PEI Fund Structures Supplement - 2011

APRIL 2011 | privateequityinternational.
com
FUND STRUCTURES 2011

A PEI supplement
Lead sponsor: Pepper Hamilton Co-sponsors: Capolino-Perlingieri & Leone Loyens & Loeff P + P Pllath + Partners
INVESTOR RELATIONS & COMMUNICATIONS FORUM

June 15 16, 2011 | 3 West Club, New York
Join us at the sixth annual Investor Relations and Communications Forum, where the focus of the program will be Creating Value and Communicating Competitive Differentiators. Hear from top industry experts and take the opportunity to network with your peers at this pivotal private equity focused event. New for 2011: Professional Development Masterclass Whether you are new to the investor relations and communications role or new to the asset class, this intensive three hour session will provide comprehensive training in two tracks: The Complete Fundraising Cycle and The Nuts & Bolts of Corporate Communications.
World class speakers include:

Sarah Ashmore Bradley
Managing Director Investcorp International Inc.
Robert D. Brown
Managing Director & Global Head of Limited Partner Service Advent International
Patricia S. Grad
Principal Head of Investor Relations Irving Place Capital
Jason Ment
Partner General Counsel & CCO StepStone Group LLC
Jim Rutherfurd
Partner Fund Investor Relations 3i
Charles W. Bauer
Managing Director EnCap Investments L.P.
For full program details please visit www.peimedia.com/irny11
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FUND STRUCTURES 2011 CONTENTS

2 Terms and conditions ILPAs efforts to standardise the industry 4 Expert commentary: Pepper Hamilton 4 Core elements 9 Passages to India 12 Offshore regimes The Channel Islands allure 14 Expert commentary: Loyens & Loeff Tax and legal developments in the Benelux region 19 GP fund commitments GPs put more skin in the game 21 Expert commentary: Capolino-Perlingieri & Leone Investing under pressure 24 Innovative fund structures Separate accounts gain ground 27 Expert commentary: P+P Pllath + Partners Germanys encouraging outlook 32 Asia regulations China lays down some rules
Mapping the road ahead

This year and next promise to be incredibly busy for fund managers, investors and their advisors particularly for those individuals leading the charge on new private equity fund offerings. Large numbers of GPs are planning a return to market in 2011, with some estimates suggesting as many as 1,500 funds will be seeking commitments globally from investors this year. Crucial factors in attracting limited partner interest remain a GPs track record and performance, but LPs many of whom are keen to temper costs and reduce relationships are now, more than ever, focused on terms and conditions. And not just with regards to fees. The latest (and looming) alternative investment fund-related tax and regulatory changes around the world are also key considerations for both GPs and LPs as they raise or commit to future funds. These are among the issues broached by expert commentators and PEI journalists this month in our annual fund structures special. Enjoy the supplement,
Amanda Janis Senior Editor, Private Equity
Supplement Editor Jenna Gottlieb jenna.g@peimedia.com Senior Editor, Private Equity Amanda Janis amanda.j@peimedia.com Editor, Private Equity International Toby Mitchenall toby.m@peimedia.com Editor, PrivateEquityInternational.com Christopher Witkowsky christopher.w@peimedia.com
Contributors Nicholas Donato nicholas.d@peimedia.com Hsiang-Ching Tseng daisy.t@peimedia.com Editorial Director Philip Borel philip.b@peimedia.com Head of Marketing Paul McLean Paul.m@peimedia.com Head of Production Tian Mullarkey tian.m@peimedia.com
Group Managing Director Tim McLoughlin tim.m@peimedia.com Co-founder David Hawkins david.h@peimedia.com Co-founder Richard ODonohoe richard.o@peimedia.com Head of Advertising Alistair Robinson alistair.r@peimedia.com Head of Business Development Jeff Gendel jeff.g@peimedia.com
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terms & conditions
Talking points
The Institutional Limited Partners Association continues to change the game for LP-GP negotiations. The trade group recently released an updated version of its Private Equity Principles that includes more information about carry clawback best practices and expanded context around the purposes of key guidelines. The guidelines are resonating with GPs, finds Jenna Gottlieb
The investor-friendly terms and conditions guidelines that were drawn up in 2009 by the Institutional Limited Partners Association (ILPA) were meant by the group to encourage better communication and negotiations among GPs and LPs.The Private Equity Principles aimed to standardise and simplify reporting, with the ultimate goal of creating consistency, accuracy and expediency in partnership financial reporting. Demonstrating that the guidelines were a work in progress, the trade group recently released an updated version of its Private Equity Principles that included more information about carry clawback best practices and expanded context around the purposes of key guidelines. The revisions to the guidelines were all part of the plan, explains ILPA executive director Kathy Jeramaz-Larson. The first set of guidelines was issued in 2009 and it was indicated at this time that ILPA was not finished, says Jaramaz-Larson. The new round came about after we were soliciting GPs that were unable to comment on the first round. We had a roundtable meeting in February last year with GPs and LPs and out of that we were encouraged to take the ILPAs Private Equity Principles and get more explicit about expectations. She adds: The need for LPs and GPs to better
Having things standardised makes it easier for smaller teams to understand the information and process it
communicate about expectations and practices is still there and the guidelines are really meant as a way to spark dialogue about terms. Game changer Private equity GPs have certainly felt the effect of the guidelines dissemination: many of them have spent the last year negotiating with LPs who have started showing up at meetings with the ILPA guidelines in hand. Considering the popularity of the guidelines among investors, big name private equity firms began to endorse ILPAs principles. Apollo Management, Coller Capital and Hermes Private Equity are a few firms that have supported the principles. In total, 140 industry organisations have thrown their weight behind the principles. In March, Kohlberg Kravis Roberts lent its support to the Private Equity Principles. The news comes at a time when KKR is currently courting investors for its 11th flagship North American fund, which is targeting between $8 billion to $10 billion. For KKR, however, neither its current nor future funds will adhere to every term on the LP wish list put forth by ILPA, according to a spokesperson.The endorsement is a commitment of our general support for the efforts of ILPA and
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more than just providing the amount other industry supporters to strengthen The need for LPs and GPs of the capital call or the distribution, the basic tenets of the principles with according to Tim Recker, chairman of the goal of improving the private equity to better communicate about ILPA. The information you need to deal industry for the long-term benefit of all of expectations and practices is with a capital call notice is more detailed its participants, said KKRs co-founders than you realise, Recker says. It can and co-chief executives, Henry Kravis and still there and the guidelines be a significant back office headache to George Roberts, in a statement. appropriately address the information. Just as GPs are getting behind the are really meant as a way to Providing consistency is a good idea, Private Equity Principles, ILPA has spark dialogue says one GP based in New York. This released a new set of guidelines. In is something were on board with. It January ILPA issued the first of five promotes efficiency internally and pleases investors, he explains. reporting templates to improve uniformity and transparency and Theres nothing to complain about. reduce expenses in administering and monitoring private equity investments. Whether GPs endorse the ILPA guidelines or not, any firm hoping to raise money had better find a copy of the amended guidelines and Good calls new templates and read them carefully. n The first template focuses on capital calls and distribution notices and was developed in consultation with general partners. ILPA chose to tackle capital calls and distribution notice reporting because it CLAWBACK REVISIONS was an issue on which both general partners and limited partners asked for help, said Jeramaz-Larson. [This was an issue] where the New components in the updated Private Equity Principles have been included industry was looking to create some efficiencies on the LP and the to allow funds to adopt the guidelines more effectively.They also include an GP side, she said about the first template. appendix on carry clawback best practice guidelines: Reporting generally speaking, the information a GP shares with Best approach is all capital back waterfalls (European style) as this will minimise excess carry distributions its LPs about the fund performance and investments has long been an area of concern for LPs. Complaints about reporting have ranged If deal-by-deal carry, then an NAV coverage test (generally from the quality of information the GP provides to the amount of at least 125%) should be performed to ensure sufficient information shared. margin of error on valuations LPs enthusiastically embraced the new guidelines as standardisation Interim clawbacks should apply, triggered both at defined of reporting would not only help LPs, but GPs as well, says one LP intervals and upon specific events (i.e. key-man, insufficient source. From a GPs point of view, you get fewer calls from LPs. NAV coverage) You shouldnt have 50 people saying, I need it in this format, the The clawback amount should be the lesser of excess carry LP source said. For LPs, especially those organisations with small or total carry paid, net of paid taxes. However, there private equity teams, having standardised reporting will definitely are often errors in the stipulated formulas which have a ease some pressure, the source says. Having things standardised material impact on fund cash flows: The tax amount should makes it easier for smaller teams to understand the information not simply be subtracted from the amount owed under and process it. the clawback and the clawback formula should take the Specifically, reporting around capital calls and distributions is preferred return into account
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expert commentary pepper hamilton
Core elements
Pepper Hamilton explores the US tax issues fund managers and their limited partners must consider when structuring to invest in the natural resource and energy sectors. By Julia Corelli, P. Thao Le, Stephanie Pindyck-Costantino, Christopher Rossi and Laura Warren
In recent years, investment in the natural resource sector has increased, due in part to investors desire to diversify their portfolio, from both a risk profile and asset class standpoint, by investing in a space that is thought to be weakly correlated to public equity markets.The natural resource sector includes items such as timber, metals, crops, and alternative energy sources like wind and solar power. To capitalise on this increased investor demand, private equity funds, including US-based private equity funds of funds, are seeking to exploit direct and indirect investment opportunities in the natural resource and energy sectors. Investments in companies operating within the natural resource sector, both within and outside the United States, can present challenges for investors due to the operational nature of the companies and the fact that many of the companies are deemed to hold real estate. This article addresses potential US tax consequences that US investors in a domestic private equity fund may encounter when investing (directly or indirectly through offshore or onshore feeders) in a company in the natural resource and energy sectors, the potential structures that may be employed to mitigate adverse tax consequences, and additional consideration under the Investment Advisers Act of 1940 (Advisers Act) associated with these structures. Certain funds may need to take into account specific rules or regulations to which certain investors may be subject, for example tax-exempt investors subject to the Employee Retirement Income Security Act of 1974 (ERISA). Tax drivers Typically, there are three general categories of investors: (i) taxable US persons1 (high-net-worth individuals and non-exempt institutional investors); (ii) tax-exempt US persons, including pension funds, IRAs, endowments and foundations; and (iii) non-US persons (foreign persons).The latter two investor types usually have significant sensitivity to fund income attributable to a trade or business because such income may cause the investor to incur tax. For example, while US tax-exempt investors are generally not subject to federal income tax on capital gain as well as dividend interest and royalty income, they are likely to have to pay tax on income derived from an unrelated trade or business (UBTI), and if they employ structures to avoid UBTI, may trigger tax on dividends, royalties and income effectively connected with a US trade or business (ECI) and/or attributable to the disposition of a US real property interest (USRPI), pursuant to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) and Section 897 of the Internal Revenue Code of 1986, as amended (Code).2 UBTI.A US tax-exempt investor is usually exempt from tax on capital gains, dividends, interest, and royalties but will be required to pay federal income tax at the highest corporate rates3 on income derived from an unrelated trade or business.Thus, the investment focus of a US tax-exempt investor is often the avoidance of UBTI. A fund will generate UBTI if it: (i) invests in an operating partnership (usually a limited liability company) directly or through another fund or pass-through entity; (ii) incurs debt to fund the acquisition of a security or investment, whether to bridge a capital call or to leverage an investment (debt financed income); or (iii) is treated as a dealer, to the extent of dealer activity. ECI. Foreign investors are generally not subject to federal income tax on capital gain or interest income that constitutes portfolio interest. Foreign investors are subject to 30 percent withholding tax on dividend income, unless a lower rate is provided in an applicable treaty. Foreign investors are taxed as US persons with respect to income effectively connected with a US trade or business and a fund must withhold regardless of cash flow (generally at a 25 percent rate). Additionally, a foreign investor that is a
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corporation will generally be subject to another level of tax on any ECI not reinvested in a US trade or business (the branch profits tax or BPT). The effective tax rate on ECI (inclusive of BPT) allocable to a corporate foreign investor is north of 50 percent. FIRPTA. Lastly, pursuant to FIRPTA and Section 897 of the Code, gains or losses attributable to the disposition of a USRPI will generally be treated as ECI and the gross proceeds realised upon disposition may be subject to 10 percent withholding. If a domestic investment fund has a foreign feeder taxed as a corporation and invests in a USRPI, the income attributable to the disposition of that investment that is passed through to the foreign feeder is all ECI. This in effect converts capital gain that is otherwise not taxable to foreign investors into income taxed at ordinary rates and possibly subject to the BPT.A US corporation with significant real estate holdings generally constitutes a US real property holding corporation (USRPHC), the stock of which is treated as a USRPI. Once a corporation constitutes a USRPHC, it maintains this status for five years regardless of its real estate holdings.4 Accordingly, the tax focus of a foreign investor is typically the avoidance of ECI (including FIRPTA) and maximisng capital gains. As with UBTI, a fund may generate ECI from investments in pass-through operating entities or due to dealer status. In addition ECI may be generated by a fund that invests in real estate assets (directly or through a pass-through entity) and USRPHCs.A fund may invest in a USRPHC, and thus a USRPI unknowingly, because corporations can inadvertently constitute USRPHCs if at some point the corporations income and value is predominantly real estate-based.5 Many foreign investors may be willing to endure federal income tax inefficiencies in order to avoid transparency. Structure alternatives Offshore feeder. Private equity funds that generally do not invest in pass-through operating entities often utilise offshore feeder structures whereby their US-based tax-exempt investors, as well as their foreign investors, make their capital commitments through an offshore vehicle (such as a Cayman Islands or BVI entity) that makes an 8832 election to be taxed as a corporation for US income tax purposes. An offshore feeder taxed as a corporation effectively blocks UBTI from debt-financed income and may effectively eliminate transparency for foreign investors. The offshore feeder is generally treated as the beneficial owner of the fund and therefore the offshore feeder, and not its owners, must provide a tax identification number and report to the Internal Revenue Service (IRS). However, as a result of the FATCA rules passed as part of the HIRE Act 6 in 2010, beginning in 2013, the ability to eliminate transparency through an offshore feeder will be significantly reduced.7 It may be important for transparency purposes, including IRS reporting, to house foreign investors in one offshore feeder and US investors (generally tax-exempts) in another.
ABC GP L.P.
(DE LP)
Tax Exempt Investors

