When forming an investment fund in the United States, fund managers must consider a variety of legal, regulatory, and tax implications. One of the most critical decisions in this process is choosing the right jurisdiction. While Delaware has long been the preferred choice for venture capital, private equity, and hedge funds due to its business-friendly laws and strong legal protections, other states — such as New York, California, and Texas — offer alternative frameworks that may better suit certain investment strategies.
The jurisdiction in which a fund is formed impacts governance, investor rights, liability protections, and regulatory compliance. Understanding the advantages and limitations of Delaware compared to other states can help fund managers make informed decisions that align with their investment goals.
This guide examines the key legal considerations for fund formation in the U.S., focusing on Delaware's dominance in the investment fund landscape while comparing it to alternative jurisdictions.
Why Jurisdiction Matters in Fund Formation
The jurisdiction in which a fund is established dictates the legal and regulatory framework under which it operates. Each state has its own corporate laws, tax policies, and investor protections that can significantly affect fund administration.
The primary factors fund managers must consider when selecting a jurisdiction include:
- Investor Preferences: Institutional and high-net-worth investors often have strong preferences for certain legal frameworks.
- Limited Liability Protections: Stronger liability shields can reduce legal risks for general partners (GPs) and limited partners (LPs).
- Flexibility in Governance: Some states allow greater freedom in structuring partnership agreements and management rights.
- Tax Treatment: State tax laws vary widely and can impact fund profitability.
- Regulatory Complexity: Some jurisdictions impose stricter compliance requirements that may add administrative burdens.
With these considerations in mind, Delaware has emerged as the leading choice for fund formation, but other states offer distinct advantages that may appeal to specific types of investment funds.
Delaware: The Gold Standard for Fund Formation
Delaware is the most common jurisdiction for investment fund formation in the U.S., particularly for venture capital and private equity funds. Its dominance stems from the Delaware Revised Uniform Limited Partnership Act (DRULPA) and the Delaware Limited Liability Company Act (DLLCA), which provide flexibility and strong legal protections for fund managers and investors.
The Delaware Chancery Court, a specialized business court, further enhances the state's appeal. This court is known for its expertise in corporate and partnership law, offering predictable and efficient resolutions to business disputes. Investors and fund managers value Delaware's well-developed case law, which provides clarity on legal issues that may arise.
Limited Partnership and Limited Liability Company Structures
Delaware offers two primary legal structures for investment funds: limited partnerships (LPs) and limited liability companies (LLCs). Most venture capital and private equity funds are structured as LPs, where a general partner (GP) manages the fund, and limited partners (LPs) provide capital while maintaining limited liability. Delaware's LP laws give fund managers broad discretion in structuring key elements such as management fees, carried interest, and capital contributions, making it the preferred choice for institutional investors.
Some hedge funds and real estate funds, however, opt for the LLC structure due to its greater flexibility in profit distributions and management roles. While LLCs provide fund managers with more operational control, institutional investors tend to favor LPs because they are more widely recognized in fund governance and investment agreements. The choice between these structures depends on the fund's investment strategy, tax considerations, and investor preferences.
Strong Legal Protections for Fund Managers
Delaware's laws provide strong fiduciary duty protections for fund managers, particularly through contractual freedom in LP agreements. Unlike other states that impose rigid fiduciary obligations, Delaware allows GPs to limit or modify fiduciary duties in the partnership agreement, reducing their exposure to investor claims. This flexibility makes Delaware particularly attractive to fund managers looking to minimize legal risks.
Favorable Tax Treatment
Delaware does not impose a state corporate income tax on investment funds that do not operate within the state, making it a tax-efficient choice for fund formation. Additionally, Delaware's lack of a franchise tax on LPs and no sales tax further enhances its appeal.
While Delaware offers numerous benefits, fund managers may consider other jurisdictions based on specific investment goals, investor preferences, or regulatory considerations.
New York: An Alternative for Institutional Funds
New York is home to some of the world's largest institutional investors, hedge funds, and private equity firms. As a global financial center, it attracts a high concentration of pension funds, university endowments, and family offices looking to allocate capital to investment funds.
While most funds still register in Delaware due to its flexible legal framework, some New York-based funds choose to form entities under New York law to align with their investors' preferences and maintain closer proximity to financial decision-makers. Additionally, fund managers who primarily operate in New York may find it administratively simpler to structure their entities under state law rather than registering an out-of-state entity.
Stronger Fiduciary Duty Requirements
Unlike Delaware, which allows fund managers to modify or limit fiduciary duties in the limited partnership agreement, New York law imposes stricter fiduciary obligations on general partners. This provides greater investor protections, ensuring that fund managers act in the best interest of limited partners.
