Private Equity Fund Formation

Jan 5, 2017 by

Private Equity Fund Formation

What is a private equity fund, and how is one formed? A private equity fund is an investment vehicle, whereby capital is used for privately negotiated investments. Types of funds include growth equity, real estate, venture capital, secondary markets, corporate pensions, endowments, wealth funds, and special opportunity.  They are typically structured as fixed-term limited partnerships, wherein the investors (the partners) have agreed to contribute capital to the fund.  In the beginning, the investors typically make unfunded commitments to the limited partnership, which will be funded during the term of the fund.  All of the investors could participate on equal terms (a traditional fund) or the investors could have different terms (an asymmetric fund).

There are a wide variety of private equity funds that one could invest in, depending on one’s goals and risk strategy.  Some examples of private equity funds include buyout, venture capital, real estate, and infrastructure funds.  Buyout funds invest in established companies, with deals that often involve a debt financing component. Buyout funds could also include growth equity funds that provide expansion capital for mature businesses, so they can scale their business operations and enter new markets. Venture capital funds primarily invest in early (or mid) stage ventures, often with high risk (and potential reward).  Real estate funds typically make equity or debt investments in commercial and residential property, utilizing leverage and generating current income, often times as part of a Real Estate Investment Trust.  Infrastructure funds invest in projects in infrastructure sectors such as transportation, water, waste, energy and other public sectors.  Lastly, there is a “fund of funds”, which generally invest in other funds, providing investors with a diversified portfolio and access to funds where they otherwise might not be permitted to invest.

The legal formation of a private equity fund requires a variety of certificates, documents, and agreements to form the fund. These include, but are not limited to, a private placement memorandum, a certificate of limited partnership, a limited partnership agreement and a subscription agreement. Additionally, forms need to be completed and filed with the Internal Revenue Service (Form SS-4), the Securities and Exchange Commission (Form D), and each state where the partners reside (blue sky filings).  Private equity investors commonly expect that a Delaware limited partnership will be formed (approximately 80% are formed in Delaware).  The limited partnership requires a general partner, which is often set up as a limited liability company in Delaware.  The limited partners are passive investors, and the general partner is responsible for overall management of the fund.

Although all of the documents identified above are necessary, two of the primary documents required to form a private equity fund are the limited partnership agreement and the private placement memorandum.  The limited partnership agreement includes the provisions of the fund, including the term, purpose, limits of liability, indemnity, management of the fund, fees, expenses, tax implications, and provisions for assignment or transfer.  The private placement memorandum is essentially the document that discloses all of the information an investor needs to make an informed decision about investing in the fund.  It includes sections on the company, management, terms of the offering, capitalization statement, description of securities, investment strategy, risk factors, fiduciary responsibilities of the directors and officers of the company, fees/expenses, tax issues, notices, and disclaimers.

Investing in a private equity fund is different than a typical investment, so there are several things one should consider before deciding whether or not to invest in such a fund.  They include the risk of the investment, the amount required to join, lack of investment control, and the potential for high return.  First, investments in privately (versus publicly) held companies tend to be somewhat riskier.  An investor could potentially lose all of their money, and the risk of loss is typically higher in venture capital funds.  Second, most private equity funds require a significant initial investment (often in the seven-figure neighborhood). Third, private equity fund investors are typically “passive”, which means they have to rely on the fund’s manager to make investments and generate liquidity from those investments.  Lastly, on the upside, private equity can provide high returns, with the best private equity managers significantly outperforming the public markets.

Even when forming a fund, an exit strategy (i.e., return on investment) should be considered.  An investor should consider how long their money will be tied up, the rate of potential return, and the risk of losing their entire investment.  Forming or investing in a private equity fund holds significant risks and almost certainly requires legal assistance.  The attorneys at Belice, Inc. are skilled at fund formation and can guide you through the entire process.

ABOUT JASON BELICE

Mr. Belice has been a corporate and real estate transactional attorney since 1998. He has significant legal experience in all aspects of representing privately and publicly held companies. Mr. Belice’s corporate practice includes domestic and international mergers and acquisitions, private placements of equity and debt, venture capital financings, film and entertainment financings, corporate governance, reorganizations, employment equity and compensation arrangements, entity formation and counseling senior company executives on complex legal and compliance issues.  For more information, please call (866) 508-8940 or go to http://www.beliceinc.com.

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