Taxable Investors
GP LPs ABC Private Equity Offshore Fund, L.P. (Cayman 8832/Corp.) LP
ABC Private Equity Fund, L.P. (DE)
Portfolio Investments
An offshore feeder taxed as a corporation is not a tax-efficient UBTI blocker or ECI blocker if the fund generates income from a US trade or business. Such income will constitute ECI to the offshore feeder and therefore, the fund will be required to withhold at a rate of 35 percent (most offshore feeders are formed in non-treaty jurisdictions) on such income. Moreover, there will be FIRPTA implications to the extent real property or a USRPHC is involved. A fund utilizing the offshore feeder structure and desiring to invest in the natural resource and energy sectors will at the outset need to plan for alternative structures that are flexible enough to address multiple structuring considerations. Many natural resource and energy-related companies are formed as pass-through entities to provide for flow-through treatment of the tax benefits, mainly in the form of deductions and tax credits. As a result, investment by private equity funds in such companies will typically be beneficial to US taxable investors who want the flowthrough treatment (which may come at the price of additional state tax reporting obligations); however, the investments often generate UBTI and ECI for tax-exempt and foreign investors. Although these investments are tax-efficient for US taxable investors, certain investors may find that
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the burden of additional state tax reporting obligations, as well as the complexity of obtaining and calculating certain deductions and credits, outweighs the tax benefits. Private equity funds typically have a provision in their governing documents that enable the manager of such funds to use one or more alternative investment vehicles (AIVs) to house a particular investment in order to accommodate tax, regulatory or other planning. Such AIV provisions typically provide funds and their managers with flexibility to form multiple AIVs above, below or parallel to the fund and to use different entity forms. Consideration must be given to how the cost of an AIV, as well as the ongoing expenses of administration of the AIV, will be shared among the fund investors and how the calculation of the managers carried interest should take the AIV into account. Domestic feeder. When a fund utilises the offshore feeder structure for its US tax-exempt investors and it invests in a natural resource-related pass-through entity, it should consider bringing its US tax-exempt investors onshore.8 This will eliminate ECI and FIRPTA concerns for such US tax-exempt investors. In deciding what type of AIV to use for US tax-exempt investors, consideration should be given to (i) whether the tax benefits expected in the ultimate investment will significantly offset the UBTI expected to be generated, and (ii) how much of the investors return is projected to be from operating income in contrast to gain on disposition. If the tax benefits are significant and the return is expected predominantly from exit, US tax-exempt investors should consider using a pass-through vehicle and not a blocker corporation. However, if the investors desire to avoid UBTI regardless of the tax cost, an onshore domestic corporation should be interposed to block UBTI. Certain regulatory provisions such as ERISA can be drivers to the structure ultimately employed by the fund. For example, if the offshore feeder is considered to hold plan assets,9 unless the fund obtains the consent of the offshore feeder investors, a domestic AIV housing such investors must generally come directly into the fund and cannot invest on a parallel basis with the fund. In this instance, there are generally three alternative blocker structures that a fund may utilise.10 The first is to impose a blocker structure above the fund that only blocks UBTI to the US tax-exempt investors coming in through the AIV. The blocker corporation will cause all income earned from the investment to be subject to a corporate-level tax. Tax benefits from the investment may offset this corporate-level tax (although generally the gain on exit will not be offset). In certain cases, the corporate-level tax may be mitigated by bifurcating the US tax-exempt investors investment into part debt at the AIV level and part equity into the blocker corporation.11 Because the blocker corporation is above the fund, the US taxable investors
ABC GP L.P. (DE LP)
Tax Exempt Investors

LPs
GP Taxable Investors
ABC Private Equity Offshore Fund, L.P. (Cayman 8832/Corp.)
LPs
LP
ABC/XYZ OFFSHOR E AIV I, L.P.

(DE Partnership)
LP
XYZ Fund (DE Partnershi p) Portfolio Investments
enjoy pass-through tax treatment, including the pass-through of tax benefits, if any. However, it also may result in additional reporting obligations to such investors. The second method imposes a blocker structure between the fund and the portfolio company. This blocks all investors in the fund and generally eliminates the pass-through tax benefits associated with partnerships, as well as any tax benefits specific to the type of investment. This structure is helpful for funds with taxable investors that are not inclined to file multiple state tax returns and to calculate or report complicated tax benefits. Because the blocker corporation is below the fund, there is a corporate-level tax on all income generated from the investment. On exit, the corporate-level tax may be avoided if an agreement can be reached to ensure that the blocker corporation is purchased on exit, rather
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than the blocker selling its interest in the underlying portfolio company. The purchase of the blocker corporation would eliminate the second level of tax on exit, and any gain should be taxable at the capital gains rate. Such an exit structure generally, however, will reduce basis write-ups for the purchaser and may therefore impact the price realisable.
ABC GP L.P. (DE LP)
Tax Exempt Investors LP
Taxable Investors
GP
ABC Private Equity Offshore Fund, L.P. (Cayman 8832/Corp.)
LPs
LP LP
ABC/XYZ OFFSHOR E AIV I, L.P.

