- Fund formation: A strategic blueprint
- What is fund formation?
- Key fund structures and vehicles
- Private investment funds
- Special purpose vehicles (SPV)
- How to form a fund: A step-by-step guide
- Step 1: Define your fund thesis and model
- Step 2: Assemble your formation team
- Step 3: Structure your entities
- Step 4: Draft governing documents
- Step 5: Set up fund operations
- Step 6: Onboard investors and close the fund
- Key regulatory considerations for fund managers
- Budgeting for fund formation and ongoing operations
- From formation to fund administration: Building for the full lifecycle
- Frequently asked questions about fund formation
- How much does it cost in legal fees to form a fund?
- How long does fund formation take?
- How should I structure fund formation to accommodate advisors receiving carried interest?
- How do I handle fund expenses before capital is called?
- What is the difference between a fund formation lawyer and a fund administrator?
What is fund formation?
Fund formation is the complete legal, regulatory, and operational process of creating a pooled investment vehicle, like a venture capital (VC) fund, private equity (PE) fund, or special purpose vehicle (SPV). This process includes structuring the fund, drafting legal documents, securing capital from investors, and ensuring you comply with all securities laws. The decisions you make during this initial stage establish the foundation for your fund's entire lifecycle.
Fund formation is the creation of the operational blueprint for your fund. The choices you make around structure, terms, and service providers will directly impact your future efficiency, regulatory compliance, and investor relationships. A strategic, integrated approach from day one prevents operational debt—the rework caused by choosing manual or disconnected systems—and sets the stage for long-term success.
Key fund structures and vehicles
After you understand the concept of fund formation, the first major strategic decision you will make as a fund manager is choosing the right fund structure. This choice depends on your specific alternative investment strategy, the types of investors you plan to bring on, and your long-term goals for your firm.
The two primary structures used by fund managers are traditional private investment funds and SPVs. Each serves a different purpose and is suited for different investment strategies, so understanding the distinction is your first step.
Private investment funds
A traditional private investment fund, often a PE or VC fund, is a long-term investment vehicle designed to make multiple investments from a committed pool of capital. These funds are typically structured as a limited partnership and operate over a period of several years. While the initial period for making new investments has a median length of five years, the total fund term is often 10 years. This long-term structure is necessary because VC-backed companies continue to stay private for longer, and while VCs earn an average 12% return, 95% of those returns are generated by the top 5% of investors, underscoring the need for a disciplined, long-term strategy for liquidity.
This structure is best suited for managers who are building a diversified portfolio or a fund of funds around a specific investment thesis, such as healthcare or real estate. If your goal is to establish a durable, multi-fund investment management firm, a private investment fund provides the framework to execute that long-term vision by allowing you to invest in a range of companies over time.
Special purpose vehicles (SPV)
A special purpose vehicle (SPV) is a distinct legal entity created to pool capital from multiple investors for a single, specific investment. This stands in contrast to the multi-investment nature of a traditional fund, offering a more focused, deal-by-deal approach to co-investment and investing.
For emerging managers, SPVs are often a strategic first step. Because raising an SPV for a single deal is typically easier than raising an entire fund, many use them to execute their first deals and build a verifiable track record investing in startups. This approach is common for new managers looking to prove themselves before a larger fundraise; in fact, most smaller SPVs are deployed by solo GPs seeking to establish a track record. The lower capital requirement and relative ease of management make SPVs particularly appealing to this class of investor, which can make it easier to raise a full fund later.
How to form a fund: A step-by-step guide
Now that you understand the basic structures, you can begin the process of forming your fund. The following steps provide an actionable playbook that can help you navigate the complexities offund formation and set you apart from those who take a less structured approach. Following a clear process ensures you don't miss critical legal or operational details.
Step 1: Define your fund thesis and model
Before any legal work begins, your investment thesis codifies your fund's strategy. A fund thesis is the story and strategy that will guide your portfolio construction and investment decisions, explaining what you invest in, why you are uniquely suited to do so, and how you will generate returns for your investors.
This thesis is a key component of your pitch to potential investors and should be clearly articulated. Key components you need to define include:
Investment focus: This is the specific industry, technology, or company stage your fund will target. A clear focus optimizes your deal flow and demonstrates your expertise and helps you stand out to both investors and founders.
