private investment funds an introduction
An introduction to Private Investment Funds What is a private investment fund?
What are the key issues for investors?
A “fund” refers to any sort of entity formed to enable investors to pool capital with a view to a common investment objective. Funds are usually managed in accordance with defined investment policies, and offer exposure to bigger or better-value stakes in more diverse investments, potentially offering improved returns while spreading investment risk. The most familiar forms are private equity, venture capital, hedge and real estate funds. But funds can be used for much more diverse assets, such as fine wine, classic cars, antique coins and so forth.
This depends on the circumstances of the investor, the size of the investment he expects to make and the objectives of the fund (among other things). But in general, the investor needs to ask the following questions: • I s the fund manager and the others involved with the fund properly regulated? • How will the structure of the fund, its domicile, and the arrangements for investment into it affect the investor’s tax liability? • Are the costs of the fund (fees to the manager and the others involved, the cost of making investments etc.) realistic or, conversely, disproportionate? The investor should also find out if the fund affords him access to his capital (e.g. by allowing him to sell or redeem his interest), or, conversely, for how long his capital will remain committed. Funds invested in illiquid assets, like real estate, often tie up investors’ capital for many years.
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What are the key issues for fund managers, general partners etc.? The answers here are reciprocal to the answers to investors’ concerns. It is imperative for the prospective manager to have proper advice on several interlocking issues. Here are some of the most important: • Choice of domicile UK or offshore? If offshore, where? • Choice of vehicle Private equity and real estate usually sit better in a partnership structure, while hedge funds are almost always corporate vehicles. But there are exceptions to both of these positions. • Tax Tax treatment of the fund itself, its investments and its investors. Investors regard tax efficiency as practically non-negotiable. • Regulation Who needs to be regulated? Does the fund need to be registered? In the UK and EEA, the impact of the EU Alternative Investment Fund Managers Directive will be highly material; and fund distribution in the USA has always been highly regulated. • Service providers Almost all funds require an administrator or custodian. Hedge funds require prime brokers. For effective distribution, managers should consider retaining a placing agent. • Fees and expenses What is paid from the fund and what must the manager pay from its own pocket? • Profit allocation Depending on the structure and duration of the fund, there is range of solutions for capturing the manager’s profit. The key is to ensure a balance between the manager’s clear entitlement to its profit for success and a return which is fair to investors.
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Setting up the fund and getting ready for launch This intense process can be expected to take several weeks, sometimes longer if the structure is particularly complex. During this period, the fund manager is likely to be separately involved in parallel tracks, such as pitching to investors, talking to regulators or offshore service providers etc. It is critical to have a practical plan for the timely production of the relevant materials. For example: • The fund will require an offering memorandum. This needs legal input as well as substantial input on commercial matters from the client. It can go through several drafts, and in the case of larger or more complex funds, a full formal verification is recommended as well. • There will be counterparty relationships to document (administrators, custodians etc.) • The fund’s constitutional documents will reflect its structure (a partnership agreement for a limited partnership; articles of association for a corporate vehicle etc.), as well as its place of establishment. • If offshore, the fund will need advice from local counsel on establishment, registration and operation. • The manager must seek advice on how the fund is promoted in countries where investors are sought. It is vital that proper advice is sought before the fund goes out to market. • The profit distribution scheme for the fund may involve the formation of further satellite vehicles, which will need to be considered at this stage. • And if cornerstone investors are intended, their special terms of investment require drafting.
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Marketing and closing It can take longer to raise a fund than many managers expect. Where the investment is substantial, prospective investors often negotiate the terms offered to them. It is also vital in today’s regulated environment that all investors are subject to proper background checks to ensure their identities are clear and to vouch for the provenance of their money. Investors may seek legal opinions from counsel to the manager with respect to matters such as limited liability. Lastly, it is conventional to re-issue the offering memorandum in updated form to reflect the terms of the fund at closing.
Afterwards Larger funds may have more than one closing. Open-ended funds (such as corporate hedge funds) have continuous dealing on a periodic basis. Funds that close successfully then need to invest their money. Although this is (typically) routine transactional work for corporate or real estate lawyers, it can be important to involve the lawyers who established the fund, where the transactions have a bearing on the fund’s constitution. Not all funds succeed. Some fail to close, while others run into financial difficulties. Funds and their managers are often sued by aggrieved investors, commercial counterparties and service providers, and regulators can become involved as well. All of this calls for legal services from investment fund experts who have experience in contentious financial services law.
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How we can help you Howard Kennedy’s private investment funds team is led by Daniel Tunkel, who has more than 25 years’ experience in handling sophisticated legal matters for clients involved with financial regulation and private investment funds. The team advises prospective fund managers, investors and other counterparties on their relationship with all of the issues noted above. We also advise clients on the following: Fund formation We work with our clients involved in fund formation to advise on best choice of domicile and structure, as well as compliance with the relevant UK and EU regulatory regimes for private and alternative funds etc. We draft or oversee the production of all relevant fund documentation, often in conjunction with relevant offshore counsel (we are well connected with firms in all the world’s major offshore fund domiciles). We also co-ordinate the process of seeking advice on overseas fund marketing. Investing into a fund Where a client wishes to seek advice on investment into a fund, we will review the fund documentation and provide our advice as a preliminary to negotiation of terms. We can also help the client to develop a bespoke structure through which to invest, if for some reason direct investment is not possible. Structuring and marketing of the fund We can introduce clients to relevant choices of offshore counsel, service providers and placing agents, in order to assist with their structuring and marketing plans.
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Financial Regulation We are experienced in advising on all aspects of UK financial regulation, and use this experience to advise on which aspects of the affairs of a private fund require UK regulation (or if there are applicable exemptions or exclusions to rely upon). Taxation of the fund We can advise on taxation of the fund, its manager and the fund’s investors (though we always advise third parties to seek independent tax advice before investing). Where the manager needs to work with a commercial counterparty in order to make the fund proposal a success, we can use our extensive business contacts to make relevant introductions. Howard Kennedy’s wider offering Separately from the above, the fund formation process may give rise to the need for corporate, commercial, real estate, IP, employment and contentious legal advice, which the different groups within Howard Kennedy are well placed to provide. Howard Kennedy also benefits from being the UK member of both the Meritas and LAW global legal networks, allowing us to provide genuinely cross-border expertise for clients.
Private Investment Funds Team
Daniel Tunkel Partner: Financial Regulation T: +44 (0) 20 3755 5749 E: daniel.tunkel@howardkennedy.com
David Gilinsky Associate: Financial Regulation T: +44 (0) 20 3755 5469 E: david.gilinsky@howardkennedy.com
Dan Hyde Partner: Dispute Resolution T: +44 (0) 20 3755 5524 E: dan.hyde@howardkennedy.com
Leigh Sayliss Partner: Tax T: +44 (0)20 3755 5526 E: leigh.sayliss@howardkennedy.com
No.1 London Bridge London SE1 9BG DX 144370 Southwark 4 Tel: +44 (0)20 3755 6000 Fax: +44 (0)20 3650 7000 www.howardkennedy.com