That said, these stronger legal obligations can also limit a general partner's discretion in managing fund assets and may make New York less attractive to managers who prefer greater contractual flexibility in structuring their fund agreements. Funds catering to institutional investors that prioritize strong governance and investor rights may see New York's fiduciary duty requirements as a positive feature rather than a drawback.
Higher Tax Burdens
One significant drawback of forming a fund in New York is the state's corporate tax environment. New York imposes a partnership-level franchise tax, which can increase the overall tax burden on funds, making it less tax-efficient than Delaware. Additionally, funds operating in New York may be subject to state and city income taxes, which can further impact fund profitability. Unlike Delaware, which does not impose a state corporate income tax on funds that do not conduct business within the state, New York's tax policies can result in higher operating costs for fund managers and limited partners.
For funds with primarily New York-based investors or those seeking to align with stricter investor protections, New York may still be a viable option despite the added tax considerations. Fund managers considering New York as a jurisdiction should carefully weigh the benefits of proximity to institutional investors and strong fiduciary standards against the potential downsides of increased tax obligations and regulatory complexity.
California: Regulatory Complexity for Venture Funds
California has one of the most stringent regulatory environments for investment funds. The California Department of Financial Protection and Innovation (DFPI) enforces strict securities laws, which can create additional compliance burdens for fund managers.
Unlike Delaware, where regulatory oversight is more predictable, California's evolving regulations can introduce added legal complexities that require ongoing monitoring and compliance efforts. Fund managers operating in the state must navigate licensing requirements, disclosure obligations, and investor protection rules that are often more rigorous than those in other jurisdictions.
Investor-Favored Legal Framework
California's fiduciary duty laws are stricter than Delaware's, offering greater protections to LPs but reducing flexibility for fund managers. The state's strong consumer protection laws also extend to investment funds, increasing regulatory scrutiny. This can be beneficial for investors seeking stronger governance safeguards, but it may discourage some fund managers who prefer Delaware's more flexible approach to fiduciary duties and contractual modifications.
Fund managers considering California must weigh the benefits of enhanced investor protections against the potential restrictions on decision-making authority within their limited partnership agreements.
High State Taxes
California imposes a state income tax on funds that operate within the state, along with additional franchise taxes on LLCs and LPs. These taxes make California a less attractive jurisdiction for fund formation compared to Delaware, where investment funds can avoid state income tax if they do not conduct business there.
Funds focused on Silicon Valley startups may still find California an advantageous location due to its proximity to the tech ecosystem and access to top-tier entrepreneurs, investors, and accelerators. For managers investing heavily in California-based companies, the benefits of local market access may outweigh the higher tax and regulatory burdens associated with operating in the state. But nothing is prohibiting you from gaining that same access with a Delaware-chartered fund.
Texas: A Growing Hub for Private Equity Funds
Texas has become an increasingly popular alternative for fund formation due to its lack of a state income tax. Unlike California and New York, Texas does not tax partnership income, making it an attractive option for funds seeking tax efficiency and reduced operational costs. The state's overall lower tax burden allows fund managers to maximize returns for investors, particularly those focused on private equity and real estate investments.
Business-Friendly Legal Environment
Texas offers business-friendly corporate laws and has a growing financial sector, particularly in Austin and Dallas, which have seen an influx of venture capital firms and private equity investors. While Texas does not have a specialized business court like Delaware's Chancery Court, its contract law is well-established, providing reasonable protections for fund managers and investors. Additionally, the state's less burdensome regulatory framework makes it an appealing alternative for funds looking to avoid excessive compliance requirements.
Limited Adoption by Institutional Investors
Despite its tax advantages, Texas has not yet achieved the same level of institutional investor adoption as Delaware. Many large pension funds, university endowments, and hedge funds continue to prefer Delaware due to its predictability in corporate governance, well-developed case law, and investor familiarity.
That said, as Texas continues to attract family offices, high-net-worth individuals, and emerging venture capital firms, its reputation as a fund-friendly jurisdiction is steadily growing. Fund managers considering Texas should assess whether its business-friendly policies and tax incentives outweigh the potential challenges of limited institutional recognition in the broader investment landscape.
Need Guidance on Fund Formation? The Fridman Law Firm Can Help
Choosing the right jurisdiction for fund formation is a critical decision that impacts liability protections, investor relationships, and tax obligations. Whether you are launching a venture capital fund, private equity fund, hedge fund, or alternative asset fund, the Fridman Law Firm provides tailored legal guidance to help fund managers navigate state-specific regulations, draft partnership agreements, and ensure compliance with U.S. securities laws.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
