EMPEA PROFESSIONAL DEVELOPMENT WEBCAST SERIES An EMPEA Professional
EMPEA PROFESSIONAL DEVELOPMENT WEBCAST SERIES An EMPEA Professional Development Webcast with Debevoise & Plimpton LLP
EMPEA UPCOMING EVENTS EM PE Week in London | 14 -16 October 2014 • 14 October: Private Equity in Emerging Markets 2014 Presented by EMPEA and Financial Times • 14 October: Members-Only Networking Reception • 15 October: Private Equity in Africa 2014 Presented by EMPEA and Financial Times • 16 October: EMPEA Fundraising Masterclass Mezzanine Finance | November 2014 An EMPEA Professional Development Webcast Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014
DISCUSSION PARTICIPANTS Gavin Anderson Erica Berthou International Counsel Partner Peter Furci Andrew Ostrognai Partner Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014
EMPEA Changing Landscape of EM PE Fund Formation September 25, 2014 Debevoise & Plimpton LLP Gavin Anderson Erica Berthou Peter Furci Andrew Ostrognai Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 4
Notices • The contents of this presentation should not be construed as legal, tax, investment or other advice • The information in this presentation regarding market data and market trends is a general overview prepared based on selected funds. The data generally does not distinguish funds based on industry focus, nor does it distinguish between funds raised by institutional and independent sponsors. These and other considerations may cause fund terms to deviate significantly from the general trends noted in this presentation. None of the information presented herein should be held out as representing the views of Debevoise & Plimpton LLP Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 5
Notices • Charts in this presentation are based on a review of key business and legal terms for approximately (a) 55 Asia-focused funds, (b) 12 Latin Americafocused funds, (c) 16 other emerging market-focused funds (which include MENA, Africa, CEE/CIS and multi-EM region funds), (d) 48 U. S. -focused buyout funds and (e) 41 Western Europe-focused buyout funds, in each case raised since 2009 and contained in the Debevoise IMG Database. The emerging market sample included a range of national and regional focuses and investment strategies including buyout funds, real estate funds, infrastructure funds and growth capital funds. The sample does not include funds of funds or secondary funds. • © Copyright 2014 Debevoise & Plimpton LLP - All rights reserved. Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 6
Table of Contents Slide Numbers 8 -13 Fund Structure and Structure Drivers 14 -21 Regulatory Considerations 22 -31 Commitments and Other Funding-Related Mechanics 32 -38 Key Person Termination and Other Investor Protections 39 -50 Management Fees and Other Economic Terms Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 7
Fund Structure Typical offshore fund structure International Investors Fund Sponsor Manager LPs GP Management Fee Various jurisdictions Fund (Limited Partnership) Tax efficient jurisdiction Holding Company Advisory Fee Treaty network or other jurisdiction Adviser Portfolio Company Investment jurisdiction Key sponsor jurisdiction / investment jurisdiction Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 Portfolio Company 8
Structure Drivers • • Levels – Fund (keep it familiar to investors) – Below-the-fund (portfolio investments) – Above-the-fund (GP, Manager/Adviser, carry vehicles) Tax – Investors (taxable/tax-exempt? Key jurisdictions? ) – Parent sponsor (capital investment) – Team (carried interest? Excess management fee? Employee bonus scheme? Co-invest? ) – JV partners, co-sponsors? Legal and regulatory – Fund – GP, Manager/Adviser – Flexibility (“drafting the deal”) Investments – capital gain? income? both? Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 9
Structure of Private Equity Funds • Common to use a limited partnership structure – General Partner makes decisions and has unlimited liability – Limited Partners provide capital, have very limited authority to make decisions and have limited liability – Limited partnership structure allows for great flexibility • Organised in a jurisdiction that will not impose tax on the Fund itself – Rationale is that tax will be paid by each Limited Partner in its home jurisdiction Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 10
The General Partner • Ultimate management control over Fund – But may delegate to or appoint Manager • • Unlimited liability Single-purpose vehicle (separate GPs for Fund I, III, . . . ) Generally structured as an LP or limited company Fund makes investments, but essentially a passive vehicle – Operates through its General Partner or Manager Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 11
The Manager/Adviser • The real “business” of the Fund sponsor – Employees, real estate, corporate goodwill are here – Finds, negotiates, oversees investments – Receives a management or advisory fee • • Can manage or advise more than one fund Generally structured as a limited company or a limited liability partnership Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 12
Who are the Investors? • • Pension plans (tax exempt, public and private/ERISA) Endowments and private foundations (tax exempt) Life insurance companies (taxable) Banks and financial institutions (taxable) Funds of funds (mixed taxable/tax exempt) DFIs (tax exempt) SWFs (tax exempt) Individuals and family trusts (taxable) Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 13
