We advise private equity clients on a range of matters from fund formation to business transactions. Fund formation, in particular, is a complex and important issue on which private equity funds must focus.
Private equity funds and hedge funds are generally structured in the form of limited partnerships, which consist of a general partner, or sponsor, operated by the fund’s management team, and limited partners, who are the investors and do not participate in the management of the fund. General partners often then contract with an affiliated but distinct management company, which assumes management responsibilities.
There are a variety of considerations when forming a fund, and many of the issues are set forth in the terms of the limited partnership agreement (LPA), which specifies the management fee (often 1 to 2%), carried interested (often close to 20% of profits) and other economic terms, including whether there is a hurdle rate, high-water mark, preferred return for limited partners, and the structure of the fund’s waterfall.
Private equity funds and hedge funds also must carefully account for various tax issues, including certain tax issues that are unique to tax-exempt investors, such as foundations and endowments. In the case of tax-exempt investors, funds often must be careful not to generate unrelated business taxable income (UBTI), which arises from the operation of a business unrelated to the tax-exempt entities’ underlying purpose, the income of which flows through the partnership to the investor and is subject to income tax. Funds must also consider whether their investors are subject to ERISA, which is the legal regime governing pension assets, and whether accepting too high a percentage of plan assets in the fund could subject it to fiduciary obligations to the plan’s beneficiaries.
In summary, there are a whole host of issues that private equity and hedge funds must consider and we are equipped to provide that guidance.