Fund size: This is the total amount of committed capital you plan to raise from institutional investors. Your fund size should be large enough to execute your strategy but realistic enough for you to raise successfully.
Portfolio construction: This is your plan for portfolio construction, defining the number of investments you'll make, your average check size, and your target ownership in each company. A well-defined construction model shows investors you have a disciplined approach.
Reserve strategy: A thoughtful reserve strategy is essential for maximizing returns and determining future allocation, as rushing to deploy capital can leave funds overexposed when markets shift.
This strategic scenario modeling is important for attracting limited partners (LP). Tools like Carta Fund Forecasting can help you project potential fund performance and stress-test your assumptions before you begin fundraising.
Step 2: Assemble your formation team
Forming a fund is a team sport that requires specialized external partners to navigate the legal, financial, and operational complexities. Assembling the right team from the outset is essential to a smooth and compliant launch, as each partner plays a distinct and vital role.
Your core formation team will typically include:
Legal counsel: A fund formation law firm or attorney is essential for providing legal advice, structuring the fund, and drafting the governing documents. They ensure your fund is set up correctly from a legal and regulatory standpoint.
Tax advisor: A tax professional ensures the fund is structured for tax efficiency for both you and your investors. They help navigate complex domestic and international regulations as tax issues can significantly impact returns.
Auditor: An independent audit firm will be required to review the fund's financials annually. This provides a necessary layer of validation and transparency for your LPs.
Fund administrator: A fund administrator provides the technology and services to manage fund administration and the fund's day-to-day operations. This includes everything from fund accounting and financial reporting to investor communications, freeing you up to focus on investing.
Step 3: Structure your entities
The standard investment fund legal entity structure involves creating three separate legal entities. This separation limits liability and creates a clear operational framework for managing the fund and its investments.
Typically, the fund itself is a Delaware limited partnership (LP), which is the entity that will hold the investments. The management company is usually a Delaware limited liability company (LLC) responsible for the operational side of the fund. The general partner (GP) is a separate entity (also typically an LLC) responsible for management decisions. This three-entity structure protects the personal assets of the fund managers from the liabilities of the fund. Carta’s Fund Formations platform digitizes and accelerates the process of setting up these entities, simplifying what can be a complex legal task.
Step 4: Draft governing documents
Your legal counsel will draft the key documents that govern the fund's operation and its relationship with investors. These documents are the legal backbone of your fund, and getting them right is paramount. The two most important documents are the limited partnership agreement (LPA) and the term sheet.
The LPA is a legally binding contract between the GP and the LPs. It defines the economic terms, such as management fees, carried interest, and distributions, as well as the rights and responsibilities of all parties involved. The PPM is a disclosure document provided to prospective investors that outlines the investment strategy, risks, and terms of the fund. Carta’s Fund Formations provides expert-vetted document templates for the LPA and term sheet that can serve as a strong starting point for discussions with your legal counsel, saving you time and legal fees.
Step 5: Set up fund operations
With the legal structure in place, the next step is to establish the essential day zero (operational tasks that bring the fund to life). This includes opening a dedicated bank account for the fund, which is necessary to hold investor capital and manage all fund-related expenses.
You will also need to establish a system of record for all financial activity, known as the general ledger (GL). This is the core of your fund's accounting system, tracking every dollar that moves in and out of the fund. Carta acts as the fund's central operating system from the very beginning, with banking integrations that connect directly to an event-based fund accounting software, providing real-time financial visibility and eliminating the need for manual data entry.
Step 6: Onboard investors and close the fund
The final step in the formation process is to onboard your fund investors and collect their capital commitments.
Traditionally, onboarding investors has been a painful process. For a small VC fund with dozens of LPs—the median number is 27, with some having more than 50—relying on a mix of emails, PDFs for subscription documents, and spreadsheets to track progress creates a poor first impression.
Carta offers a modern, professional solution that streamlines the entire process. It allows LPs to review and sign subscription documents digitally in a secure, easy-to-use portal. At the same time, it gives GPs a real-time dashboard to track fundraising progress and automatically run required know your customer (KYC) checks, ensuring a smooth, efficient, and compliant closing.