(DE Partnership)
ABC/XYZ Blocker (DE Corp.)
Portfolio Investments
XYZ Fund (DE Partnershi p)
The third option contemplates a blocker structure under the fund (as in method two) and in addition, a parallel AIV taxed as a partnership through which the taxable investors may elect to invest. This method is effective for funds that have both (i) US-taxable investors that are not inclined to file multiple state tax returns or to calculate or report complicated tax benefits and (ii) US-taxable investors that desire passthrough treatment and do not mind additional reporting requirements. This method is also effective to facilitate a funds investment in another fund with a natural resource or energy focus (New Resource Fund) and that has a blocker structure already in place. In such case, (i) the tax-exempt investors would be brought onshore through a passthrough AIV that invests in the fund, (ii) the fund would invest in the New Resource Funds blocker structure, and (iii) the electing US-taxable investors of the fund would go into the New Resource Fund through a pass-through parallel AIV. The New Resource Funds blocker structure may employ a leverage mechanism to reduce the corporate-level tax, but there will generally not be an ability to sell the blocker corporation.
Advisers Act considerations In creating AIVs, fund managers will need to consider whether the AIVs will have an impact on their compliance with the Advisers Act. AIVs are considered to be private funds12 and clients of an investment adviser. Accordingly, fund managers may need to disclose information about the AIVs in their Form ADV and comply with the custody rules for the AIVs. 3 Reporting requirements. In 2010, the SEC proposed rules13 that significantly amend Form ADV to provide for enhanced disclosures and impose reporting requirements on registered investment advisers and private fund advisers that are exempt from registration under the proposed rules (exempt reporting advisers).14 The proposed rules are due to become effective on July 21, 2011. At that time, registered investment advisers and exempt reporting advisers would need to disclose on their Form ADVs information about all of their private fund clients (including the AIVs). Specifically, they would be required to disclose information about the size, investment strategy, assets and liabilities, number of investors and service providers of their private fund clients. This information must be filed electronically and will be publicly available. Custody. AIV users also should focus on the custody rules of the Advisers Act. An investment adviser is deemed to have custody of client assets if it or a related person in any capacity (such as general partner of a limited partnership) has legal ownership of or access to client funds or securities. In the typical AIV structure, a related person of the fund
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manager will serve as the general partner of the AIV and, as a result, the manager generally will have custody of the AIVs assets. With custody, the AIVs funds and assets need to be held by a qualified custodian and subject to surprise examinations and quarterly account statement delivery requirements. An adviser may be deemed to comply with the surprise examination requirements with respect to its private fund clients (including AIVs) and is not required to comply with the account statement delivery requirements if (i) an audit of the private fund is conducted by an accounting firm registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board (PCAOB), (ii) the private funds audited financial statements are prepared in accordance with GAAP, and (iii) such audited financial statements are delivered to investors in the private fund within 120 days after the end of its fiscal year. AIVs would be no exception and must be audited by an appropriate accounting firm. To be qualified to prepare the audited financial statements under the custody rules, the accounting firm must be subject to regular inspection by the PCAOB.While an accounting firm may be registered with the PCAOB, it may not be subject to regular inspection by the PCAOB and would thus fail to be qualified to prepare the audited financial statements under the custody rules, rendering the fund manager subject to the surprise audit and account statement delivery requirements of the custody rules. The net result for the fund complex is enhanced auditing requirements that can drive up costs of the funds administration significantly. Conclusion Structuring fund investments into natural resource- and energy-related companies is complicated and may result in multiple entities in the final structure. Offshore vehicles and AIVs can be structured as series partnerships and segregated portfolio companies to reduce entity proliferation, but those often trigger increased corporate governance, tax planning and regulatory complexities. The key is to plan at the initial stages of fund formation and to build in the flexibility that will be needed to address multiple future structuring contingencies while maintaining both the overall intended economics and investor confidence about the managers integrity and transparency. Fund managers need to ask the right questions of investors in the subscription materials so that the fund does not have to go back to investors to ask for elections, consent, permission, or forgiveness. n
1 U.S. person generally has the meaning set forth in Regulation S, promulgated under the Securities Act of 1933, as amended. 2 A USRPI includes: (i) a direct interest in real property located in the United States or the Virgin Islands; (ii) an interest in a domestic corporation that has been a United States Real Property Holding Corporation (USRPHC) at any time within a five-year period ending on the date of disposition of the interest; or (iii) an interest in a partnership meeting certain ownership tests. If a partnerships assets are 90 percent or more USRPIs, cash, and cash equivalents, and at least 50 percent of its assets are USRPIs, the partnership interest itself is treated as a USRPI for purposes of FIRPTA withholding. Special rules apply for publically traded partnerships. Assets held by LLCs that are owned by the partnership are treated as assets of the partnership. 3 Certain U.S. tax-exempt investors, such as charitable remainder trusts, are required to pay 100 percent tax on UBTI. 4 There are a few exceptions to the five-year taint, including the disposition of all U.S. real estate by such corporation in taxable transactions. 5 A corporation will constitute a USRPHC if the fair market value of the U.S. real property interests held by the corporation is more than 50 percent of the sum of the fair market values of its: (i) U.S. real property interests; (ii) its interests in real property located outside the United States; and (iii) its other assets used or held for use in a trade or business. Natural Resource and energy companies tend to have valuable real estate (including power plants and wind mills), which may at any given time constitute more than 50 percent of the value of such companies trade or business assets. Moreover, any start-up company may inadvertently constitute a USRPHC if it acquires office space before other assets. 6 H.R. 2847, the Hiring Incentives to Restore Employment Act (HIRE), was signed into law on March 18, 2010.This law contains provisions previously included in proposed legislation in the Foreign Account Tax Compliance Act of 2009 (H.R. 3933, S. 1934), known as FATCA. 7 Once FATCA is effective, funds may want to have separate offshore feeders for U.S. tax-exempt investors and foreign investors. This may entitle the foreign investor feeder to limit its reporting requirements provided it enters into an agreement with the IRS providing that it does not have and will not have U.S. investors. FATCA guidance is still pending.To plan for this, many funds are separating their foreign feeders prior to FATCAs effective date. 8 Planning for foreign investors is outside the scope of this article but will often be aligned with planning for tax-exempts in that the most tax-efficient structures may utilize a domestic blocker. 9 The plan asset regulations (29 U.S.C. 2510.3-101) define what constitutes plan assets. As a general rule, if more than 25 percent of any class of equity securities in the offshore feeder is held by employee benefit plans governed by ERISA or Section 4975 of the Code, then the offshore feeder has significant ERISA investors and the assets of the feeder will be deemed plan assets for purposes of ERISA. 10 To the extent there are not significant ERISA investors in the offshore feeder, other structures may be utilized, such as a parallel AIV housing the tax-exempt investors that invests alongside the fund. 11 The availability of a part debt-part equity investment may be limited and, among other things, depends upon the number of investors, their percentage ownership and the debt-to-equity ratio. 12 The SEC considers hedge funds, private equity funds and other types of pooled investment vehicles exempt from the definition of investment company under the Investment Company Act of 1940 (Investment Company Act) (i.e., Section 3(c)(1) or Section 3(c)(7) of that act) as private funds. 13 See Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers with Less than $150 Million in Assets Under Management, and Foreign Private Advisers, Investment Advisers Act Release No. 3111 (Nov. 19, 2010); and Rules Implementing Amendments to the Investment Advisers Act of 1940, Investment Advisers Act Release No. 3110 (Nov. 19, 2010). 14The SECs proposed rules provide for an private fund adviser exemption to registration. Under this exemption, advisers with a principal office and place of business in the United States would be exempt from registration if they act solely as investment advisers to qualifying investment funds and managed private fund assets of less than $150 million (inclusive of all assets managed inside and outside of the United States.).
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Passages to India
Pepper Hamilton discusses key considerations for structuring India-focused investment funds. By Todd Betke, Julia Corelli, Valrie Demont and P. Thao Le
While much of the developed world suffered a substantial economic downturn following the financial meltdown of September 2008, India continued to be one of the most attractive emerging markets for foreign investment, generating real growth rates (GDP) of 9 percent in 2008, 7.4 percent in 2009 and 7.4 percent again in 2010. Although there have been recent reports of foreign investors departing India due to regulatory and tax uncertainty and frustration with bureaucratic red tape, a variety of factors suggest that India is likely to remain an attractive destination for significant investments by private equity funds for the foreseeable future. Key drivers The principal drivers of foreign investment in India over the long term include the fact that it is an English-speaking, common law jurisdiction governed by a stable democratic regime. The country also features a young, educated workforce that is in position to provide business and manufacturing services at internationally competitive wages. Indias urban centers are experiencing rapid growth, and an expanding middle class with rising household incomes is producing increasingly attractive consumer markets. In addition, over the past decade, Indian businesses have become increasingly organised, moving from mom and pop sole proprietorships to corporate structures with diversified shareholders and more experienced management. Finally, Indias large and continuing investment in infrastructure throughout the country has generated growth across many sectors and now provides a strong base for additional economic activity. In short, the social and economic factors that have driven foreign investment in India over the past decade appear likely to fuel continued interest in the country, particularly for investors with the skill and experience to navigate through what is admittedly a sometimes uneven and challenging regulatory process. Three routes There are three main avenues for investing in India: through a Foreign Direct Investment (FDI), as a Foreign Institutional Investor (FII), and as a Foreign Venture Capital Investor (FVCI). Foreign Direct Investments. Foreign Direct Investments are generally permitted without any special registration of the investor with the Indian regulatory authorities. They may be made either through the automatic route, in sectors in which no prior governmental approval is required, or via the approval route in which prior governmental approval is required in certain sectors, including for certain investments in banking and financial services, telecommunications, single-brand retail, civil aviation, petroleum, defense, print media and broadcasting. In addition, Foreign Direct Investments in certain sectors may also be subject to specified caps on the maximum percentage of a companys securities that can be owned by foreign investors. Such sectors include, for example, defense (26 percent), telecommunications (74 percent), singlebrand retail (51 percent), insurance (26 percent), banking (74 percent) and print media (26 percent). Finally, a number of sectors, including gambling, certain real estate activities, multi-brand retail and certain agriculture projects, prohibit foreign investment altogether. In addition, Foreign Direct Investments are subject to certain pricing regulations under which the price for securities of listed companies issued or sold between an Indian and a non-Indian party must be determined by following certain guidelines issued by the Securities Exchange Board of India (SEBI), and the price for securities of unlisted companies issued or sold between an Indian and a non-Indian party must be set at fair market value as determined by an accredited investment bank or accounting firm using the discounted free cash flow method.
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Foreign Direct Investments are also subject to additional restrictions in cases in which the foreign investor had already invested in a venture or had a tie-up or technical collaboration in the same field prior to 12 January 2005. Finally, FDIs in listed securities are also subject to post-IPO lock-up periods and to compliance with the mandatory offer provisions of the Indian takeover code. Foreign Institutional Investors. Foreign investors who desire to invest primarily in Indian publicly traded securities (such as hedge funds) may elect to register as a Foreign Institutional Investor with the SEBI, a process that generally requires four to six weeks following submission of a completed application. To qualify as a FII, the foreign investor must be regulated by an appropriate foreign regulatory authority (such as the U.S. Securities and Exchange Commission (SEC) or the U.S. Financial Industry Regulatory Authority (FINRA)) and have carried on regulated activities for at least 12 months. FIIs are also required to possess a track record, professional competence, financial soundness and a general reputation for fairness and integrity, and to provide audited financials for a period covering at least 12 months. Investments by FIIs are generally limited to publicly traded equity securities with no more than 30 percent of the investments made by an FII in debt securities. FIIs are subject to the same governmental approval and sectoral cap requirements as Foreign Direct Investments as summarized above. However, FIIs are not subject to the SEBI pricing regulations or the regulations on pre-existing ventures and generally are not subject to lock-ups except for post-IPO lock-ups for pre-IPO equity. FIIs remain subject to compliance with the Indian takeover code rules. In addition, FIIs cannot own more than 10 percent of the equity of any one company, or more than 5 percent of the equity of any one company on behalf of a corporate or individual sub-account. In addition, no more than 24 percent of the total issued capital of a listed company can be owned by FIIs in the aggregate. Foreign Venture Capital Investors. Alternatively, foreign investors who desire to invest primarily in the securities of Indian privately owned companies (such as private equity funds and venture capital funds) may elect to register as a Foreign Venture Capital Investor with SEBI. To qualify as a FVCI, the foreign investor must possess a track record and demonstrate financial soundness, experience and a reputation for fairness and integrity. However, the processing time for registration as an FVCI is somewhat longer and less certain than for FIIs. In addition, whereas FIIs generally focus on investments in publicly traded companies, FVCIs are required to invest at least 67.77 percent of their capital in securities of privately held companies. FVCIs are subject to the same governmental approval and sectoral cap requirements that apply to FDIs and FIIs, but are generally not subject to the SEBI pricing regulations or the regulations on preexisting ventures. Further, FVCI are also exempt from the post-IPO lock-up rules (provided the investment has been held for at least 12 months) or, under certain circumstances, from the takeover code rules. As a result, registration as an FVCI is often the most attractive route for managers of private equity funds. Tax considerations In general, the Indian tax code levies a tax on capital gains from direct or indirect sales of shares of Indian companies by non-residents. As a result, it is critical that private equity funds investing in India be organised in a jurisdiction that has a double-taxation avoidance agreement (DTAA) with India in order to achieve tax efficiency. Jurisdictions with favouurable Indian DTAAs include Mauritius, Cyprus and Singapore. Each of these agreements generally provides that tax residents of these jurisdictions are exempt from Indian capital gains tax. In addition, these jurisdictions do not themselves impose any local tax on capital gains. However, dividends and interest may be subject to local tax at varying rates, although these taxes may be offset via available foreign tax credits. Specific information concerning each of these jurisdictions is set forth below. Mauritius. The India-Mauritius DTAA provides that Mauritius tax residents are exempt from capital gains on the sale of shares of Indian companies. In addition, Mauritius levies no local tax on such gains. This allows Mauritius residents to avoid the approximately 10 percent to 42 percent capital gains tax applicable in India on the sale of securities. However, interest received from Indian companies is subject to taxation in India at the rate of approximately 20 percent to 42 percent and Mauritius entities holding a global business license granted by
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the Mauritius authorities are not subject to Mauritius tax on interest. Payment of dividends in India is subject to a company-level tax of approximately 17 percent and Mauritius entities holding a global business license granted by the Mauritius authorities may be subject to Mauritius tax on dividends from India of up to 3 percent (subject to reduction via foreign tax credits). Formation of a company in Mauritius generally requires approximately four to six weeks, and submission of a comprehensive due diligence package. It is also imperative that effective management and control be implemented at the Mauritius-entity level in order to avail of the benefit of the India-Mauritius DTAA. However, Mauritius remains an attractive jurisdiction for investment fund formation due to its clear rules for achieving tax residency, which have been upheld by the Indian Supreme Court, and its generally flexible corporate laws, which can be tailored to achieve market-standard results for investors and managers even though a limited partnership vehicle is not available. Cyprus. The India-Cyprus DTAA also provides that Cypriot tax residents are exempt from capital gains on the sale of shares of Indian companies, and Cyprus does not tax any such gains locally. India levies a 10 percent tax on interest, as does Cyprus. However, Cyprus generally does not tax dividends from India (subject to available foreign tax credits). Cyprus offers access to the European Union and a more favourable treatment for debt investments. However, formation of a Cypriot entity can be a slow process, and there is some uncertainty surrounding the mechanism for achieving tax residency. In particular, the Cyprus requirements of effective management and control at the Cyprus-entity level must be strictly adhered to in order to avail of the benefit of the India-Cyprus DTAA. Also, its corporate laws are rigid compared to Mauritius, which can create challenges for replicating traditional legal and economic arrangements between investors and managers. Singapore. The India-Singapore DTAA also provides that Singapore tax residents are exempt from capital gains tax in India, subject to certain conditions, and Singapore does not generally impose local taxes on such gains. There is an approximately 15 percent Indian tax payable on interest received from Indian companies, and Singapore also taxes interest locally at the rate of approximately 17 percent, although this may be reduced through foreign tax credits. Singapore generally does not tax dividends from India. While Singapore features a well-defined process for achieving tax residency as well as a wealth of experienced business and financial advisors to help streamline the incorporation process, there is some uncertainty over whether the capital gains exemption applies to entities that are formed with the primary purpose of taking advantage of the exemption. Specifically, the Singapore entity must have had more than $200,000 of total annual expenditures on operations in Singapore for the preceding 24 months to benefit from the protection of the India-Singapore DTAA. In addition, it is worth noting that the India-Singapore capital gains tax exemption will cease to apply in the event that the same exemption available under the India-Mauritius treaty is removed. As a result, Mauritius remains the most popular jurisdiction for Indian investment fund formation. Common structure The below diagram illustrates a common structure used by investment funds targeting investments in India:
In general, this involves formation of a Mauritius holding company that can either serve as the investment fund itself, investing directly in the securities of Indian companies, or as a feeder fund
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that invests in an Indian master fund through which the actual investments are made. Under this structure, all foreign investors become shareholders of the Mauritius holding company, while any Indian investors would invest through the Indian fund. Certain additional arrangements may be undertaken in order to ensure that the Mauritius holding company is a tax resident of Mauritius, and therefore not taxable in India.These arrangements seek to implement effective management and control of the Mauritius entity in Mauritius and include incorporation of a separate Mauritius entity to serve as the fund manager, and the appointment of individuals resident in Mauritius as directors of the Mauritius holding company and the fund manager. This structure is designed to enable all decisions made in respect of the Mauritius entities to be formally made in Mauritius, and to permit all documents that are required to be executed on behalf of the Mauritius entities to be signed and kept in Mauritius.To the extent that India-focused investment funds have management teams on the ground in India that are sourcing and monitoring investments in Indian portfolio companies, this structure contemplates an arrangement by which the local team is housed in a separate advisory company that subcontracts with the Mauritius fund manager and receives compensation for services. The local team may also invest directly in the Indian fund vehicle and receive incentive compensation through that entity. Finally, the Mauritius holding company may establish a wholly-owned Mauritius subsidiary in order to further insulate the holding company and its investors from Indian taxation. Additional considerations As noted above, Mauritius does not offer the kind of limited partnership vehicle traditionally used by general partners and limited partners for private equity funds. While the Mauritius corporate laws are generally flexible enough to permit substantially similar legal and economic results (generally, through a shareholders agreement that contains terms similar to those used in limited partnerships), some investors and managers prefer to use the traditional corporate structure rather than wade through the complexities associated with implementing the market-standard bargain in Mauritius. One mechanism for achieving this goal is to impose a Cayman or other offshore limited partnership above the Mauritius holding company. Additional offshore vehicles may also be added to serve as blocker corporations for investors that are sensitive to unrelated business taxable income (e.g., tax-exempt investors) and/or to accommodate special legal or economic terms applicable to investors or groups of investors. Regulatory developments In recent years, there have been many regulatory developments in the United States and internationally that may affect Indian investment funds and their operations. United States. With the passage of the Private Fund Investment Advisers Registration Act of 2010 (Advisers Registration Act), significant changes have been made to the Investment Advisers Act of 1940 (Advisers Act) that limit the exemptions from SEC registration for managers of private fundsi.The SEC has proposed rulesii that seek to define and clarify significant aspects of these limited exemptions.Two of the exemptions provided by the proposed rules are the private fund advisor exemption and the foreign private adviser exemption. Under the proposed private fund adviser exemption, advisors with a principal office and place of business in the United States would be exempt from registration if they act solely as investment advisors to qualifying investment fundsiii and manage private fund assets of less than $150 million (inclusive of all assets managed inside and outside the United States). Advisors with a principal office and place of business outside the United States (non-U.S. advisors) would also be able to rely on the private fund advisor exemption provided that all of the advisors clients that are U.S. personsiv are qualifying private funds.Thus if a non-U.S. advisor to an Indian investment fund had a U.S. investor with co-investment rights, the manager would probably not be able to rely on this exemption. Furthermore, all private fund advisors exempt from registration with the SEC, including foreign private advisors with U.S. clients, are still required to submit reports with the SEC and periodically update them.The reporting requirements require private fund advisors to disclose: (i) information about the advisors organisation, ownership and operations; and (ii) information about their private fund clients (i.e., a funds size, investment strategy, assets and liabilities, number of investors, service providers, etc.). These reports would be filed electronically and would be publicly available. Another exemption, for foreign private advisers exempts certain other foreign advisors from registration. The proposed rules define a foreign private advisor as one that has no place of business in the United States, has fewer than 15 U.S. clients and U.S. investors in private funds that it
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manages, and less than US$25 million of assets under management from such clients and investors, and does not hold itself out as an investment advisor to U.S. investors, and does not act as investment advisor to a registered investment company or any business development company. Even though the SECs proposed rules have not been finalized, the Advisers Registration Act requires that all advisors that are required to be registered with the SEC as a result of the Advisers Registration Act do so by July 21, 2011. Managers should be aware of the registration and reporting requirements under the Advisers Act and consider whether the addition of private funds established for investments in India would require them to be registered under the Advisers Act or submit reports as required by that act. Cayman Islands. In addition, the Organization for Economic Development recently recognised the Cayman Islands on its white list of jurisdictions employing internationally recognised tax standards.This action may enable the Cayman Islands to distinguish itself from other jurisdictions that may be regarded as tax havens and increase the use of Cayman vehicles for investment in India and elsewhere. Furthermore, in 2009, the Cayman Islands Monetary Authority was admitted as an ordinary member of the International Organization of Securities Commissions (IOSCO), which is recognised by SEBI as an appropriate foreign regulatory authority for purposes of FII registration in India, thereby opening the way for Cayman Islands funds to seek FII qualification with SEBI. India. Finally, over the past several years there has been a lot of pressure and various attempts by Indian regulators to renegotiate the India-Mauritius tax treaty. More recently, several provisions of the new Indian Direct Tax Code that are coming into effect could have a significant impact on the continued use of income tax treaties with India.While such actions would undoubtedly face strong commercial opposition from the international investment community, a revision at some point in the future of the IndiaMauritius DTAA cannot be ruled out. As noted above, if the capital gains tax exemption in the India-Mauritius DTAA is removed, the corresponding provision in the India-Singapore DTAA would also fall.This possibility may be remote, but it could cause investments through other jurisdictions, including Cyprus and, more recently, the Netherlands or Luxembourg, to increase. In general, as with any complex cross-border commercial transaction, it is critical that fund managers targeting investments in Indian companies carefully consider all of the legal, tax and regulatory issues in effect at the time the investment is made. However, given that investment funds often have terms of 10 years or more, it is also important to consider how the legal landscape may evolve in the future, and to implement structures that are designed to provide the maximum security and flexibility in the face of any future changes. Doing so requires the careful selection of legal and tax advisors across multiple jurisdictions, each of which should have substantial experience with the relevant commercial terms, with the vehicles in the applicable jurisdictions, and with the local advisors across such jurisdictions. For fund managers willing to engage such advisors, implement cuttingedge structures and, yes, endure some bureaucratic delays and regulatory uncertainty, India will remain an attractive target for foreign investment. n Pepper Hamilton LLP is not admitted to practice law in India. You should contact your Indian law advisor to address any specific Indian law questions you may have.
(i) The SEC considers hedge funds, private equity funds and other types of pooled investment vehicles exempt from the definition of an investment company under the Investment Company Act of 1940 (Investment Company Act) (i.e., Section 3(c)(1) or Section 3(c)(7) of that act) as private funds. (ii) See Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers with Less than $150 Million in Assets Under Management, and Foreign Private Advisers, Investment Advisers Act Release No. 3111. (iii) The SECs proposed rules define qualifying private fund as any private fund that is not registered under the Investment Company Act and has not elected to be treated as a business development company under that act. (iv) U.S. person generally has the meaning set forth in Regulation S, promulgated under the Securities Act of 1933, as amended. Indias revised Consolidated FDI Policy, which was just released by the Indian Department of Industrial Policy and Promotion (DIPP), Indias regulator in charge of formulating Indias Foreign Direct Investment Policy (FDI), amends and replaces in its entirety, effective as of April 1, 2011, Indias prior Consolidated FDI Policy. The new Consolidated FDI Policy in particular eliminates the need for prior FIPB approval of new investments in the same field in cases where the foreign investor already had in place a joint venture or a technology transfer or trademark agreement with an Indian party on or prior to January 12, 2005. This change does not affect, however, the requirements to obtain FIPB approval for investment in sectors subject to sectoral caps. The Consolidated FDI Policy also streamlines and simplifies the approval requirements for investments in holding and shell companies and clarifies that prior FIPB approval is required for investments by foreign investors into companies incorporated in India and whose only activity is investing in the capital of other Indian companies, regardless of the amount invested. Similarly, FIPB prior approval is also required for investments by foreign investors in companies incorporated in India and that do not have operations or downstream investments. The full text of the new Consolidated FDI Policy can be found at http://dipp.nic.in. Pepper Hamilton LLP recently authored an U.S.-India Alert on this development that can be found at http://www.pepperlaw.com/publications_update.aspx?ArticleKey=2065.
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Core elements
Authors
Passages to India
Authors
Julia D. Corelli +1 215.981.4325 corellij@pepperlaw.com
Todd W. Betke +1 202.220.1221 betket@pepperlaw.com
P. Thao Le +1 617.204.5105 lep@pepperlaw.com
Julia D. Corelli +1 215.981.4325 corellij@pepperlaw.com
Stephanie Pindyck-Costantino +1 215.981.4406 costantinos@pepperlaw.com
Valrie Demont +1 212.808.2745 demontv@pepperlaw.com
Christopher A. Rossi +1 610.640.7846 rossic@pepperlaw.com
P. Thao Le +1 617.204.5105 lep@pepperlaw.com
Laura D. Warren +1 215.981.4593 warrenl@pepperlaw.com
Pepper Hamilton LLP 3000 Two Logan Square Eighteenth and Arch Streets Philadelphia, Pennsylvania 19103-2799 +1 215.981.4000
Office locations include Berwyn, Boston, Detroit, Harrisburg, New York, Orange County, Philadelphia, Pittsburgh, Princeton, Washington, DC, Wilmington.
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offsHore regimes
Safe harbour
Shifting winds are now at the back of some popular offshore financial centres, reports Nicholas Donato
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Guernsey: increasingly attractive to GPs
Cosmopolitan cities like London and Paris are attractions in their own right as leading international hubs of commerce and culture. For these jurisdictions a tweak to the law here or a change in rules there may in the short-run result in some chagrin, but its a fair price to pay to be part of a large diversified financial centre buzzing with activity, argue some policymakers. However, recent game-changing developments may push EU private equity activity (and other business) to offshore financial centres. For one, its safe to assume most high-performing (and thus well-compensated) fund managers in the UK, a country which takes the lions share of buyout activity in Europe, are still left disgruntled from recently imposed tax hikes. Last year, top earners in the UK saw their income tax rate jump to 50 percent from 40 percent. Private equity managers were also hit by the countrys VAT rate rising to 20 percent from 17.5 percent earlier this year. Similar tax hikes were recently instituted in Spain and France. The combined effect could be enough to convince more than a handful of GPs to follow in the footsteps of Terra Firma Capital Partners Guy Hands and the founder of Alchemy Partners, Jon Moulton, in moving to Guernsey. The island has a 20 percent tax
on income and zero tax on capital gains. Terra Firma itself has established operations on the island and is joined by fellow buyout giant Permira. Likewise a number of firms have chosen to establish funds on the island: BC Partners, Permira, Apax Partners, Coller Capital and Kohlberg Kravis Roberts, to name just a few. Guernsey isnt the only Channel Island providing a less stringent regulatory and legal landscape for private equity players compared to other EU locations. For instance, Jerseys laws on limited partnership arrangements are flexible on the timing of capital distributions and require less paperwork when communicating with regulators. In Jersey you can set up a partnership in as little as three days, says Nigel Strachan, chairman of the Jersey Funds Association. Corporate partner Jersey is also set to provide fund managers two new forms of the limited partnership arrangement. Expected in the second quarter of 2011, the island will offer GPs the separate limited partnership (SLP) and incorporated limited partnership (ILP), both of which will have its own distinct legal personality, whereas the latter goes one step further in being structured entirely as a corporate body. Moreover it is expected by UK tax practitioners that both the SLP and the ILP will be UK tax transparent.
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The advantage of a distinct legal personality is the partnership being able to contract, hold property, sue and be sued purely in their own name, which is in contrast to traditional LPs which are only able to do so through their GP, highlights a legal release from Channel Islands law firm Carey Olsen. The ILP, a hybrid structure mixing the elements of a partnership and corporation, works much like a company while still retaining the essential features of a partnership. For instance in the event an ILP had to be wound up, the partnership would be governed by the more familiar and detailed insolvency provisions provided by Jersey company law. Further, as a body corporate, the ILP is a more robust fund vehicle, says James Mulholland, a London-based Jersey funds partner at Carey Olsen. One benefit is that banks may prefer lending to a fund that is an ILP for capital call financing since it is a discrete body corporate as the contracting party, which ultimately gives the banks greater security. It is also worth noting that Jersey and Guernsey limited partnership arrangements fall outside the scope of recent UK tax rules which mandate a general partner of English and Scottish limited partnerships to file tax returns for all of its LPs and disclose the identity of its investors to UK tax authorities. British law firms are telling us that new HM Revenue & Customs guidelines create a GP administrative burden and an unwelcome headache, says Mulholland. From bad to good In the past few months, however, nothing may be more important for private equitys strong presence in offshore financial centres than the regulatory efforts currently underway in the EU. After a nearly twoyear long debate, the Alternative Investment Fund Managers (AIFM) directive has preserved non-EU nations ability to market funds across the important 27-member bloc. Until at least 2018, offshore managers can continue pitching their funds to EU investors in line with national private placement regimes, subject to meeting information exchange agreements. At that point EU regulators will decide whether the national regimes will go by the wayside. If so, funds domiciled offshore will have to obtain an EU marketing passport which, after meeting various requirements, allows a fund to be offered to professional investors across all EU-member states. Third country funds marketing through private placement regimes will however need to comply with some basic transparency and reporting
provisions. A GPs home state must also avoid landing on the Financial Action Task Force (FATF) blacklist, which monitors suspected money laundering and terrorist financing activities. In fact, many argue the directives extensive requirements will be a net positive for the Channel Islands and other popular destinations for fund domiciliation. The directive, which has been watered down from more onerous previous drafts, still subjects GPs to a new era of reporting requirements and transparency measures. Among other changes, the bill will place restrictions on asset stripping portfolio companies, fund managers pay and places limits on the use of leverage. Those hungry to poach business from the EUs 54 billion private equity industry (according to EuropeanVenture Capital Association 2010 statistics) are quick to point out they have the freedom to bypass the AIFM. The directive does not apply to offshore funds which write-off any marketing campaign to EU investors, whereas it captures all EU domiciled funds, regardless of its target investor geography. Importantly, the directive also makes no rules against reverse solicitation or passive marketing. This means non-compliant funds are barred from knocking on the doors of EU investors, or whats known as active marketing, but says nothing against EU institutional investors who are the ones initiating dialogue concerning an investment in a noncompliant offshore fund. Notably, EU cornerstone investors willing to take the lead in linking up with an offshore fund can continue doing so without violating the directive. Carey Olsens Mulholland has played witness to the growing appetite for funds structured under the more flexible and lenient regulatory systems provided by offshore islands. He expects Channel-Island-based fund activity to experience a significant uptick in 2011. We are currently spending a lot of time talking to City law firms about their clients especially those who have historically used onshore structures, about moving their next fundraising offshore, and even some migrations of existing funds as well, says Mullohand, who attributes the EUs stricter regulatory landscape as a primary driver of the shift. In Guernsey alone private equity assets under management on the island have grown in value by nearly 50 percent in the last 12 months to reach 62 billion by the end of September 2010, according to Guernsey Finance. Or as Gavin Farrell from offshore law firm Mourant Ozannes puts it: No one has a fund structure based in the EU now unless they absolutely have to for EU marketing or regulatory reasons. n
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expert commentary loyens & loeff
Investment management in the Benelux: Recent tax and legal developments