AIFMD • • Affects the management and marketing of alternative investment funds (“AIFs”) by managers of AIFs (“AIFMs”) ‘Marketing’: a direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM of units or shares in an AIF it manages to or with investors domiciled or with a registered office in the EU Part of a raft of increased regulation in the private fund space worldwide More onerous obligations to satisfy to market funds in the EEA Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 14
Significant AIFMD Dates By July 22, 2013 (Phase 1): • This was the deadline for EEA Member States to give effect to the AIFMD through national legislation. This was the earliest date on which an EEA AIFM that requires authorization under the AIFMD could apply for authorization. • Note that generally EEA AIFMs that become authorized will be able to market one or more EEA AIFs to professional investors across the EEA without relying on the national private placement regimes under the AIFMD “marketing passport. ” Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 15
Significant AIFMD Dates (cont’d) No earlier than 2015 (Phase 2): • Subject to appropriate advice from the European Securities and Markets Authority (“ESMA”), the AIFMD will be extended to require authorization of: • Non-EEA AIFMs that manage one or more EEA AIFs; • EEA AIFMs that wish to market one or more non. EEA AIFs to professional investors across the EEA under the AIFMD “marketing passport; ” • Non-EEA AIFMs that wish to market one or more AIFs to professional investors across the EEA under the AIFMD “marketing passport. ” • Note that the AIFMD permits national private placement regimes to remain in place from 2013 -2018. Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 16
Significant AIFMD Dates (cont’d) No earlier than 2018 (Phase 3): • Subject to appropriate advice from ESMA, national private placement regimes will no longer apply, i. e. , following withdrawal of the national private placement regimes. AIFs will only be able to be marketed to professional investors in the EEA by an EEA AIFM or by a non-EEA AIFM under the marketing passport which will require such manager to be authorized under the AIFMD. Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 17
Anti-Bribery Considerations • Key Risks for EM Managers: – Fundraising (e. g. , SWFs) – Using third parties (e. g. , placement agents, consultants) – Deal sourcing – Governmental approvals for transactions – Governmental approvals for business operations Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 18
Anti-Bribery: FCPA and UKBA U. S. Foreign Corrupt Practices Act • Anti-bribery provisions: Prohibit corrupt payments or providing anything of value to a foreign official – Directly or indirectly through an intermediary – To obtain a quid pro quo or secure an improper advantage – Applies to US issuers, US persons, US conduct Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 19
Anti-Bribery: FCPA and UKBA (cont’d) UK Bribery Act • Broader applicability than the FCPA • Not limited to foreign officials • Includes a strict liability corporate offence (only defence is “adequate procedures”) • Applies to any company “carrying on business” in the UK, regardless of where the bribe is paid Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 20
Anti-Bribery: FCPA and UKBA Mitigating Risks: • Adopt and enforce tailored compliance policies (sponsorlevel, portfolio company-level) – Identify local and industry-specific risks • Risk-based due diligence on counterparties, intermediaries, potential investments, JV partners – Liability for “deliberate ignorance” • Contract provisions (R&W, indemnity, audit right) • Training, periodic assessment, documentation Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 21
Commitments • The Limited Partners may require that total Commitments be capped at some amount • • The Principals often invest through the Fund Institutional funds typically include a Commitment from the firm Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 22
Co-Investment and Parallel Funds • • Co-investment funds may have different terms • • • Key investor point: avoid cherry-picking Generally invest at the same time and on the same terms as the Fund Generally cannot exit prior to the Fund’s exit Share Investment expenses, indemnification expenses Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 23
Closings • The amount of time that the General Partner may hold closings to admit additional Limited Partners is limited in duration • Limited Partners want the General Partner’s focus to move to doing deals; concern over new investors getting to take a risk-free look at deals and buy in at cost instead of increased value • In today’s market, you often see a 12 to 18 month admission period, beginning on the date of the Initial Closing Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 24
Subsequent Closing Partners • Limited Partners admitted to the Fund after the Initial Closing generally participate in all deals made prior to their admission • Contribute an amount equal to their proportionate share of all funded Commitments of Partners admitted in prior closings, plus interest • Amounts contributed by subsequent closing Partners (other than amounts attributable to the Management Fee) are refunded to the previously-admitted Partners and, other than the interest component, may be drawn down again by the Fund • Note, if the Management Fee is based on invested capital, then amounts are refunded to the previously-admitted Partners, not the Manager Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 25
