Parts 1-3 of this series of articles have looked at the areas where you should have conviction in order to invest the time and other resources required to launch a fund, as well as covering the fundamental cash flow and pertinent business considerations for any want-to-be fund manager.
An important feature of investment management that we have not yet touched on, however, is regulation. Private equity and venture capital managers must be regulated in any market in which they plan to attract and invest client monies and importantly they need to be regulated before marketing the fund.
In the UK, firstly you must decide if it is right for you to get fully regulated yourself as a fund manager, through the Financial Conduct Authority (FCA), or if you want to access the required permissions through a “regulatory umbrella” (for example The Fund Incubator) either temporarily or for the life of the fund. For many first time fund managers, the umbrella route is preferable, as it is quicker by several months and provides access to compliance and regulatory expertise that may not be available in-house. This choice comes at a cost, of course, which should be weighed against the advantages of being able to market your fund sooner and focus your attention on investor and investment management.
In the EU, fund managers must be aware of a number of regulations, the key one of which is the Alternative Investment Fund Managers Directive (“AIFMD”), which provides, in principle, a means for private equity funds to access a marketing “passport”, which allows a manager registered in one qualifying jurisdiction to market and invest in other European jurisdictions. Numerous terms and conditions apply, as one might expect.
However, this is complex legislation and there are a large number of specific points that must be understood in the context of your particular fund, the set-up of your fund management vehicles and the nature of your investments – and professional legal and compliance advice should be sought. For example, depending on the size of your fund, it may be possible to be identified as a “sub-threshold” AIFM (“Alternative Investment Fund Manager”) if the aggregate assets under management (across all relevant funds) are below €500m – although this threshold drops to €100m if leverage is used to boost the size of the fund, as is often the case with hedge funds – it does not normally relate to debt used to acquire portfolio companies.
Alternatively, specialist venture capital or social investment funds may, likewise, access the passporting regime with fewer regulatory restrictions if they register as a European Venture Capital AIFM (“EUVECA”) or European Social Entrepreneurship Fund AIFM (“EUSEF”), respectively.
Once your structure and regulatory status is confirmed, you will need to engage the services of a specialist law firm to draft up the required documentation for marketing and allowing subscriptions into your fund.
The key documents are:
- the Private Placement Memorandum (PPM), which is the key marketing document and lays out the commercial terms of the fund, as well as the investment strategy, details on the members of the management team and other pertinent topics, including any prior track record of investing.
- the Limited Partnership Agreement (LPA), which sets out the terms under which investors will come into the fund and what the processes of the fund will be, vis-à-vis its investors and investments, and how the spoils will be shared.
- the subscription booklets, which each investor completes to subscribe to the fund and sets out various warranties and so forth.
The PPM will typically be supported by a series of roadshow materials to illustrate the opportunity being pursued, the investment strategy to capture it and the ability of the team to execute this strategy.
At this stage you may also want to engage or have earmarked a fund administrator, a fund auditor and have commenced the process of arranging the required bank accounts for the fund.
- Funds administration, accounting and reporting can be undertaken in-house or via specialist independent fund administrators (for example Mainspring Fund Services). Your choice of fund administrator is important because this service provider will be responsible for some of the most important investor communications, accounting and reporting through the life of your fund, running the process that draws committed investor capital into the fund and organising the distribution of proceeds back out. Many investors prefer funds administration to be undertaken independently to the fund management and many fund managers prefer to outsource this function allowing them to focus on investment selection and management – the raison d’être of the fund.
- It is worth noting that the opening of a bank account hardly seems worth a mention but it often takes a good deal longer than expected, due to the complexity of partnership fund structures and the Anti-Money Laundering (AML) and “Know Your Customer” (KYC) obligations for all involved.
So, before you begin marketing your fund to investors you MUST ensure that you have:
- The proper regulatory permissions in place (either directly or through a regulatory umbrella)
- The correct documentation, drafted by a specialist legal adviser
It is also advisable to have identified the correct capital management infrastructure, including bank accounts, auditor and fund administrator
With all this in place, it’s now time to reach out to investors, which we will cover in our next article, PART 5: RAISING CAPITAL.