Understanding Hedge Fund Structures: From GP & LP to Performance Fees in 2025

In 2025, hedge fund management is no longer just about executing winning strategies, it’s about operating within increasingly complex legal, operational, and accounting frameworks. Unlike mutual funds or ETFs, hedge funds are structured to offer maximum flexibility in investment and governance, but that flexibility introduces operational risk if not matched with sound internal controls, compliance measures, and clear fund documentation.

This article breaks down how hedge funds are structured today, from legal setup and fee modeling to operations, reporting, and investor protection, using industry-sourced insights and regulatory best practices.

The Foundation of Hedge Fund Structures 

Hedge funds are typically structured as limited partnerships (LPs), with the fund sponsor acting as the general partner (GP) and outside investors participating as limited partners (LPs). This setup allows GPs to maintain control over investment decisions while limiting LP involvement to passive capital contributions. 

Unlike registered investment companies, hedge funds are exempt from many public reporting requirements, allowing them to operate with tailored strategies, lockup periods, and fee arrangements. According to the Managed Funds Association (“MFA”) this limited partnership model is standard across the U.S. hedge fund industry and provides fund managers with broad discretion in selecting service providers, defining liquidity rights, and allocating profits and losses to partners. 

Roles and Responsibilities: GP vs LP 

General Partners (GPs) 

The GP is typically responsible for: 

• Designing the fund strategy and investment approach 

• Selecting third - party service providers (auditors, fund administrators, legal counsel) 

• Executing trades and managing risk 

• Overseeing  investment operations, compliance, and financial reporting 

GPs also invest their own capital in the fund, which helps align their interests with those of LPs. 

Limited Partners (LPs) 

LPs contribute capital and receive allocations of profit, loss, and expenses. Their rights, responsibilities, and protections are defined in the Limited Partnership Agreement (LPA), which includes terms such as: 

• Redemption rights and lock - up periods 

• Access to financial statements and NAV reports 

• Voting rights on key governance issues 

Clear delineation of authority and responsibility between GP and LP is critical for avoiding operational confusion and legal disputes. 

Accounting, NAV, and Profit Allocation 

Capital Accounts and NAV 

Each LP has an individual capital account tracking contributions, withdrawals, and earnings. Net Asset Value (NAV) is calculated using daily or monthly valuations by an independent fund administrator. Shadow accounting , maintaining a parallel internal set of books, is increasingly common to validate third-party reports and catch discrepancies. 

Fee Models and Legal Structuring 

The traditional “2 and 20” (2% management fee, 20% performance fee) is being reworked in 2025 to meet investor demands for fairness and transparency. 

Modern Fee Features 

• High - water marks: Ensure performance fees are only paid on new net gains 

• Hurdle rates: Require returns to exceed a minimum threshold before fees apply 

• Investor - specific terms: Side letters may outline modified fee arrangements 

Legal and accounting treatment of fees must follow U.S. GAAP, particularly when side pockets or illiquid assets are involved. As EisnerAmper explains, designated investments in side pockets must be excluded from fee calculations until valuation is reasonably certain. 

Governance, Legal Frameworks, and Compliance Obligations 

Entity Formation 

As previously mentioned, most hedge funds are formed as LPs. A separate management company (usually an LLC) is created to manager the fund and receive the asset-based management fee

Required Documents 

1. Private Placement Memorandum (PPM)  -  Discloses among others, items like investment risks, investment strategy, investor eligibility, fees, redemption rights
    
2. Limited Partnership Agreement (LPA)  -  Legal contract defining fund governance and investor rights 
   
   
3. Subscription Documents & Side Letters  -  Capture investor commitments and special terms 

A professionally drafted PPM is essential for regulatory compliance and risk mitigation under Regulation D (Rule 506(b) or 506(c)). 

Regulatory Filings and Controls 

Fund managers must comply with: 

• SEC filings: Form ADV, Form PF, and Form D 

• AML/KYC: Required identity verification and sanctions screening of each LP 

• Custody Rule: Custodian or independent verification of assets 

• Audit obligations: Annual audits by a PCAOB - registered firm

Operational Workflows and Internal Controls 

Core Operations 

Effective hedge fund operations rely on well - defined workflows, typically involving: 

• Trade lifecycle: Execution → allocation → settlement 

• Treasury management: Monitoring liquidity, managing FX exposure 

• NAV reconciliation: Between internal shadow books and the fund administrator 

• Reporting hierarchy: Roles and responsibilities must be documented clearly 

As described in OpsCheck’s systems overview, hedge funds need automated execution, reconciliation, and oversight platforms to scale without operational risk by being burdened with manual processes. 

Structural Risks and Risk Mitigation 

Common Pitfalls 

• Liquidity mismatches: Between redemption terms and asset liquidity 

• Weak documentation: Missing or inconsistent LPAs, PPMs, or side letters 

• Overreliance on single service providers: Leading to valuation or compliance gaps 

• Misaligned incentives: Fee structures rewarding short-term performance 

According to EisnerAmper, the 2008 crisis revealed how under-structured redemption rights (e.g., lack of gates or lock - ups) created chaos when investors rushed to redeem from funds holding illiquid positions. 

Hedge Fund Structure Checklist 

Before launching or restructuring a hedge fund, managers should assess the following: 

• Clear GP/LP governance roles in legal agreements 

• Shadow accounting to verify NAV and fees 

• Documented liquidity provisions and lock - ups 

• Fee terms consistent with GAAP and investor expectations 

• Compliance calendar covering all regulatory obligations 

• PPM tailored to strategy, risks, and redemption terms 

• Internal controls mapped through SOPs and approval workflows 

Future Trends in Hedge Fund Structuring 

Hedge funds in 2025 are evolving toward more transparent, modular, and tech-enabled frameworks: 

• Digital investor portals for real-time capital account visibility 

• Fee compression is driving adoption of tiered or deferred fee models 

• Side pockets and designated investments are re-emerging for illiquid strategies 

• Pre - trade compliance tools are becoming standard for managers operating under multiple regulatory regimes 

Proper structure isn’t just a legal it’s a competitive advantage. 

Final Thoughts 

A well-structured hedge fund in 2025 must go beyond strategy. Managers are responsible for building legal, accounting, and operational systems that can withstand regulatory scrutiny, scale effectively, and promote transparency with investors. 

This article reflects current best practices in hedge fund governance, financial reporting, compliance, and operations. For further reference, explore foundational resources from across the industry: 

• How Hedge Funds Are Structured  -  MFA Alts (PDF) 

• Structuring, Valuation & Legal Considerations  -  HF Law Report 

Cartesian FinOp Partners supports hedge fund managers by helping design and implement institutional-quality operational frameworks, covering areas such as shadow accounting, fee model validation, fund reconciliation, and audit‑ready reporting structures.  

These capabilities align with the core needs of hedge fund managers navigating the demands of today’s market.