a typical fund formation takes anywhere from six months to well over a year. Complexity, however, does not mean inaccessibility. Fund formation can be reduced to four overlapping workstreams: structuring, drafting, securities compliance, and closing. These are not boxes to check, but a framework of considerations that, with the right guidance, any founder can navigate.
Structuring Decisions
The first and most important consideration of fund formation is a thorough blueprint to guide the process. Without a well-considered structure, issues are sure to arise, causing delays, eroding investor confidence, and adding extra costs. Prospective founders should have a cognizable grasp on five key aspects of their fund:
Founders must first answer broad questions about their fund before diving into the details: What are the fund’s strategy and goals, its competitive advantage, and its risks? Articulating these points helps determine what type of fund you need, which investors you can realistically attract, and how the fund must be set up to pursue that strategy. Getting these answers right allows founders to make the decisions that follow correctly the first time.
Funds are broadly structured as either open-end or closed-end vehicles. Most first-time fund founders default to a closed-end structure. A closed-end fund raises capital over a defined period and expires after a set time period, typically ten years. An open-end fund has no fixed endpoint, and capital is continuously recycled. This decision dictates your investment horizon, how you manage liquidity, and the operational complexity your fund must be built to handle.
The jurisdiction in which a fund is formed has important implications for governance, investor expectations, tax considerations, and the legal framework that will govern disputes. While Delaware has long been regarded as the default choice for private investment funds due to its extensive body of business law and well-established Court of Chancery, Texas has become an increasingly attractive alternative. With the creation of the Texas Business Court and the continued development of sophisticated Texas business jurisprudence, many sponsors, particularly those headquartered in Texas or investing in Texas-based assets, are choosing to domicile their funds in Texas rather than Delaware. For many of our clients, a Texas fund offers a practical and cost-effective solution while providing a familiar legal framework for both sponsors and investors. Delaware continues to offer advantages in certain circumstances, particularly where investor anonymity or other Delaware-specific features are important, but it is no longer the automatic choice for every fund. Ultimately, the optimal jurisdiction should be determined by the sponsor’s investor base, investment strategy, operational footprint, and long-term business objectives rather than by convention alone. The limited partnership is the default structure for most private funds, but it is not the only option. The right entity structure is heavily dependent on the investment thesis and tax allocation. Founders are often surprised to learn that they are typically forming two or three entities, each serving a distinct legal and economic purpose.
Drafting & Investor Negotiations
Once the structural decisions are made, founders must translate those decisions into a set of binding legal agreements and begin negotiations with prospective investors. These things happen at the same time, and they push and pull against each other.
The drafting process is not a one-time exercise that gets handed off to lawyers and returned finished. It is iterative and founder driven. The Limited Partnership Agreement (“LPA”), a document that governs a fund, should accurately reflect the hundreds of decisions about economics, governance, investor rights, and other structuring decisions. Ensuring the LPA is drafted correctly the first time is paramount.
Investor negotiations are happening at the same time. Sophisticated investors come with questions, requests, and, in many cases, demands for more favorable fee structures, governance rights, reporting obligations, and investment restrictions. To attract larger, more sophisticated investors, founders often offer individual investors more favorable terms in what are known as side letters. To complicate these negotiations, some investors may insist on their side letter to have a Most Favored Nation (“MFN”) clause. The MFN clause permits an investor to review the terms granted to later investors and elect to adopt those same benefits.
When an investor is ready to commit, they formally do so by signing the fund’s subscription agreement. This locks in their capital commitment and confirms their legal eligibility to participate in the fund. It is the point at which the investor relationship becomes legally binding, and with it comes a new set of obligations for the founder.
Securities Considerations
All the while, as structuring decisions, drafting, and investor negotiations are taking place, the SEC has been lurking in the background. How a fund is structured, who its investors are, and how it is governed all carry regulatory consequences. Fund formation is a highly regulated activity governed by federal and state securities law, and from the moment a founder decides to start a fund, securities law must be considered.
Securities law is best visualized as three, sometimes four, layers. The goal of a founder here is to structure around statutory obligations and find exemptions to costly and burdensome registration requirements.
The first layer is the Securities Act of 1933, which governs the act of raising capital from investors. When a fund accepts investor capital, it is issuing securities, and the Securities Act requires that those securities either be registered with the SEC or qualify for a specific exemption.
The second layer is the Investment Company Act of 1940, which governs the fund as an entity. A fund that does not qualify for an exemption under this Act faces substantial operational restrictions that greatly increase the difficulty of running a fund. Most private funds are structured specifically to avoid triggering registration under this Act.
The third is the Investment Advisers Act of 1940, which governs the founder as a fund manager. Depending on the size of the fund and assets under management, a founder may be required to register with the SEC as an investment adviser, a designation that carries its own ongoing compliance obligations.
The fourth layer is state securities law, colloquially known as blue sky laws. Even where federal exemptions apply, most states require their own separate notice filings wherever an investor is located. A fund with investors across multiple states must navigate multiple state regulatory regimes simultaneously, each with its own deadlines and fees.
Closing & Post-Closing Responsibilities
Closing is the moment the fund becomes real. It is the point at which investor commitments become legally binding, capital can be called, and the fund is authorized to begin deploying into investments. Most funds do not close all at once, however. A first close is held once enough investor commitments are secured to begin operations, often 20 to 40% of the target fund size.
Subsequent closes bring in additional investors over time. Each subsequent close adds complexity due to equalization. Equalization requires late-joining investors to be treated as though they had been present from the beginning. Managing this process fairly, and in accordance with the fund’s governing documents, is one of the first operational tests a founder faces.
Once the final close is complete, the fund’s formation is behind it. What follows is operational and regulatory obligations. Capital must be called from investors as investments are made. Returns must be distributed according to the waterfall structure established in the fund’s LPA. Investors must be kept informed through regular reporting, annual audits must be completed, and regulatory filings must be maintained. Each of these obligations flows directly from the decisions made and the documents drafted.
Formation and operation are not separate endeavors; one is the direct consequence of the other. A fund’s structuring, drafting, and closing process determines how a fund will run for the entirety of its life.
Conclusion
Fund formation demands strategic clarity, legal precision, and the patience to work through a process that is rarely straightforward. While complex, founding a fund is possible for anyone with the right help and experience. Even the largest funds began at the structuring decisions stage. At RR&A, we help clients through every step of the fund formation process, turning their financial edge into compliant funds. From initial structuring to post-close responsibilities, we work to ensure that your fund is formed without undue delay or burden. Contact RR&A to start the path from vision to a viable fund.
Disclaimer: The information and material on this website is general information about our practice and firm. This information does not offer specific legal advice and the use of this information does not create an attorney-client relationship with RR&A or any of its attorneys. The information on this website should not be used for legal advice, and persons should not act upon the information on this website without engaging professional legal counsel.
Hunter is a Law Clerk at R. Reese & Associates in the Houston office. To learn more about Hunter, visit his attorney page.