Loyens & Loeff partner Marco de Lignie discusses the latest developments and changes in the fundraising industry in Luxembourg, Belgium and the Netherlands
The Luxembourg VAT rules regarding Fund services This update regarding VAT in the investment fund sector reflects a communication prepared by representatives of the VAT working group of the Luxembourg investment fund association (Association luxembourgeoise des fonds dinvestissements or ALFI) which aims to summarise recent discussions with the Luxembourg VAT authorities (Administration de lEnregistrement et des Domaines) regarding the VAT rules applicable to investment funds and their service providers. This communication was released on 24 January 2011. The EU VAT directive allows member states to apply a VAT exemption for management services rendered to collective investment funds, and that member states have the right to define eligible funds. ALFI confirmed that the VAT exemption is also available for services related to the management of the investments, such as investment advice and assistance in the establishment of the investment policy of a fund supplied by a third party to the management company of a Luxembourg investment fund. This confirmation is very important in view of the huge amounts of fees paid by Luxembourg investment funds and their management companies to specialised advisers. Luxembourg implements UCITS IV and enhances its investment fund legislation UCITS IV has been implemented into Luxembourg law in as flexible a way as possible. Its main improvements in comparison with the currently applicable UCITS regime are the following: A simplified and accelerated notification procedure for cross-border distribution under the so-called EU passport for UCITS funds General provisions relating to UCITS mergers, covering both domestic and foreign mergers of UCITS Possibility of master-feeder UCITS structures A short standardised document summarising key investor information, replacing the simplified prospectus of UCITS Introduction of a so-called EU passport for UCITS management companies Reinforcement of regulatory requirements and strengthened cooperation between national supervisory authorities (e.g. regulator-to-regulator communication)
Other main changes to the Luxembourg investment fund legislation Cross sub-fund investments: A sub-fund may in future invest in one or more other sub-funds under the same umbrella (UCITS and other UCI). However, the duplication of management fees is not permitted in this context (unlike investments in another UCITS, where there is no such prohibition, though the maximum proportion of management fees charged must be disclosed). Management regulations are subject to Luxembourg law: For clarification purposes, in particular concerning the residency of common funds managed cross-border (UCITS and other UCI), the 2010 Law requires the management regulations of such common funds to be subject to Luxembourg law. Mergers of UCITS: The receiving or absorbing UCITS is granted additional flexibility for a period of six months in relation to certain investment restrictions.
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UCITS and other UCI organised as investment companies: transfer of annual reports, record date, and translation of articles of association: It is no longer necessary to send shareholders the annual report etc., together with convocations to an ordinary general meeting. The board of directors may fix a date five days before an ordinary or extraordinary general meeting as a reference point by which to measure attendance rights and quorum and majority requirements (record date). Abolition of the requirement to translate articles of incorporation drawn up in English into German or French for purposes of registration with the Luxembourg Register of Commerce and Companies. Regulatory measures: The authorisation for one sub-fund under an umbrella (UCITS and other UCI) may now be withdrawn, without entailing the withdrawal of the authorisation of one or all the other sub-fund(s) under that umbrella and/or the entire umbrella. When delegating functions to third parties, other UCI and non-UCITS management companies (2010 Law, Chapter 16) are subject to the same requirements as UCITS and UCITS management companies (2010 Law, Chapter 15). In particular, asset management functions may only be delegated to authorised investment managers subject to prudential supervision. In the case of a non-EU manager, there must also be a cooperation agreement between Luxembourg and the other national supervisory authority concerned. Management may not be delegated to the depositary. Taxation: Foreign UCITS and other UCI managed by a Luxembourg management company are expressly exempt from Luxembourg taxation. However, non-resident investors (including feeder funds) making profits from the sale of shares in a corporate UCITS or other UCI are no longer subject to taxation in Luxembourg. The following are exempt from capital duty (taxe dabonnement): UCITS or other UCI which are listed on a stock exchange/ traded on a regulated market or replicate the performance of one or more indices (this means that in particular exchange traded funds are also exempted from capital duty)

