The general mechanisms behind a Private Equity Fund
A Private Equity (also referred to as a Closed-End Fund) is a form of alternative investment. It is a pooling of funds from selective investors that invests directly into private companies. An investment in a Private Equity is suitable for various types of investors such as an institutional investor, who is able to evaluate the returns, risks and impact of such investment. Private Equity financing can help a distressed business to achieve signficant turnaround in order to reap positive Internal Rate of Return.
The Private Equity main drivers for change are:
- Growing a new business
- Bringing about operational change
- Financing an acquisition
- Taking a public company private
Operational improvements and financial restructuring allows achieving Private Equity returns. The experience and leadership ability of the Private Equity manager are also paramount.
Legal and constitutive framework for Private Equity Fund
One of the fundamental constitutive documents of a Private Equity Fund is the Private Placement Memorandum. Such document provides valuable and confidential information to prospective investors that enable them to evaluate a possible investment in the Fund.
The main points covered in the Private Placement Memorandum are:
- Executive Summary and Purpose of the Fund
- Investment Strategy
- Growth Strategy
- Investment Process
- Management of the Fund
- Risk Factors
- Tax and Regulatory matters
The Private Placement Memorandum also serves as the marketing tool, in addition to providing guiding principles on the management of the Fund. It helps persuade investors to participate in the Fund during the capital-raising period. Other constitutive documents such as the Shareholder’s Agreement, Management Agreement, Advisors Agreement, Investment Agreement, Side letter and Constitution are equally important in the proper running of the Fund.
Moreover, a Private Equity Fund must abide to local and international laws and regulations to avoid the risks of regulatory sanctions. For instance, the promoters must perform a valuation of the portfolio companies, which is in line with International Private Equity Guidelines.
Typical structure and lifecycles of a Private Equity Fund
A Private Equity Fund can be structured (with limited life) as:
- A Company
- A Trust
- A Limited Partnership
- A Foundation
- A Protected Cell Company
How to best structure the Private Equity Fund depends on the needs and purpose of the investment, as well as on the promoters of the Fund and its Fund Administrator.
Below is a typical Private Equity Fund structure:
Figure 1: Typical Private Equity Fund structure
The promoters can also be the founders of the Fund Manager (also known as CIS Manager), whose responsibility is to market the fund via its Private Placement Memorandum. The Fund Manager provides management services to the Private Equity Fund in return for management fees. The Investors / Limited Partners are, in most cases, composed of institutional or sophisticated investors. They invest their funds through their respective capital commitment and drawdowns with a view of positive Internal Rate of Return. One of the fundamental role of the Fund Manager is to ensure that there is proper reporting from portfolio companies up to the investors and / or regulatory bodies where applicable. The Fund Administrator has a pivotal role in ensuring compliance with the Fund constitutive documents and ensuring that all stakeholders’ (investors, Fund Managers, regulators) interests are preserved.
The lifespan of a typical Private Equity Fund is ten years. However, this ten-year cycle generally does not start until the Fund Manager raises substantial capital in order to meet the targeted total capital commitment. Therefore, the lifespan may stretch to an additional two years depending on market dynamics and negotiation phase.
The lifecycle is as follows:
- Raising capital and building the team (committee members / board / investment managers / sub-advisors) can take 1 to 2 years. The process of raising capital and persuading the investors is very time consuming and critical. However, upon completion of the first / initial closing, subsequent and final closing will be natural. The fund’s success definitely relies on human capital in terms of expertise, leadership skills and competencies.
- Sourcing deal flow and investment period normally starts as from year 3 to year 6. All resides on the risk appetite of the Fund Managers to secure lucrative deals, and if there is built-in structural elements to protect against downside risk. Due diligence, implicit investor / portfolio relationships, gut feeling and favourable market / political dynamics are vital during the investment period. To avoid unsuccessful investments, the Fund Manager must apply a proper investment process, as stipulated in the fund documents.
- Monitoring and improving the portfolio companies ranges as from the 3rd to the 7th year. The implementation of vigorous internal control measures at the level of the portfolio companies to ensure sustainability are required. Fund Managers, along with the representative of the investors, usually perform site visits in the actual country where the investment is being made to better manage and control their investments. The board / committees of the fund undertake value creation actions to address inefficiencies.
- Divestment period normally occurs during year 8 to year 9. Once the investments arrive at maturity, and after proper management, the Fund Manager decide to exit the portfolio companies (via management buy-out or Initial Public Offering for example). The investors receive the income proceeds through waterfall distribution. Depending on the fund’s success, the Fund Manager is also entitled to carried interest which is based on the performance of the investments.
- Reaching year 10, the Fund has reached its objectives. The Fund Manager, in collaboration with the Fund Administrator, decides to launch the winding-up process to dissolve the Private Equity Fund in line with its constitutive documents.
Figure 2: Private Equity Fund lifecycle
Valuation is primordial
The valuation of the portfolio companies is primordial. The board’s fair valuation is critical and is one of the key indicators of performance or non-performance of investments. Valuation is highly relevant to investors and stakeholders. In addition, institutional investors require Fair Value to make asset allocation decisions and produce financial statements for regulatory purposes.
The valuation guidelines differentiate among the basis of valuation, which defines what the carrying amount purports to represent, a valuation technique (such as the earnings multiple technique), which details the method or technique for deriving a valuation, and inputs used in the valuation technique (such as EBITDA). Usually, the Fund Manager provides for Fair Value assessment on a quarterly basis to enable better decision making and for analysis / reporting purposes.
Figure 3: Valuation of a Private Equity Fund
As a conclusive note, the emergence of Private Equity has been tremendous over the past decade. Such kind of scheme promotes risk mitigation, effective revenue and profitability, sustainable investments and favourable returns if properly instigated.
How can Sunibel help in your Private Equity Fund project?
As an international Fund Administrator, Sunibel Corporate Services collaborates with Fund Managers and Limited Partners as from day 1 till the winding-up of the Fund. We guide Fund Managers throughout the project lifecycle, allowing them to focus on their core activities: creating value and driving positive returns for the investors.
Each fund has its own attributes: its structure, investors’ requirements, regulatory and fiscal requirements. Our structured integration process and rigorous work methodology enable us to provide you with turnkey solutions adapted to your requirements.
- Fund Structuring and Fund Administration for funds in several jurisdictions: Mauritius, Malta, BVI, Cayman Islands
- Setting-up of an Investment Manager
- Pro-active Investor Relations;
- Statutory compliance services
- Company secretarial services
- Accounting services and shadow accounting for existing funds
- Net Asset Value (NAV) calculation
- Asset Valuation
- Tax administration services and tax advisory
- Performance Fee Equalisation
- Purchase and redemption of shares
For more information about our Fund Administration services, do not hesitate to contact us.
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- The general mechanisms behind a Private Equity Fund
- Structuring your Private Equity Fund in Mauritius: choosing the right Fund Administrator
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- Private Equity: Investor Relations Overview