Private equity funds in Europe are usually considered to be ten-year funds. Investors are told that this is the time frame within which the investment manager will source appropriate transactions, make the various investments and then effect realisations. The documentation constituting the fund will usually provide for a fixed end date, subject to extension if a particular percentage of investors agree.
Most fund documents provide that after final closing, when all investors are contractually bound to advance monies upon receipt of a drawdown notice, the investment manager will have an investment period of between three to five years in which to make the investments. From the outset, investment managers tend to be thinking about their realisation strategy but, following the end of the investment period, that will be their main focus. Post investment period, the level of management fees will usually be reduced and be based on an NAV calculation of assets within the fund, so the fees will continue to decrease over time, as assets are realised. Thereafter, drawdowns from investors can usually only be made to pay such management fees, fund expenses or for other narrowly prescribed uses, including usually a limited amount for follow-on investments, so increasing the amount invested into, or related to, existing investments.
Once the formal end date of the fund is approaching, the investment manager will need to decide whether to wind up the fund or, if there are still unrealised investments in the fund, whether to extend its life to allow a more orderly disposal of the assets. Most fund documents provide for two single year extensions, often subject to investors’ consent. However, sometimes assets cannot be disposed of quickly or there is a potential tax liability to deal with so, the manager may have to extend the life of the fund even further.
If the investment manager decides to wind up the fund, it will need to devise a detailed plan to effect the runoff. This is usually put together with the help from professional advisers and/or service providers, including lawyers and administrators. The legal framework must be adhered to but there are also many practical issues which need to be considered.
The investment manager owes fiduciary duties to each of the investors so it must ensure that everyone is treated fairly and full disclosure is made to all limited partners. Clear communication with all investors as to what is proposed in terms of realisation of assets, distributions and the costs and timing of the termination exercise is vital. In some cases an investment manager may be terminating its entire business, but in others it may be changing its investment strategy and wanting to raise new funds. In the latter case, keeping all investors on side, particularly those which might go into a new fund, will be key.
Keeping the relevant regulator(s) informed is also important. An investment manager should ensure that it is fully on top of the provisions of the documentation governing the fund, including the requirements in any side letters, plus the underlying legal framework of the jurisdiction where the relevant fund and/or the manager itself is based. Having a clear detailed document, setting out the action plan, timetable, documents required and responsibilities schedule is helpful to everyone involved.
The fund manager should think about the best way to realise value from the assets including any potential tax issues and the satisfaction of all liabilities of the fund. Sometimes there are contingent liabilities, such as tax payments, which have been carried within the fund and need to be dealt with. The manager will need to think about (and often take tax professional advice on) the most cost-effective way to undertake the runoff. Reducing the costs of the structure early in the process will be important, particularly if there are only a small number of assets remaining which cannot support heavy expenses going forward. Documentation will need to be retained for at least six years.
An investment manager may consider in specie distributions. Although these are technically difficult, they may provide a better longer-term solution for investors and avoid the need to keep the fund structure in place, with its associated costs. Alternatively the formal fund structure may be wound up and the general partner will hold all remaining assets on behalf of the investors.
Mainspring has considerable experience in assisting fund managers effect a wind down of large numbers of interrelated funds. Stephen Geddes and Damian Simmons are both happy to discuss these issues in more detail, since finding a solution that works for all of the investors and does not cost too much to operate is a key factor in implementing an effective wind down. Early detailed planning will make the whole process, which can be difficult and time consuming, run far more smoothly.