UCITS or other UCI and their sub-funds which are reserved for pension funds (this was already the case, but only for pension funds of the same group) UCITS and their sub-funds whose main objective (over 50 percent) is to invest in microfinance institutions
New legal framework for Belgian REIT and introduction of institutional REIT status The Royal Decree of 7 December 2010 on REIT (SICAFI /Vastgoedbevak) modifies the regulatory regime applicable to REITs by abolishing and replacing the royal decrees of 10 April 1995 and of 21 June 2006. A review of the former regulatory framework was necessary due to the legislative modifications of the past years, but besides these modifications, the purpose of the Royal Decree is to innovate and modernise the regime applicable to REIT. In this respect, the introduction of the status of institutional REIT (SICAFI institutionelle Institutionele vastgoedbevak) is probably the most awaited modification.The key institutional REIT changes are summarised below. The Royal Decree, which entered into force on 7 January 2011, now allows the application for the new status of regulated and nonlisted investment vehicle in real estate, namely the institutional REIT (SICAFI institutionnelle / Institutionele vastgoedbevak). The institutional REIT must be controlled exclusively or jointly by a Belgian public REIT, the other shareholder(s) (if any) being institutional investor(s). This status of institutional REIT permits the following optimisations: an asset management optimisation as it allows the REIT to group its assets per categories in several subsidiaries; a cash flows optimisation, as it allows to avoid cash-traps by having these subsidiaries subject to the same distribution obligations and accounting referral; a tax optimisation, as the conversion into an institutional REIT can replace the (time consuming) former acquisition of subsidiaries followed by their merger into the REIT to benefit from the same tax regime. Moreover this new vehicle shall allow the set-up of joint ventures between public REITs and institutional investors. Developing such joint venture in the scope of public-private partnerships is indeed one of the main goals of the Royal Decree.
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expert commentary loyens & loeff keynote interview xxxxxxxxxx

Accounting aspects Public and institutional REITs apply in their statutory and consolidated financial statements the IFRS-IAS standards. The scope of application of IFRS is not limited to the sole accounting of the REITs but is broadened to regulatory requirements as compliance with many regulatory limits are to be assessed on a consolidated basis the scope of which being determined by IFRS. Moreover, IFRS definitions are explicitly rendered applicable and therefore enter within the Belgian regulatory framework. With respect to the fair value, it must be referred to the relevant IFRS / IAS standard depending on the asset concerned (e.g. IAS 40 with respect to investment property).
Tax aspects The Royal Decree does not modify the tax regime applicable to REITs, the main characteristics being as follows: Exit tax Electing for the public or institutional REIT status leads to a step-up of the assets to their market value in the hands of the company concerned, the latent capital gain being subject to 16.5 percent exit tax. Corporate income tax and treaty protection Public and institutional REITs are formally subject to corporate income tax and are therefore granted tax residence certificates but however on a reduced taxable basis (i.e. abnormal or benevolent advantages received, certain non-reported and disallowed expenses). In other words, investment proceeds (rental income, capital gain, interest income for excess cash) are not taxable. This formal subjection to the corporate income tax should allow the REITs to claim treaty protection. Annual real estate tax Real estate assets held by the public or institutional REIT are subject to the annual real estate tax (prcompte immobilier / onroerende voorheffing). This tax is usually recharged to the tenants on the basis of the lease agreement provisions. Inbound income Belgian source dividends are subject to withholding tax at a rate of 15 or 25 percent, which is entirely creditable and reimbursable for the excess. No tax credit is available for foreign source inbound income subject to foreign withholding tax.
Outbound income The standard withholding tax rate is of 15 percent for dividends distributed by public REITs and 25 percent for dividends distributed by institutional REITs. However exemptions based on domestic law or tax treaties may apply. Dividends Dividends paid to foreign entities, which are not conducting a business or a lucrative activity and are totally tax exempt in their country of residence, benefit from a withholding tax exemption Subscription tax Public and institutional REITs are subject to a .08 percent subscription tax calculated on the net amounts invested in Belgium at the end of the preceding financial year. VAT Public and institutional REITs benefit from a VAT exemption on the management fees they are invoiced.
The Netherlands introduce a regulatory opt-in for collective portfolio management An authorisation by the Netherlands Authority for the Financial Markets (Autoriteit Financile Markten or the AFM) for managers of investment funds is presently only available if the relevant fund is open for investment by -in short- retail or semi-retail investors. It is recognised that this may be a marketing handicap for fund managers.This is particularly relevant for fund managers wishing to target institutional investors which as a matter of law or internal regulation may only invest in regulated investment schemes. In light hereof draft legislation was proposed that introduces an opt-in right for fund managers if the fund is offered to qualified investors. The opt-in right is incorporated in the FSA and entails a light regulatory regime. The opt-in right is referred to in the FSA as an application for a declaration of supervision (verklaring van ondertoezichtstelling). Fundraisings It is important to note that the regulatory opt-in is only available if the relevant fund is offered exclusively to qualified investors, including (not exhaustive): a legal entity or company which has obtained a license or is regulated to be active on the financial markets in another way; a legal entity or company which neither has a license nor is regulated in another way to be active on the financial markets
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and which corporate purpose is solely to invest in securities; a natural person having its residence in the Netherlands who meets certain rules issued by governmental decree and who has been registered by the AFM as a qualified investor at his own request; or a natural person or company that is considered a qualified investor in another EU member state, as meant in section 2(1) (e) under (iv) or (v) of the Prospectus Directive (2003/71/EC).
investment funds depositary must have own funds of at least EUR 112,500. An open-ended fund must maintain a liquidity of at least ten per cent (10 percent) of its assets under management.
Status of the proposal and timing: This draft piece of legislation was adopted in the second chamber of Dutch Parliament and is presently being debated in the first chamber of Dutch Parliament. We do not know exactly when the proposed legislation will come into force, but this may be as soon as mid-2011. Key requirements: If the opt-in right is exercised the following key requirements will apply to it. Expertise and integrity: All persons involved in the day-to-day policy of a manager or depositary must have adequate expertise (deskundigheid). Such expertise is related to the type of manager or depositary concerned and to the activities that will be carried out by the persons involved. Pursuant to a change of law that is likely to be implemented very soon members of supervisory board of a manager or depositary will be included in the screening on adequate expertise. Business operations: A manager or depositary shall not be affiliated to persons in a formal or actual control structure which is impenetrable to such an extent that it constitutes or may constitute an impediment to the adequate exercise of supervision of the manager, the investment company or the depositary. Delegation or outsourcing of certain activities by the manager or depositary is generally permitted. Managers and their depositaries must have a minimum amount of own funds at their disposal. The manager must have a minimum amount of own funds of at least EUR 125,000 if the portfolio to be managed amounts to less than EUR 250 million. In case of a portfolio to be managed of an amount of more than EUR 250 million, a minimum amount of own funds of EUR 225,000 applies. The
Conduct of business A manager or depositary shall in its dealings with its clients act prudently. For managers the conduct of business rules include in particular that: (i) the manager must comply with provisions as to client communications, (ii) the manager should act in the interest of the investors and must treat the investors equally under comparable circumstances, (iii) the manager may not execute orders from clients at their expense with such frequency or of such magnitude that these transactions, in the given circumstances, apparently only serve to the benefit of the manager or its affiliates (unless at the explicit instruction of a client) and (iv) the manager must refrain from executing transactions for clients with insufficient financial resources. Requirements relating to the funds In respect of funds that do not have legal personality, the manager must ensure that an independent depositary (legal entity) will be engaged in the safekeeping of the funds assets. The said depositary may act as a depositary for multiple funds. Where a depositary acts as depositary of multiple funds, it is relevant to note that the FSA provides that the assets of a fund shall be exclusively to cover claims arising from (i) liabilities relating to the management and custody of that fund and (ii) its rights of participation (segregated assets). n
CONTACTS:
Marco de Lignie T +31 20 578 56 05 E marco.de.lignie@loyensloeff.com Loyens & Loeff Fred. Roeskestraat 100 1076 ED Amsterdam The Netherlands
NEW FOR 2011
Leading papers on private equity theory and practice
Call for papers

PEI is actively seeking papers for inclusion in its new peer-reviewed journal The Review of Private Equity. This new quarterly publication is designed to bridge the gap between academic research and practitioner-led thought leadership. The journal, with its multidisciplinary advisory board, will focus on publishing new thinking on key aspects of this asset class and welcomes papers for review from all private equity practitioners, including academics, consultants, general partners, lawyers and limited partners. To learn how you can enhance discourse about the asset class by contributing to this contemporary publication or for any further information about submitting a paper or abstract for consideration, please visit:
www.peimedia.com/review
Submit your papers to:
Catherine Hill - Editor, Specialist Publications
T: +44 (0) 20 7566 5478 E: catherine.h@peimedia.com
april 2011
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gp fund commitments
Wanted: skin in the game