Key regulatory considerations for fund managers
Throughout the formation process, you must navigate a complex regulatory landscape to ensure compliance. These rules are designed to protect investors and maintain the integrity of the private markets, and failure to comply can have serious consequences.
Fund managers must structure their funds to be exempt from registration under the Investment Company Act of 1940. This is typically done by relying on Sections 3(c)(1) and 3(c)(7), which limits the fund to 100 investors and requires all investors to be qualified purchasers, respectively. Additionally, managers often use the “VC exemption” to file as an Exempt Reporting Adviser (ERA), reducing the reporting burden compared to fully registered advisers.
Separately, exemptions under Regulation D allow you to raise capital without registering the securities offering, provided you sell primarily to accredited investors. Additionally, you must comply with the Investment Advisers Act of 1940 and file forms like Form ADV, which governs your registration status, and potentially Form PF, a confidential reporting form for certain SEC-registered investment advisers to private funds.
Budgeting for fund formation and ongoing operations
An important and often underestimated aspect of launching a fund is budgeting for both the initial organizational costs and expenses. For emerging managers, understanding these costs is essential for building a sustainable firm. As Eric Friedman, managing partner at Graph Advisors, explained during Carta’s VC Masterclass: Setting a Target Fund Size webinar, "Your fund size is the budget. How you allocate those fees across especially the first two to five years matters a lot."
While legal formation can be a significant one-time expense, it’s just one part of your fund’s overall operating budget. For emerging managers, planning for these costs is essential. According to a Carta analysis of about 2,000 private funds, the median VC fund between $1 million and $10 million in size spends about 3.4% of its committed capital on operating expenses during its first five years.
Service provider | Nature of cost |
Legal counsel | A one-time flat fee for fund structuring and document drafting, with hourly billing for ongoing needs. |
Tax and audit | Annual fees for tax return preparation and the required yearly fund audit. |
Fund administration | An ongoing fee, often based on assets under management or committed capital, for technology and operational services. |
From formation to fund administration: Building for the full lifecycle
The choices you make during fund formation have long-term consequences for your fund's operations, efficiency, and investor relationships. A fragmented approach that relies on disconnected spreadsheets and multiple vendors creates operational debt, increases risk, and erodes investor trust over time. This risk is tangible: Late fulfillment of capital calls, for instance, is significantly more common at smaller funds. In VC funds with $1 million to $10 million in commitments, 12% of LPs are at least one week late on their payments—nearly double the rate for funds over $100 million.
An integrated fund management software approach, however, turns fund administration into a strategic advantage. When you use a unified system, the data captured during Carta Fund Formations and Closings flows seamlessly into the event-based general ledger. This single source of truth then powers everything from portfolio valuation to the Auditor Portal, ensuring consistency, accuracy, and transparency across the entire fund lifecycle.
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Frequently asked questions about fund formation
Here are some common questions new fund managers have about the fund formation process. While platforms like Carta can significantly lower formation costs, it is important to note that they are not a replacement for retaining legal counsel.
How much does it cost in legal fees to form a fund?
Legal fees to form a fund typically range from $50,000 to over $200,000 in the United States, depending on fund complexity, structure, and law firm.
How long does fund formation take?
While traditional, manual processes can take several months, a technology-driven platform like Carta can streamline the fund formation process. A standard fund can often be launched in as few as six weeks.
How should I structure fund formation to accommodate advisors receiving carried interest?
Advisors are typically admitted as members of the GP entity (which is responsible for decision-making and receives carry). They are granted a percentage ownership of carried interest, often subject to a vesting schedule. Note that for this process, Carta provides the advisor agreement but does not provide the vesting agreement.
How do I handle fund expenses before capital is called?
Before capital is called, you can handle fund expenses with a management company loan or GP advance, then reimburse these advances from the fund after capital is called. You must disclose this approach in fund documents.
What is the difference between a fund formation lawyer and a fund administrator?
A fund formation lawyer provides essential legal advice, drafts the fund's governing documents to ensure compliance, and helps structure the fund. A fund administrator, in contrast, provides the technology and services for fund management to operate the fund according to those legal documents.
