Incubator art funds are in essence art investment vehicles aimed at generating returns through the purchase and sale of art. The primary difference between an incubator art fund and a traditional art fund lies in the fact that the incubator does not initially accept money from third party investors. Rather, the incubator will for an initial period of time utilize and invest funds that are provided by the art fund manager itself. Then, after a certain period of operating the incubator fund by such art fund manager, during which the art fund manager can develop an auditable performance record, the incubator fund can then legally use such track record to market the fund to potential investors.

The use of an incubator fund structure has become particularly popular among prospective art fund managers for a number of reasons. Unlike traditional hedge fund managers, who elect to start a hedge fund after years of successfully trading for a previous fund or financial institution, art fund managers have for the most part had no experience in operating an investment vehicle. While many art fund managers improperly cite their prior investment returns in connection with buying and selling art as a dealer or collector, such returns are not analogous to the operation of an art fund and therefore cannot be legally marketed to prospective investors. For example, art dealers/collectors neither charge annual management fees and performance fees nor do they incur substantial legal, administration and accounting costs in connection with the formation and ongoing governance of an investment vehicle. Such charges have a direct impact on the returns to be garnered from investing in works of art, which precludes the use of prior returns by individual dealers/collectors when marketing an art fund. By setting up an incubator art fund and utilizing his or her own money, an art fund manager can develop a proven track record without risk to third party investors. In addition, as the incubator fund is not initially marketed to investors, no offering documentation is required to be prepared, thereby taking out the lion’s share of the legal costs associated with launching an art fund.

Naturally, the use of an incubator fund structure has its drawbacks. For one, the art fund manager is risking his own money in the endeavor and is not paid any management fees by investors for running the fund. In light of the difficulty in generating significant returns on art investments in the short-term, many incubator funds must operate for several years before a sufficient marketable performance record is achieved. Finally, most prospective art fund managers either lack or are unwilling to personally risk the amount of monies that would permit the art fund to acquire the character and number of art works dictated by their ideal investment strategies. Accordingly, art fund managers of incubators usually operate a tamer version of their ideal art investment fund.

Step One. The art fund manager forms the (i) actual art fund, (ii) the general partner of the fund if structured as a limited partnership and (iii) the art fund management company creates the requisite operating documents and authorizing resolutions for such entities.

Step Two. The art fund begins acquiring and selling art works and developing an auditable track record.

Step Three. The art fund manager develops the offering documents and engages an accountant to audit the performance results of the incubator fund to date. The art fund manager will then circulate the offering documentation – namely the private placement memorandum, underlying operating documents for the fund and the subscription agreement – as well as the audited financial statements of the incubator art fund to prospective investors.