Nothing says back me! to an LP like a hefty commitment from a manager to its own fund. Some GPs have always been ahead of the game, while others are starting to realise that 1% just wont cut it anymore. Toby Mitchenall reports
factor in his backing the fund. The fact When Stirling Square Capital PartAnte up ners, a London-headquartered midthat Stirling Square raised 375 million A poll of private equity professionals at PEIs annual market private equity firm, closed its 50 percent more than for its predecessor CFOs and COOs Forum in New York in January second fund on 375 million last year, fund in the fundraising down-market of showed that more than half of the attending GPs are one particular element stood out: the 2009-2010, suggests that other LPs were intending to make commitments to their next funds GP commitment. also impressed. of more than 2 % of the total fund size. Traditionally, The investment team at the For Axcel Partners, a Danish midthe GP commitment would be between 1% and 2% firm accounted for 28 million, market firm, a hugely successful In the future, how much will management or 7.5 percent, of the funds total investment from its third fund prompted contribute to your own funds? capital. According to an LP source, it to increase the manager commitment >5% if you include commitments from to its latest vehicle to 6 percent from 1 <1% 16 21 a separate, associated vehicle, the percent. The partial exit which spurred management exposure to the fund the increased GP commitment was Axcels GP commitments accounts for more like 15 percent. investment in Danish jewellery retailer Pandora, which generated venture-like This is far in excess of what you might 1% - 2% 2% - 5% expect. The GP commitment to a returns of 30x for the firm and its limited 28 35 fund does vary, but will normally sit partners. The phenomenal success of the Pandora exit has made the individuals at in the 1 percent to 2.5 percent region Source: PEI depending on the size of fund and the Axcel, led by managing partner Christian liquid net worth of the partners. Frigast, a considerable amount of money. Stirling Square declined to comment on the separate entity As a result of the partners increasing their individual net worth, the that apparently boosts the teams exposure to the fund, but on team has increased its own commitment to Fund IV. The fundraising the topic of GP commitment, investor relations director Robert effort is perhaps unsurprisingly understood to be progressing well. As of February this year the firm raised around DKK3 billion Swift says, Feedback from LPs on our approach has been extremely (402 million; $530 million) surpassing its target and is likely encouraging and it undoubtedly helped in our fundraising exercise. to pull in another DKK500 million, said a source with knowledge This size of contribution is by no means inconsequential. Being of the process. able to demonstrate that the individuals in control of the fund One European firm to really go long on its own funds is have much to lose as well as gain they have their own skin in Amsterdam-based mid-market player Egeria. The investment team the game is compelling for limited partners. One LP in Stirling of the firm contributed an eyebrow-raising 20 percent to their most Squares fund said the GP commitment was certainly the deciding
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always was a certain amount, especially in recent fund, which closed towards the end the mid-market. of 2008, heavily over-subscribed, on 500 LPs want to see Whether or not these instances million. represent a wider trend toward increased Caroline Huyskes, a partner with Egeria, managers prepared to GP commitment is debatable. What is an says limited partners undoubtedly appreciated undeniable fact, however, is that for at least the large commitment. The fact that we put eat their own cooking most of our own net worth into our own fund two years GPs have been facing an incredibly shows LPs a good sign of confidence. We feel tough fundraising market. Much has been that the best place to invest our own money written about the pendulum of power is in our own funds. We know exactly where swinging towards the LPs, who during the money goes. a period of fundraising difficulty have While the GP commitment to the next been able to push for more advantageous terms and conditions. The creation of the Egeria fund may not be quite at the 20 percent Institutional Limited Partners Associations level, the team will always make up at least 10 Private Equity Principles, which codified percent, says Huyskes. a number of LP-friendly fund terms in The reasons behind an out-sized 2009, was evidence of the perceived shift GP commitment can vary. The most in negotiating power. straightforward reason is to demonstrate to LP demands to date, however, have LPs that you have faith in your own ability to focused more on fee structures and the invest the capital and make better returns than payment of carry, rather than GP fund you could make elsewhere. It is a selling point commitments. Nevertheless, a poll for the fund: LPs are reassured by your selfconducted among attendees at PEIs annual belief and the genuine alignment of interest. CFOs and COOs Forum in New York The liquid net worth of the management team in January suggested that the size of GP plays a major role in deciding the commitment commitment is indeed trending upwards. size. LPs are keen to ensure that the investment According to the survey, 35 percent of team will feel an investment loss in relative, the audience believed GPs in future would as well as absolute terms. contribute between 2 percent and 5 percent to their own funds; a Six percent is a very high number for an independent fund and further 16 percent of those surveyed said contributions would be will certainly make LPs sit up and take note, said Bruce Chapman, a London-based placement agent with Threadmark, in a prior discussion more than 5 percent. 28 percent predicted the GP commitment would about the Axcel fundraise. Chapman noted that it would be very come in at between 1 percent and 2 percent; 21 percent said GP difficult for any obviously wealthy manager to raise a fund in this commitments would be less than 1 percent. environment without committing a substantial amount. Anecdotal evidence from fundraisers backs this up. Kelly Deponte, A check on the personal financial situation of investment team a partner with placement and advisory firm Probitas Partners, says that members is not uncommon, says Dermot Crean, managing partner at for a lot of investors, 1 percent is just not enough anymore. Certainly placement agent Acanthus Advisers. There is certainly more probing among the funds we are seeing, he says, GP commitments are being by limited partners on this than there used to be although there raised. LPs want to see managers prepared to eat their own cooking. n
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expert commentary capolino-perlingieri & leone
Investing under pressure

General partners investment choices at the end of the investment period are critical, yet complex, writes Dante Leone
As the net asset valuations of private equity funds for their own fundraising cycle; to the general for the last few quarters have showed, the global inconvenience of redeploying commitments By involving limited partners to different managers. Other limited partners financial crisis of 2008 and 2009 has failed to bring the private equity world to its knees1. may simply be relieved that the fund manager in the thought process However, available data on dry powder at has not been able to deploy much capital, as underlying their investment private equity houses of all dimensions proves they may have had liquidity problems of their that the crisis has had a rather chilling effect on own in the past few years, and would have decisions, managers treat the pace of investments2. had difficulty in honoring large capital calls for funds to which they had committed in the As a result, a large number of managers of them as an internal rather years 2006 to 2008. private equity funds of the vintage years 2006 than external sounding Finally, many other limited partners will to 2008, with a standard four- or five-year take a very hard position on maintaining investment period, are being confronted with board investment discipline, and not straying away a looming deadline to their funds investment from tested and proven strategies in order to period, at a time when they have been able to make up for a slower pace of investments at invest a relatively low percentage of their funds the beginning of the investment period. total commitments. This diversity in opinions among investors In this commentary3, we are going to analyse is actually quite important, because as we will see later on modifying some of the issues raised by such a scenario, highlight certain structural intricacies and suggest possible tweaks to fund agreements that would be the deadline for the expiration of a funds investment period could require conducive to the lessening of tensions originated by the impending deadline. approval by a high percentage of the funds limited partners, and a small group of motivated limited partners might be successful in preventing any such modification. Limited partner perspectives On this subject as on many other ones different constituencies of Fund manager concerns limited partners may have very diverse views. There are those who may feel strongly that the fund manager should Fund managers will typically have several concerns of their own about do its best to deploy as much as possible of the funds commitments prior the looming deadline. to the end of the investment period, at the risk of accepting somewhat Some of them will be confronted with the negative perception of lower returns. their failure to use the capital that they had been expected to deploy upon Limited partners would take such a position for various reasons: from receiving the original mandate from investors. Others will be concerned that, as a result of the deployment of a institutional demands to deliver on asset allocations that had been set at smaller amount of capital, the total carry pool will also likely be smaller. times when the financial crisis was not taken into account; to pressure
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Limited partners in independent, small or Yet another group of fund managers will be mid-sized funds may be sensitive to the issues alarmed by the fact that the end of the investment of management fee flow. And they may also period would bring about a significant decrease in be amenable to accommodate the needs of the flow of management fees payable by the fund the managers by delaying the step-down in to them. And, because they are not yet ready to management fees or increasing the amount of go back to fundraising, the drop in fees will make it quite difficult to support the team. (Think a fee income from portfolio companies that may significant portion of good managers of funds of be retained by the fund managers. vintages 2006 to 2008, with few or no exits having Fund manager options materialised and a portfolio that is not mature enough for the performance to be assessed by Private equity fund managers do have a number new potential investors.) of options in addressing the rapidly approaching In fact, most private equity fund agreements investment period deadline. Leone: GPs have options stipulate a change in the basis for the calculation A first course of action could be to continue of the management fees after the end of the investing exercising the same investment investment period, from a percentage of discipline displayed in normal times, thus Small and mid-sized aggregate commitments to a percentage of the risking to have invested less than an optimal aggregate cost of the investments held in the percentage by the time the investment period fund managers may be funds portfolio. comes to a close. At times, the calculation takes into account confronted with stark choices A second course of action could be to ramp other factors such as changes in the value of up the pace of investments, trying to make up regarding the survival of their for the ground lost in 2008 and 2009. the portfolio (write-ups, write-downs and/or write-offs) or whether the manager has already Assuming deal flow does not simply increase teams after the end of the started advising a successor fund. The norm, to the benefit of fund managers, one way to investment period however, remains a significant step-down in augment the investment pace would be to pay management fees. a little more for companies, to the extent that While this would not be a noteworthy possible returns are still attractive, or to deploy problem for managers that are part of a large franchise that is able to keep more capital per single deal (whether by structuring a smaller portion of them going in spite of a drop in management fees, it will be an issue for the price as debt or by going after larger opportunities). smaller fund managers. Another way to achieve the same result would be to expand their As a result, small and mid-sized fund managers may be confronted investment targets at the risk of departing somewhat from the original with stark choices regarding the survival of their teams after the end of the investment thesis and invest in different sectors of the economy, in investment period. companies at different stages of development or in different geographic Some fund managers could decide to cut the salaries of the principals. areas.Although in certain instances this may be possible without the need Others could resort to reducing headcount at a more junior level. Either to consult limited partners (to the latters chagrin), a funds governing documents quite likely condition a similar expansion of the managers scenario would have the significant disadvantage of making the fund managers investment scope to a consent obtained from the limited partners or at ill equipped to extract the best possible performance from their current the very least from the funds advisory committee. portfolio or to complete a successful fund raising in the future.
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A third possible course of action would be similarly subject to consent: asking for an extension of the investment period beyond the original termination date. Fund agreements In a typical private equity agreement, the investment period lasts five years from the initial or final closing. After the end of the investment period, the manager may continue to draw down commitments to fund expenses and management fees, but new investments are prohibited. Typical exceptions to this general prohibition are investments that have been negotiated or closed prior to the end of the investment period and further investments in the same portfolio assets held by the fund at the end of the investment period (so-called follow-on investments). In some cases, the responsibility to waive these limitations and to extend the investment period, or to avert a decrease in the managers fee flow (e.g., by allowing the managers to retain a higher percentage of fees from portfolio companies) is vested in the funds advisory committee. In which case, the composition and functionality of the advisory committee will be crucial. In a majority of cases, however, prolonging the investment period or changing the basic economics of a fund - for example, by increasing management fees post-investment period - will require the consent of most or all of the limited partners. Consequently, a strong principled position by limited partners holding a relatively small percentage of the funds commitments could be enough to prevent any such changes to fund agreements. Lessons learned Most of the times, fund managers are acutely aware of the necessity to engage with limited partners, well in advance of the actual deadline, in an open discussion regarding the possibility of protracting the investment period or tweaking the economics of the fund. By involving limited partners in the thought process underlying their investment decisions, managers treat them as an internal rather than external sounding board. However, as we have noted above, these discussions may be somewhat hampered by the rigidity of the funds governing documents, which often require approval by special majorities and, when basic economics are affected, may even demand consent by each single investor. This is the main reason why a growing number of limited partners are realising that, while it is paramount for fund agreements to contain very clear limits setting forth the managers possible area of action such as a precise definition of the investment scope or the type of targets building flexibility in the agreements (e.g., through a smart use of the advisory committee) is extremely advantageous. Being able to cope with varying economic circumstances throughout the life of a fund may make all the difference between an anxious or demoralised manager and a properly incentivised one. Which is to say, between a fund with a low chance of success, and one with very good odds. n
1. Prequins Private Equity Performance Report of February 2011 notes significantly better performance for private equity, as compared to public indices, for 1-, 3- and 5-year periods as of 30 June 2010 (private equity returns for 1 year, 3 years and 5 years stand at 17.6%, -1.9% and 15.7%, in all cases considerably higher than returns for the same period from Standard & Poors 500 or MSCI Europe; MSCI Emerging Markets would have outperformed private equity only in the 1-year horizon). 2. Bain & Companys Global Private Equity Report 2011 showed global buyout deal value for private equity of only $170 billion for 2008 and $81 billion for 2009, as compared to $479 billion for 2006 and $503 billion for 2007.That makes for over $1 trillion of dry powder by private equity funds at the end of 2010. 3. This piece is based in part on a panel discussion held in Berlin in February 2011. Thanks go to Laurence Zage, Philippe Roesch and Jan Johan Khl for providing much of the fodder for the thoughts underlying this commentary.
CONTACTS:
Dante Leone dleone@cp-dl.com Capolino-Perlingieri & Leone www.cp-dl.com Via Quintino Sella 4 20121 Milan Italy Tel: +39 02 8905 0320 Fax: +39 02 7005 27881
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innovative fund structures
Custom made
Earlier this year, the $15 billion San Francisco Employees Retirement System, a prolific investor in private equity over the years, committed $20 million to venture fund of funds Weathergate Capital for a customised investment vehicle that would invest only in the very earliest-stage startups in the venture life cycle. The commitment was a separate account for the retirement system that gave San Francisco exclusive access to entrepreneurs trying to create the next blockbuster technology company like Facebook, Groupon, Google and Amazon in the past. San Franciscos Weathergate partnership represents a customised type of account that exposes the pension to niche investments, and gives it more control over decision-making. These types of customised accounts are more popular than ever in todays environment as limited partners seek more control and look for breaks in fees and other costs. The Weathergate arrangement also fulfills one of the big reasons why LPs enter unique accounts with managers it provides access to a strategy that would be otherwise closed to an LP. But unlike more traditional fund of funds, these types
Limited partners have growing appetite for customised accounts giving them greater flexibility on economics and deal selection. While the traditional private equity fund is not disappearing, LPs are seeking more options for their alternatives exposure, finds Chris Witkowsky Without a separate account, you wont really have that one-to-one interaction with the GP
of accounts are tailored to the requirements of a single client. It gives [clients] a lot more involvement and the ability to tailor the goals for the investment programme, explains Steve Cowan, managing director of 57 Stars, which creates and operates emerging marketsfocused separate accounts. 57 Stars, known as Pacific Corporate Group International until last year when management took full control of the firm, counts the California Public Employees Retirement System as one of its clients. Often the description they will use in describing this arrangement is, we are seeking to act as an extension of the investment team, Cowan says. Separate accounts have traditionally been an option for the biggest institutions in the business, but relatively moderatesized players can get into the act as well, as evidenced by San Franciscos move with Weathergate. While sources say the traditional private equity fund model is not going away any time soon, it has certainly evolved to a point where many LPs have an array of choices to get exposure to various strategies, or breaks on costs, if they are not getting what they want from traditional fund managers.
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Perks for pensions As institutions further develop their private equity programmes, they will often seek more control in investment decisions and try to reduce fees. One investment executive at a large public pension recalls a recent discussion had with a traditional fund manager. We said, wed like to invest with you, but we dont like your economics, he says. While fund of funds have traditionally offered such products to clients, regular GPs and even some private equity consultants have been offering customised products to meet their customers needs. Cleary, people are doing more [separate accounts] because of the better economics and certain structural features like limitations on leverage and pace of deployment, says the pension staffer. US public pension plans especially benefit from separately managed accounts as they often have small staffs overseeing alternative investments and benefit from the additional help. CalPERS, for example, has a number separate accounts with
managers like 57 Stars and Apollo Global Management; Oregon and Washington States pensions are the sole LPs in two funds managed by fund of funds Fisher Lynch Capital. Oregon also entered into a fixed income managed account with Kohlberg Kravis Roberts. The massive New York State Common Retirement Fund has numerous separately managed accounts that give it access to various strategies like energy and emerging managers. New Jerseys state system, which has about $72 billion in assets, started its alternatives programme in 2005. The pension built the programme around separate accounts, according to documents from the pension detailing the programme. New Jersey has customised accounts with Credit Suisse, Neuberger Berman, Hamilton Lane, Fairview, BlackRock and Asia Alternatives. With Credit Suisse, the pension gets access to small and mid-market US investments, along with emerging managers. With Hamilton Lane, the pension gets exposure to international managers as well as large-cap buyout firms. The pension also has accounts with Fairview for access to new
KEEPING IT IN THE FAMILY

