Founders' classes

When fund managers launch new hedge funds, they often need to attract their first investors quickly. To do this, they may create separate founder share classesDifferent categories of fund shares with varying fee structures, rights, or redemption terms offered to different investor types. that offer better deals than what regular investors receive later on. These founder classes typically come with advantages like lower fees and most favored nation provisions, which guarantee that founding investors will always receive terms that are at least as good as those offered to any future investor.

Think of it like being an early customer at a new restaurant that offers discounted prices to its first patrons. The restaurant wants to build a customer base, so it provides incentives to those willing to take a chance on an unproven establishment.

The hedge fund industry has become increasingly competitive, making it harder for new funds to raise money. This competition has led more managers to adopt founder class structures as a way to stand out. These arrangements typically offer fee reductions to early investors and may include additional incentives.

For example, some funds offer tiered fee structureA fee arrangement where the rate decreases as investment amounts or thresholds increase, providing volume discounts to larger investors. that provide even better terms when the fund reaches certain asset levels. This approach encourages founding investors to commit larger amounts of capital upfront, helping the fund reach its target size more quickly.

The founder class approach helps fund managers offer better terms to multiple early investors without creating administrative headaches. Since the founder class terms are built directly into the fund's main legal documents, managers don't have to negotiate separate deals with each early investor. This saves time and reduces complexity.

Managers can open and close these founder classes based on their fundraising needs while still maintaining control over how the fund operates. This structure works particularly well for managers who expect strong investor demand but need to secure initial capital first.

Founder classes represent just one way for new hedge funds to attract early capital. They serve as an alternative to more complex seed investor arrangements, which typically require fund managers to share a portion of their profits or revenues with investors. Seed investments also usually involve longer lock-up period Lock-up period A lock-up period is a specified timeframe during which investors in a hedge fund are prohibited from redeeming their investment, designed to provide the manager with stable capital to execute the investment strategy. , during which investors cannot withdraw their money.

Compared to these seed arrangements, founder classes provide a less burdensome way to secure early-stage capital. While anchor investments offer another option, founder classes maintain clearer boundaries between giving investors better economic terms and allowing them to influence management decisions.

The regulatory landscape for hedge funds has seen significant changes recently. In June 2024, the Fifth Circuit Court of AppealsFederal appellate court that reviews decisions from district courts in Texas, Louisiana, and Mississippi. vacated the SEC's Private Fund Adviser RulesSEC regulations that would have imposed additional disclosure and operational requirements on private fund advisers before being overturned by the Fifth Circuit Court of Appeals., which would have required specific disclosure and consent procedures for preferential arrangements like founder classes. This means fund managers are no longer subject to those particular requirements.

However, the SEC continues to focus on enforcing fiduciary dutyLegal obligation to act in the best interests of another party, requiring utmost good faith and loyalty. rules and ensuring transparency around side letter Side letter Side letters are separate agreements between a hedge fund and a specific investor that modify or supplement the standard fund terms, typically granting special rights or preferences to large or strategic investors. arrangements through its examination priorities. In October 2025, new enhanced Form PF Form PF Form PF is a required SEC filing for investment advisers who manage private funds with at least $150 million in assets. The form collects detailed information about how these funds operate, including their use of borrowed money, investor makeup, and investment holdings. This data helps regulators monitor risks that could affect the broader financial system. reporting requirements went into effect for large hedge fund advisers. These new rules require much more detailed reporting about fund structures, investor classifications, and fee arrangements.

Under these reporting changes, fund managers must provide specific information about different share classes and their associated terms. This makes founder class structures more visible to regulators, even though the previous prescriptive disclosure rules were removed. The regulatory environment continues to evolve, requiring managers to balance the benefits of founder classes with ongoing compliance obligations.