Drawdowns • Unlike a hedge fund, a private equity fund only calls capital as and when needed to make investments and to pay Fund liabilities and expenses • • Generally upon 10 days’ prior written notice Credit facility Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 26
Limited Partner Default • • Penalty for failing to contribute capital on time or at all • Enforceability issues, especially in bankruptcy Penalty for transferring all or a portion of its interest in contravention of the Limited Partnership Agreement Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 27
Term and Investment Period • • 10 -year term, plus 2 or 3 one-year extensions • Once the Investment Period is over, the Fund cannot make new portfolio investments, but may (i) complete portfolio investments that are in process, (ii) make follow‑on investments [in an aggregate amount up to [25%] of total Commitments], and (iii) continue to draw down Commitments to pay Fund liabilities and expenses Five-year investment period beginning on the date of the Initial or Final Closing Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 28
Reinvestment/Recycling • Provision allows the Fund to reinvest capital returned to the Limited Partners within limited time frame (e. g. , capital invested by the Fund and realised within [13] months) • Generally permitted to recycle capital funded to pay Fund expenses or organisational expenses Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 29
Diversification • Provision prevents the General Partner from putting too much money in any one deal, and sometimes in any one industry and/or outside a specified geographic location • Typically includes guarantees Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 30
Exclusion from Certain Investments • A Limited Partner may be excused from a deal if participating in such deal would be illegal or is otherwise prohibited by statute or regulation, and in certain other limited circumstances • A Limited Partner may be excluded from a deal if the General Partner determines that such Limited Partner’s participation in such deal would be illegal or would impose a material tax, regulatory or other burden on the Fund, and in certain other limited circumstances Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 31
Key Person Termination • Provision protects the Limited Partners in the event that Mr. or Ms. Big, or a certain number of Principals, leaves the Manager or devotes insufficient time to the Fund • Suspension of Investment Period to propose qualified replacements • • Management Fee consequences? Could be very difficult to maintain the Manager’s business in the event of termination of the Investment Period Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 32
Terms: Key Person Key person provisions (Source: Debevoise IMG Database) Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 33
Terms: Key Person (cont. ) Operation of key person provisions (Source: Debevoise IMG Database) Asia (53) Latin America (12) Other Emerging Markets (15) US Buyout (48) 100 90 80 70 % of 60 Funds 50 40 30 20 10 0 Automatic Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 Triggered by a Vote 34
No Fault Termination • Provision allows the Limited Partners to vote to terminate the Investment Period (or, in some funds, to remove the General Partner or force the Fund to wind up) for any or no reason • Important to have the percentage vote large enough (e. g. , 75%, 80% or 85% in interest) to avoid minority of investors forcing a decision on the majority of the investors • Accounting consolidation issue for institutional sponsors Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 35
Terms: No Fault Removal • Removal without cause – Relatively rare in U. S. funds – Appears in approximately 76% of European funds in the sample – Where offered, typically require 75%+ vote to invoke 90 Asia (50) Latin America (12) Other Emerging Markets (16) US Buyout (43) 80 70 60 % of Funds 50 40 30 20 10 0 None Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 66. 67% vote 36 75% or higher vote
For-Cause Removal • If a court has determined that the General Partner engaged in certain conduct (e. g. , conviction of a fraud or felony having a material adverse effect on the Fund), the Limited Partners may vote to remove • Generally majority or 66 -2/3% in interest required to remove • Considerations: haircut on the carry Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 37
Successor and Affiliate Funds • Generally will need Advisory Committee or Limited Partner approval to make investments on behalf of a successor fund before the earlier of (i) the end of the Investment Period and (ii) the date on which [80%] of total Commitments have been invested, reserved or committed • • Affiliate conflicts: other funds and activities Deal flow allocation: right of first refusal Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 38
Management Fee • During the Investment Period, traditionally a fixed percentage of total Commitments, paid on a semi-annual or quarterly basis (there are some variations) • After the Investment Period, generally a fixed percentage of total invested capital; there are some variations (write-offs, writedowns, successor funds) • Reductions for other fees: directors’ fees; transaction fees; monitoring fees; advisory fees; break-up fees Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 39
Terms: Management Fees Management fee during investment period by fund size – all strategies (Source: Debevoise IMG Database) + Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 40