one of 300 LPs in a fund. Family offices have been actively seeking out cusAnother structure some family offices are tomised accounts in the past few years, as fees involved with is called a syndicate. In this have become more burdensome and returns, in general, have not lived up to expectations in prisituation, several families enter into a structure that vate equity, says John Rompon, managing partner allows them to collaborate and co-invest against a with McNally Capital, which advises family offices specific investment theme like investing in clean on private equity. technology, for example, or India. The family offices participate directly in One of the structures some family offices have selecting investments in a number of core funds chosen is the club deal, in which a manager gets following the investment theme so in an India together one or more limited partners and raises fund, the LPs would help pick 10 Indian funds money for a specific deal, rather than a fund. Families like this its not typically the that would give the family offices macro exposure subject of auction, its semi-proprietary, youre to India. At the same time, each family may want getting complete transparency into the risk youre Rompon: family offices look for additional exposure to healthcare. Each individual taking, Rompon says. Youre looking exactly at alternative options investor could then commit additional money to the company youre going to buy and you know your risk. so-called satellite funds getting targeted exposure as well, Rompon LPs in this kind of structure also have a lot of leverage over the says. This is a custom-built fund of funds for families, Rompon says. terms of the transaction, because the sponsor has a deal but no money. Families are beginning to move their weight around and demand a They can negotiate every element of the economics the fees, little more customisation. the holding period, Rompon says. You cant do that when youre
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and emerging managers, and Neuberger Berman for venture funds. New Jersey declined to comment about the programme. One private equity LP who has experience with customised accounts says a big advantage, especially for institutional investors with small teams, is the education investment staff get from the managers. Without a separate account, you wont really have that one-to-one interaction with the GP, the LP said. The separate account managers are an extension of staff. [Theres opportunity to] leverage their organisation to help in other areas, not just where theyre mandated. Investment staff, for example, can spend a few days with the managers learning how to perform proper due diligence. The GPs running separate accounts are also good sources of information about other managers in the market. Institutions also benefit from the separate accounts because of cross pollination, according to one LP, meaning that investment professionals from other asset classes like real estate may also benefit from conferring with managers of separate accounts ion private equity, the LP said. All the extras can make running a separate account intensive for GPs, but from the LP perspective, the additional education and information makes it worth the extra layer of fees, the LP said. Its about accessing top managers and also helping to train staff and use [the managers] as extensions of staff.
People are doing more [separate accounts] because of the better economics and certain structural features like limitations on leverage and pace of deployment
Travel companions One way separate account managers can educate their clients is to take them around the world, meeting the GPs in their portfolio and watching the due diligence process. 57 Stars is glad to take its clients on trips to meet managers, Cowan says. One large US state pension plan makes several trips each year to Europe, Asia and various regions in the US to meet with managers. Meeting with GPs in person is essential to performing appropriate due diligence on managers in the portfolio, the head of the private equity programme at the pension says. Theres a lot of back log of re-ups coming, the official says. There are lots of folks we want to dig into, we want to meet with. The pension is planning a trip to Brazil in the future to meet with managers in the region to possibly build exposure in its portfolio. The task, though, is somewhat daunting as the pension doesnt know any managers in the region and is not wellversed on the culture. This is another situation in which a separate account manager could be helpful, the official says. Beyond the economic benefits of separate accounts, the educational aspect of the relationship can be extremely beneficial to institutions struggling with small staffs looking to broaden their horizons into other strategies of the asset class. n
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ex p e rt co m m e n ta r y p + p p l l at h + pa rt n e r s
Germanys encouraging outlook

The German Private Equity and Venture Capital Association in March published its annual review of private equity activities in Germany in 2010 together with the prospects for 2011. Andreas Rodin of P+P Pllath + Partners examines some of the findings
As a consequence of the financial crisis, the total than the venture capital firms (68 percent anticipate amount of private equity invested in 2009 dropped an increase). Firms participating in the interviews to 2.78 billion from 9.18 billion in 2008. Because had stated that they intend to consummate more Germanys economy recovered much faster than syndicated investments in the future despite of the upward trend in the German economy. While it is expected the total amount invested in 2010 increased common that several venture capital firms provide by approximately 60 percent to 4.44 billion in the capital in financing rounds, it is interesting to note aggregate and 1,300 companies had obtained private that also more than 50 percent of the other private equity financing. Thirty percent of the investments had equity firms projected for 2011 an increase of cobeen consummated by non-German private equity investments with other investors. firms and the remaining balance of 70 percent by While enterprise valuations had remained stable German players. in 2010, only one-third of all private equity firms Indeed, 2.52 billion representing 57 percent believe that this will not change, but more than 50 of the 2010 volume had been invested in buyout Rodin: growth on horizon percent assume an increase in 2011 and 8 percent transactions, where majority positions in portfolio believe that the increase will be significant. companies had been acquired. Also, 1.26 billion It is expected that in 2011 investment representing 28 percent had been invested in growth opportunities can be derived mainly from the financings, replacements and turnaround situations following sources: secondary buyouts, spin-offs, growth capital involving minority positions in portfolio companies. Venture capital and minority investments in family owned enterprises and majority investment activities remained low with little increase in 2010 overall investments in family owned companies. Divestments by banks, as 0.66 billion had been invested in this segment. Seed and early buyouts of distressed companies as well as investments in publicly stage financings of 0.37 billion in 2010 are even lower by 11 percent listed companies are expected to be insignificant. compared to the 2009 level. Later stage venture capital investments The private equity firms view on the most attractive industry of 0.29 billion, however, increased by 25 percent vis--vis 2009. branches has not changed.The main emphasis is on companies engaging Projections for 2011 in renewable energies, water and environmental technologies. The Because of the positive economic environment and the continuing venture capital firms are still focusing on software, information upward trend in Germany, 75 percent of all private equity firms technology, internet as well as biotechnology, pharmaceutical, anticipate further growth of the investment activities in 2011. The medical technology. Private equity firms consummating buyout transactions of mid-sized companies indicated a preference for buyout industry is more optimistic (86 percent have a positive view)
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traditional industry segments, including mechanical engineering, plant construction and consumer goods. The most interesting question related to acquisition financing. Just 42 percent of all private equity firms are optimistic that the amount of equity capital required for a buy-out transaction will be lower than in 2010 and 2009, but still one third even assumes an increase. Debt capital/EBITDA multiples are generally expected by the majority of all firms interviewed to increase. Private equity divestment Exit transactions have become a major challenge for private equity firms during the last years. Industry players had more or less stopped to acquire enterprises in order to grow, but had put emphasis on stabilizing their own business during the financial crisis, and the German and international stock markets had little capacity for initial public offerings. But private equity firms are optimistic that the exit environment will improve in 2011 and 80 percent anticipates an increase of exit transactions. Indeed, 75 percent of all firms expect trade sales to become more important because strategic investors have sufficient cash available for acquisitions and want to grow again. Private equity fundraising Fundraising continues to be very difficult also in Germany. Only 930 m had been raised in 2010 representing a decrease by 13 percent against the already frustrating level of 2009 with 1.07 billion. The vast majority of the German private equity firms had very successful fund closings in 2007 with 5.66 billion in the aggregate.Thirty-nine firms stated in interviews that they already started fundraising again or are about to do so in 2011 and 2012. The objective is to raise a total amount of 4.22 billion during these years, 1.68 billion for venture capital and 2.54 billion for buyout/growth capital. In light of the positive analysis of the investment and divestment activities and the environment for exits the prospects for fundraising should be viewed similarly positive. But all private equity firms had expressed in their interviews concerns about the success of the fundraising efforts. They anticipate increasing competition among themselves and realized that institutional investors are still hesitant to increase their private equity exposure again. Moreover, the German private equity industry suffers from the poor basic conditions in Germany and these conditions may become even more relevant following the implementation of the EUs Alternative Investment Fund Managers (AIFM) directive. Fund structuring developments When setting up new funds private equity firms have to take into consideration a large number of new regulatory and tax aspects that will have an impact on structuring.They affect the managers, the investors, marketing of funds and the investment activities.These new rules are summarised below: AIFM directive Timetable. The AIFM directive was adopted on the European level in November 2010. It will enter into force once it has been translated into the languages of the member countries (expected in April/May 2011). The member countries have to transpose the directive into national law within two years following the effective date on the European level. While the directive itself now contains with binding effect the basic principles governing the new regulation it refers to implementing rules with respect to approximately 100 items that are important from a practical perspective.These implementing rules will be developed by ESMA, the new European regulatory authority, by September/October 2011 and will be submitted to the European Commission which will adopt them. ESMA directed a call of evidence to the relevant market participants to get more information on alternative investment funds operating in the EU, to determine the legal format for the delegated acts and to quantify the financial impacts associated with the directive. ESMA has established four working groups to deal with the delegated acts efficiently.The German regulatory authority (BaFin) is responsible for the authorisation provisions and operating conditions, the French regulatory authority (AMF) for the rules on the depositary and the UK regulatory authority (FSA) for the rules on transparency, leverage, risk management and delegation.The fourth working group shall deal with the third country rules. BaFin has directed a call of evidence to practitioners, including the German Private Equity and Venture Capital Association, to provide to it as much practical information as possible thereby enabling BaFin and ESMA to make proposals that
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consider the characteristics of the funds and their managers. It is important for the private equity industry to interact with BaFin and ESMA closely during the next following months in order to achieve that the implementing rules are consistent with the basic features characterising private equity funds. Transitional provisions. While the directive immediately applies to all managers falling within the scope of its application once the 2-year period for the national transposition has expired (i.e. as of April/May 2013), the directive contains special provisions on its application to funds that are existing as of such date. Closed-ended funds that do not consummate investments anymore following the final transposition date (i.e. April/May 2013) can be operated by their managers without authorisation under the directive. The same applies to closed-ended funds whose subscription period expired on or before the final transposition date and that are constituted for a period of time that expires on or before the third anniversary of the final transposition date; provided, however, that in such cases the provisions of the directive regarding the annual report as well as the provisions regarding funds that acquire control of a non-listed company shall apply. Third-country rules. The directive also applies to an international set of facts. Two different situations have to be distinguished: EU AIFM marketing and/or managing a non-EU AIF. In case of management without marketing the EU AIFM requires authorisation from its national authority and has to comply itself with the directive except of the provisions regarding the depositary and the annual report; in addition, the member country of the AIFM and the third country must have entered into an agreement on the cooperation between their regulatory authorities. In case the AIFM (also) markets a non-EU AIF using the EU passport for marketing, the EU AIFM requires authorization, shall fully comply with all provisions of the directive and shall observe specific notification procedures; in addition, the third country must have entered into a cooperation agreement on regulatory matters, must have agreed on exchange of tax information in accordance with the OECD tax convention model, and must not be listed by the EU as a non-cooperative country for antimoney laundering purposes. In case a non-EU AIF shall be marketed without passport, the notification procedures do not apply. Non-EU AIFM. In case a non-EU AIFM intends to manage an EU-AIF, such none-EU AIFM must generally fully comply with the directive and must obtain authorization from the so-called member country of reference (which is generally the country of residence of the EU-AIF); in addition, the non-EU AIFMs home country must have entered into an agreement on the cooperation between the respective regulatory authorities and on the exchange of tax information and must not be listed as a non-cooperative country for anti-money laundering purposes. If a non-EU AIFM intends to (also) market in the EU a non-EU AIF or an EU-AIF the requirements that have to be met depend on whether such funds shall be marketed with or without the passport. In the former case, the non-EU AIFM shall fulfill the requirements for managing an EU-AIF and specific notification procedures have to be observed. Simplified rules apply to marketing of funds without using the passport. Marketing activities are limited to private placements subject to national regimes and delegated acts by the European Commission and ESMA. While for marketing without passport no authorisation or legal representative in the European Union is required, compliance with the reporting disclosure requirements is required. Areas of regulation. The important areas of regulation, including authorisation, initial capital of AIFMs, operating conditions for AIFMs, risk management, valuation, depositary, transparency requirements, annual reports, disclosure to investors, reports to the regulatory authorities, had already been set out in our article in the 2010 Fund Structuring Supplement to which we may refer. The following briefly explains specific obligations for AIFMs of funds that acquire control over non-listed companies. These requirements apply if one or more AIF managed by the same AIFM or if several AIF managed by different AIFMs cooperate with the objective that they acquire control over non-listed companies other than micro, small and medium sized enterprises and other than real estate holding companies. For the purposes of the directive control means more than 50 percent of the voting rights. In case control was acquired by an AIF, individually or jointly, the AIFM of such AIF shall notify thereof the non-listed company, its shareholders and the regulatory authority of the member country of the AIFM. The notification shall include information about the
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policy for preventing conflicts of interests, the specific safeguards established to ensure that transactions between the company and the AIFM/AIF shall be at arms length, the intentions with regard to the future business of the non-listed company and the likely repercussions on employment, including any material change in the conditions of employment. All such information shall be disclosed by the board of directors of the non-listed company to the workers council or, in its absence, to the employees themselves. In its annual report for an AIF exercising control the AIFM shall present a fair review of the development of the companys business at fiscal year-end and shall give an indication of any important events that have occurred since the end of the fiscal year, the companys likely future development as well as information concerning acquisition by the company of own shares. As an alternative, the AIFM shall use its best efforts to make sure that the annual report of the company itself contains this information. In addition, such company related report shall be disclosed to the workers council or, in its absence, to the employees themselves. In order to protect the capital of a non-listed company controlled by one or more AIF the directive includes specific provisions against asset stripping. Before the second anniversary of the date when control was acquired the AIFM shall not allow any distribution, capital reduction, share redemption or acquisition of own shares if, as a consequence of such action, the companys net assets would become lower than the amount of the subscribed capital plus mandatory reserves, or if an amount exceeding the companys annual surplus plus profits brought forward was paid to the shareholders. Transposition into national law. The European directive only contains provisions regarding the regulation of managers of AIF and addresses product related regulation only to the extent necessary to achieve efficient manager regulation. The directive therefore does not prevent the member countries from adopting national requirements in respect of fund structures or the composition of the portfolios. Given the fact that the private equity market is international and likely competitive the German private equity industry strongly supports that Germany does not introduce specific fund structuring or investment related regulatory restrictions into domestic law when transposing the directive. VAT on management fee Management of private equity funds established in Germany after 1 January 2008 is subject to value added tax (VAT). This is unprecedented in Europe. The European rules provide for an exemption of management of investment funds. In our judgment, the administrative practice of the German revenue service violates the European rules as interpreted by the European Court of Justice. The transposition of the AIFM directive into national law is an excellent opportunity for the German revenue service to reconsider the scope of application of the VAT exemption under the EU rules and it appears that such exemption could now be extended to private equity funds. Insurance companies, pension funds Investments by insurance companies and pension funds in private equity funds are typically allocated to their so-called equity basket. The regulatory provisions governing such basket have been amended in June 2010. Investments in funds are only eligible for the equity basket if the fund pursues a business model: Pursuant to the official reasoning private equity funds should not be adversely affected by such new requirement because their investments are exposed to entrepreneurial risks.
CONTACTS:
Dr. Andreas Rodin Andreas.Rodin@pplaw.com Patricia Volhard Patricia.Volhard@pplaw.com P+P Pllath + Partners Hauptwache Zeil 127 60313 Frankfurt/Main Telefon:+49 (69) 247 047-17 Telefax:+49 (69) 247 047-30
april 2011
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asia regulations
China lays down some rules

