Throughout the current economic cycle, private funds have remained an important way to link investors with managers who have the drive, skills and connections to source and manage investment opportunities.
This trend has been particularly prevalent in the area of smaller funds (i.e. those with an equity base of below, say, £50 million), and which target a particular industry sector, for example cleantech investments.
By 'private' fund we mean a fund which is intended for an investor base of private individuals rather than institutional investors.
They are 'unregulated' in the sense that the funds themselves are not FSA registered and therefore cannot be offered directly to the public. However, this type of fund is very much subject to regulation. In the UK, this covers how they can be promoted, and who can establish them and operate them.
You will probably already have a vision for your fund management business, what it will be known for and how it will develop. Investors generally want a long-term relationship with people who form part of a sustainable business, rather than a one-off investment opportunity. This means that you need to view your fund management business as an entity in its own right, distinct from any individual fund which you may want to launch.
You will need to consider what the organisation chart for your fund management business will look like (including the roles of CEO, COO, finance director, head of compliance, investment managers and, crucially, owners / investors), and which positions in that chart you want to occupy in the long term.
This may seem over the top, especially if initially you need to perform many of those roles yourself, but it will help focus on the systems which will drive the business forward.
You will need to choose a name for your fund management business, one which does not conflict with the intellectual property rights of other businesses. You should also consider whether your chosen name is capable of being registered as a trade mark.
In addition to confirming who will perform the internal roles, you will need to establish your external team of advisers, ensuring access to legal, regulatory / compliance, tax, financial modelling and fundraising skill sets.
Setting your fee structures will be critical. This will be likely to be a mix of annual fees linked to the size of the fund, transaction-based fees and also performance fees.
- The trend for annual fees is for them to relate to the funds actually drawn down by from investors (rather than total committed funds, or the gross assets of the fund including any gearing. Typical annual fees for smaller funds would be in the range of 1% to 2.5%.
- Transaction-based fees are less likely to be acceptable to investors than they were previously, and the expectation now is for transaction-related charges to relate only to third party expenses.
- Performance fees (also known as 'carried interest' or 'carry') are generally welcomed by investors, since they tend to align the managers' interests with those of investors. A classic performance fee structure would allow the managers to participate in 20% of the profit achieved for investors, after their capital has been repaid and after a specified threshold of profits has been achieved. That threshold (commonly referred to as a 'hurdle') is often calculated by reference to an internal rate of return on their investment, or alternatively a notional interest rate.
It is important to get feedback on the attractiveness of the overall package for investors.
You may already have personal contacts who you know will be willing to invest with you. Alternatively – although it's harder work and more expensive in terms of fees – it is possible to raise funds via independent financial advisers (IFAs).
You will need to be clear about how the fundraising costs will be paid for – whether the fundraisers you engage (and the investors) will agree to those costs being deducted from the amounts raised, or whether they will expect you to fund those expenses. Investors will probably want to see some personal investment from you.
The legal, tax and regulatory structure of the fund will depend on factors such as the location of the fund manager/s (i.e. you), the location and profile of the likely investors, the nature of the assets to be acquired and the investment and exit strategy.
Structuring options may include onshore or offshore limited partnerships, unit trusts or companies. In general, although choosing an appropriate structure is central to the fund's attractiveness, legal, tax and regulatory issues should not represent an obstacle to achieving what you want to achieve.
Any fundraising activities are likely to be subject to legal and regulatory restrictions, and it is important to work with experienced advisers as the sanctions for breach can be severe. In general, an information memorandum will be required which will explain the proposed investment strategy, the relevant background information, the fund management team and its track record, and also explain how the fund is structured.
This document will need to be verified as factually accurate by reference to objective standards, and it will usually need to be approved by an FSA authorised person. It is important to recognise that the regulatory restrictions on financial promotions apply not just to written materials, but also to real-time communications.
All the time and effort you have invested so far will help you and your team secure commitments from prospective investors. Once you have reached critical mass in terms of the minimum total committed funds, you can move on to 'first closing', meaning that applications from investors become unconditional, and often an initial draw-down of funds may be made to cover set-up costs.
Now you are ready to start investing the fund and providing a return for you and your investors.
About: Paul Sutton
Paul is a corporate partner in McGrigors' London office. He specialises in helping corporates and fund managers to optimise their legal structures, often in conjunction with tax advisers. He has particular experience of establishing and restructuring funds in the real estate and renewable energy sectors.
He regularly works with FTSE100 and Fortune 500 companies, real estate funds and infrastructure funds. Paul is a contributor to the LexisNexis online resources on transfer pricing, and has written articles for other publications such as the Tax Journal and Butterworths Journal of International Banking & Financial Law.