Alternative Management Fees • Increased prevalence of variable rates post-global financial crisis – Management fee is lower for LPs investing at first closing (“early bird discount”) – Different management fee base during all or part of the Investment Period or perhaps limited to the fundraising period – Carried interest discounts? Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 41
Alternative Management Fees (cont. ) • Management fee varies based on size of LP’s Commitment – Specified Discount on Headline Rate – Tiers of increasing discounts for tiers of increasing large Commitments • Management fee payable by all LPs varies based upon aggregate Commitments – MF rate is 2% of aggregate Commitments up to $1 bn or 1. 25% of aggregate Commitments above $1 bn Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 42
Distributions (aka The Waterfall) • First: 100% to the Limited Partners to return contributed capital • Second: 8% preferred return – 100% to the Limited Partners to give them an 8% return on those amounts • Third: GP catch-up – 100% to the General Partner to “catch up” to the 80/20 deal • Fourth: 80/20 split – 80% to the Limited Partners and 20% to the General Partner • US model: more likely to return only capital on realised deals, capital for [net] unrealised loss deals and management fees and other fund expenses allocable to such amounts prior to carried interest • Current income waterfall Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 43
Terms: Distributions Distribution waterfall (Source: Debevoise IMG Database) 100 90 80 Asia (54) Latin America (12) Other Emerging Markets (16) US Buyout (48) 70 % of Funds 60 50 40 30 20 10 0 Deal-by-Deal Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 Return all Contributions 44
Carried Interest Clawback • • Protects the 80/20 deal • • Interim clawback • Escrow/reserve account If at the end of the Fund it is determined that the General Partner has received more than 20% of the profits, then it must return the amount of any over-distributions (account capped on an after-tax basis) Guarantee of clawback is typically several, not joint and several Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 45
Terms: Distributions Frequency of GP clawback operation (Source: Debevoise IMG Database) 90 80 70 Asia (53) Latin America (10) Other Emerging Markets (16) US Buyout (48) 60 % of Funds 50 40 30 20 10 0 Interim Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 End of term only 46
Terms: GP Clawback Provisions GP clawback guarantees (Source: Debevoise IMG Database) Asia (51) Latin America (10) Other Emerging Markets (12) US Buyout (46) 80 70 60 % of Funds 50 40 30 20 10 0 None Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 Several (or Sponsoronly guarantee) 47 Joint and Several
Terms: GP Clawback Provisions (cont. ) Escrow arrangements (Source: Debevoise IMG Database) 90 Asia (53) Latin America (11) Other Emerging Markets (16) US Buyout (48) 80 70 60 % of 50 Funds 40 30 20 10 0 None Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 Yes 48
Indemnification • Absent gross negligence, fraud, willful misfeasance, reckless disregard of duty or gross negligence (“Disabling Conduct”), none of the General Partner, the Manager or the Advisory Committee will be liable to the Fund or the Limited Partners • Definition of Disabling Conduct Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 49
LP Clawback • Under certain circumstances, the General Partner may require the Partners to return distributions for the purpose of satisfying any Fund obligations or liabilities • Often limited by time and/or amount Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 50
EMPEA PROFESSIONAL DEVELOPMENT WEBCAST SERIES Launched in 2008, EMPEA has hosted almost 40 webcasts to date drawing more than 5, 000 participants from 70 countries and over 900 unique firms. Webcast Topics have included: • Market Based Solutions for Impact Investing • Changing Landscape of EM PE Fund Formation • Identifying and Mitigating Risks in Southeast Asian Investments • Investment Spotlight: Secondaries • The Appeal of Africa: Maximizing Investment Opportunities While Mitigating Risk • EMPEA Guidelines: A Legal and Regulatory Framework for Global Private Equity • Private Equity Fund Structuring, Oversight and Administrative Matters • LP Outlook for Emerging Markets: Preview of EMPEA’s 2012 LP Survey Results • Anti-Corruption Policies: What Every EM PE Practitioner Should Know • Investment Spotlights: Emerging Europe & Mexico • The MENA Region: An Overview and Update • Private Equity in North Africa: What Every LP Must Know Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014 • The Impact of the Dodd-Frank Act on Investment Adviser Regulation in the U. S. • Private Equity Investing in the Middle East, North Africa and South Asia • Evolving Key Terms & Conditions in Today’s EM PE • How Will the ILPA Principles Shape GP-LP Relationships in Emerging Markets? • Strategies to Address and Prevent LP Defaults • Role of the Secondaries Industry in Emerging Markets Private Equity • Corporate Governance in Emerging Markets Private Equity • Frontier Markets & Beyond • The Future of Growth Markets: More Than Just a BRIC in the Wall • Measuring and Benchmarking Private Equity Performance • LP Outlook for Emerging Markets: EMPEA’s 2014 LP Survey Results
EMPEA CONTACT INFORMATION • For follow-up questions on this or other webcasts, please contact Emily Sandhaus at sandhause@empea. net or +1. 202. 333. 8171. • For Members-Only Research Requests, please contact research@empea. net or +1. 202. 333. 8171. • Please also visit www. empea. org for further information. Changing Landscape of EM PE Fund Formation An EMPEA Professional Development Webcast – 25 September 2014
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