The National Development and Reform Commission has laid the foundations for private equity regulation, especially around fundraising. Hsiang-Ching Tseng explains the implications for GPs
form and submit their business license, PPMs and In February, the worlds second largest economy Limited Partnership Agreements for review. took a first step towards regulation of its private However, Sussman asserts, since many GPs equity industry with the implementation of a pilot use so-called short forms to preserve the measure in six key regions. Under the Circular on Further Regulating the confidentiality of their arrangements and operations, Development, and the Administration on Filings, they should not be too concerned. In this case the of Equity Investment Enterprises in Pilot Areas, main fund partnership agreement and management private equity firms with assets under management contracts which would be the articles disclosed to of over RMB500 million will have to register the NDRC tend to be fairly standardised, but are with Chinas National Development and Reform supplemented with side agreements which [fund Commission (NDRC). managers] would not disclose to any authority, says Larry Sussman, managing partner at law firm The measure applies to both domestic and foreign OMelveny & Myers in Beijing. GPs with onshore private equity funds registered in Hoo: reputational risk Beijing, Shanghai, Tianjin, Jiangsu Province, Zhejiang comes with failure to In this way, some fund managers may be able to Province and Hubei Province. Onshore private equity comply continue to keep sensitive issues a secret despite the real estate funds are also believed to fall under its new recordal requirement, Sussman states. The NDRC is also asking GPs to file audited remit, although the Circulars reach does not extend annual financial statements and annual business reports within a to global or pan-Asian funds with China strategies. four-month period after the end of every fiscal year. In addition, The measures have been broadly welcomed. That is in part the Circular entitles NDRC to conduct annual reviews of the because they represent potential upside for GPs in that disclosure to private equity firms contained within its records, to check on the NDRC clears them for due diligence from the countrys largest their operations. LP the $120 billion Social Security Fund. With an allocation to What the NDRC plans to do with the information it collects is private equity of up to 10 percent, SSF has the capacity to deploy unknown and the NDRC declined to comment when approached. about $12 billion to the asset class. However, there has been some concern over what exactly firms However, failure to comply with disclosure requirements may lead will be required to disclose and how intrusive a regulator the a firm to be publically named, the NDRC has stated, without NDRC will turn out to be. going into further detail. I think people are very concerned about disclosure because The Circular does not provide for an explicit penalty [for nonthey dont want to disclose any sensitive details about their fund disclosure] perhaps other than disclosing the names of those who terms and deals, says Sussman. do not comply to the public, says Maurice Hoo, partner at law In order to register, firms are asked to fill in an NDRC-issued firm Orrick, Herrington & Sutcliffe in Hong Kong.
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Drawing comparisons with the West The NDRCs focus on fundraising, disclosure and risk management encourages comparison between its Cirnational standard on cular and the moves towards more stringent regulation fundraising Focus on fundraising seen from Europe and the US. But Orricks Hoo asserts As well as asking firms to submit information for review, that the similarities end there. the NDRC has issued a set of best practice guideI would say theWestern regulations are products of the lines for private equity managers to follow. As with industry-wide financial crisis, and as such many provisions have found their way into the regulations seen recently in the US from the Securities and Exchange earlier drafts and the final regulations as a reaction to political pressures, Commission (SEC) and in Europe with the passing of EUs Directive and aim at purging the financial systems of certain perceived evils, he says. on Alternative Investment Fund Managers, a key focus is fundraising. In China, however, where financial crisis was not the primary motivation for reform, Hoo believes that the Circular is more According to the new rules, private equity firms can no longer use contemplative. He points out that at this stage it lays down only broadwebsites, publications, messages, or conferences to market themselves brush principles, rather than detailed rules, and has only been applied to the general public, nor can they use commercial banks or securities to six pilot regions. companies to transmit information for them. They are not allowed It is an initial step toward regulating an industry that the West to make specific promises about returns to investors and should only initially did not regulate much and then may have gone towards overraise money from LPs who recognise and have the ability to shoulder regulation, Hoo adds. the risk although the NDRC has yet to clarify who those LPs are. As such, reaction from the industry has been moderate. In a question and answer session with Chinese reporters published on its website, the NDRC explained the reasoning behind its thrust: It lays out [some] best practices principles, and that is actually valuable One of [the problems the private equity industry has] is that to the industry because right now I think the practices are a little bit all there are no regulations around fundraising. Because private equity over the place, says Hoo. investment is relatively high risk, the capital is usually raised from People are OK with it because its not overly intrusive at least for now it doesnt look to be. These are the rational things fund manager specific targets in a private way so that only the institutional investors would already do, says OMelvenys Sussman. and high-net-worth individuals can participate. But currently, some He points out that though people want to avoid national regulation of the private equity firms in our nation hold seminars and forums to advertise their funds, and therefore let in public investors who dont as much as possible, everyone knew it would eventually happen at some have the basic ability to recognise the risk theyre taking. point, and its almost unavoidable in some respects. n
However, Hoo asserts that reputational damage is threat enough for many firms with serious private equity intentions: If you get the stigma of being a violating fund, I expect that status will affect your portfolio companies.Therefore ultimately people wont want you to invest in them, and investors may not invest in you, and that affects your business. Any GP hoping to slip under the radar of the NDRC can think again. Under Chinese company law, any new business must register with the State Administration for Industry & Commerce (SAIC), which could then alert the NDRC to any firm formed with equity investment Sussman: rules set a in mind.
Even if it remains unclear exactly who firms are able to target for capital, the guidelines have been welcomed as a long-awaited one-stop national standard for private equity fundraising. Prior to this, fundraising PPMs were drafted based on a draft of this notice as well as other unpublished guidelines. Now we have guidelines published for the content of a PPM that youre giving the prospective investors, says Sussman.
FUND STRUCTURES 2011
CONTACTS
Lead sponsor: Pepper Hamilton
www.pepperlaw.com 3000 Two Logan Square Eighteenth and Arch Streets Philadelphia, Pennsylvania 19103-2799 United States Tel: +1 215 981 4000 Fax: +1 215 981 4750 Office locations include Berwyn, Boston, Detroit, Harrisburg, New York, Orange County, Philadelphia, Pittsburgh, Princeton, Washington, D.C., Wilmington. Contacts: Julie D. Corelli Tel: +1 215 981 4325 corellij@pepperlaw.com Christopher A. Rossi Tel: +1 610 640 7846 rossic@pepperlaw.com www.cp-dl.com Via Quintino Sella 4 20121 Milan Italy Tel: +39 02 8905 0320 Fax: +39 02 7005 27881
Co-sponsor: Capolino-Perlingieri & Leone
Co-sponsor: P + P Pllath + Partners

www.pplaw.com Hauptwache, Zeil 127 60313 Frankfurt/Main Germany Tel: +49 (0)69 247 047 0 Fax: +49 (0)69 247 047 30 Contacts: Dr. Andreas Rodin Andreas.Rodin@pplaw.com Patricia Volhard Patricia.Volhard@pplaw.com
Contacts: Giancarlo Capolino-Perlingieri gcapolino@cp-dl.com Dante Leone dleone@cp-dl.com
Co-sponsor: Loyens & Loeff

www.loyensloeff.com Fred. Roeskestraat 100 1076 ED Amsterdam The Netherlands Tel: +31 20 578 57 85 Fax: +31 20 578 58 00 Contact: Marco de Lignie Tel: +31 20 578 56 05 marco.de.lignie@loyensloeff.com
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APRIL 2011 | privateequityinternational.

FUND STRUCTURES 2011

INVESTOR RELATIONS & COMMUNICATIONS FORUM

World class speakers include:

For full program details please visit www.peimedia.com/irny11

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fund structures 2011

FUND STRUCTURES 2011 CONTENTS

Mapping the road ahead

Amanda Janis Senior Editor, Private Equity

pr ivat e equity international

terms & conditions

fund structures 2011

pr ivat e equity international

expert commentary pepper hamilton

fund structures 2011

keynote interview xxxxxxxxxx

Tax Exempt Investors

GP LPs ABC Private Equity Offshore Fund, L.P. (Cayman 8832/Corp.) LP

ABC Private Equity Fund, L.P. (DE)

pr ivat e equity international

e x p e r tt c o n t ee n t e wy xp ex x x x xh a m i l t o n keyno e i mm rvi ar x pper xxx

Tax Exempt Investors

ABC Private Equity Offshore Fund, L.P. (Cayman 8832/Corp.)

ABC/XYZ OFFSHOR E AIV I, L.P.

ABC Private Equity Fund, L.P. (DE)

XYZ Fund (DE Partnershi p) Portfolio Investments

fund structures 2011

keynote interview xxxxxxxxxx

ABC GP L.P. (DE LP)

Tax Exempt Investors LP

ABC Private Equity Offshore Fund, L.P. (Cayman 8832/Corp.)

ABC/XYZ OFFSHOR E AIV I, L.P.

ABC Private Equity Fund, L.P. (DE)

ABC/XYZ Blocker (DE Corp.)

XYZ Fund (DE Partnershi p)

pr ivat e equity international

k e y n r tt e on tm e n ite w yxp e p p ex x h a m i l t o n expe o c i m erv ar xxxx r xxx

fund structures 2011

e x p e r tt e on tm e n i e w yxp e p px x xh a m i l t o n keyno c i m erv tar xxx er xxx

pr ivat e equity international

eeyno c i m erv ar xxxx r xxx k x p e r tt e on tm e n ite w yxp e p p ex xh a m i l t o n

fund structures 2011

keynote interview xxxxxxxxxx

private equity international

e x p e r tt c o n t ee n t e wy xp ex x x x xh a m i l t o n keyno e i mm rvi ar x pper xxx

fund structures 2011

keynote interview xxxxxxxxxx

pr ivat e equity international

e x p e r tt c o n t ee n t e wy xp ex x x x xh a m i l t o n keyno e i mm rvi ar x pper xxx

Julia D. Corelli +1 215.981.4325 corellij@pepperlaw.com

Todd W. Betke +1 202.220.1221 betket@pepperlaw.com

P. Thao Le +1 617.204.5105 lep@pepperlaw.com

Julia D. Corelli +1 215.981.4325 corellij@pepperlaw.com

Stephanie Pindyck-Costantino +1 215.981.4406 costantinos@pepperlaw.com

Valrie Demont +1 212.808.2745 demontv@pepperlaw.com

Christopher A. Rossi +1 610.640.7846 rossic@pepperlaw.com

P. Thao Le +1 617.204.5105 lep@pepperlaw.com

Laura D. Warren +1 215.981.4593 warrenl@pepperlaw.com

fund structures 2011

Guernsey: increasingly attractive to GPs

PRIVATE FUND COMPLIANCE FORUM 2011