Terms in the fund documents
Typical terms to be set out in the fund documents
The fund documents should set out the key terms and provide the framework within which the GP will operate the fund.
The minimum requirements for the fund documents heavily depend on the jurisdiction and applicable regulatory requirement and as such should be checked by legal counsel.
It is recommended that the fund documents should address, at a minimum, the following matters:
Investment strategy
Team
Structure and powers
Reporting
Financial terms
Co-investments
Term and new funds
Risk factors
Tax considerations
Regulatory disclosure
Marketing restrictions
- the investment scope of the fund;
- the investment policy, investment criteria and investment period of the fund, including the applicable investment, lending and borrowing guidelines and investment restrictions. (NB: These must be set out particularly clearly as, often, these important matters will not be set out in any detail in other key documents, and they are usually incorporated by cross-reference to the private placement memorandum);
- the responsible investment approach of the GP and/or the fund and the procedures for ensuring compliance with any associated policies.
- a description of the management structure and the management team, and identification of the key executives of this team;
- a description of the team’s skills and experience;
- details of team continuity, dynamics, decision-making processes and team succession.
- a description of the legal structure of the fund;
- a summary of the powers of the GP;
- conflict of interest resolution procedures;
- remit and composition of the LPAC;
- Key Person provisions regulating the departure of key executives (for example, requiring the GP to cease new investments if key personnel are no longer available to make the key investment decisions);
- GP removal provisions (e.g. in the event of fraud, negligence, etc.);
- transfer of GP and LP interest provisions;
- indemnification provisions.
- a summary of the key reports on the fund produced by the GP for LPs;
- their frequency (e.g. quarterly financial statements, half-yearly reports and annual audited accounts);
- the timetable within which they will be circulated to LPs;
- the valuation policies to be used in such reports;
- disclosure and detailed breakdown of the nature and source of all fees paid directly or indirectly by portfolio companies to the GP and/or any related entities/individuals (such as employees, operating partners, advisers or similar);
- other reports, such as those covering ESG matters or those required to satisfy tax and other regulatory obligations.
- the establishment costs of the fund, those to be borne by the fund (and any cap thereon) and those to be borne by the GP;
- the terms of the management fee (including the point at which it commences) and the differentiation of costs borne by the fund and the GP;
- the provisions dealing with fees received from portfolio companies by the GP or its related parties, and to what extent such fees received will be offset against the management fee or otherwise credited to the fund and any other fee and expense allocation provisions required so that LPs have a proper understanding of the fees and expenses charged (keeping in mind any regulatory requirements such as under the AIFMD);
- the GP capital commitment;
- the carried interest arrangements, including the rate, basis of calculation, catch-up, escrow, clawback and true-up provisions;
- the mechanics for drawdown of commitments and in the event of an LP’s default on such a drawdown (which should normally impose significant sanctions on a default to reduce the risk of such default);
- if applicable, the pricing of interests, units, shares, etc. in the fund;
- how distributions to LPs will be made.
- the allocation policy for co-investment opportunities, including disclosure of any priority co-investment rights;
- the policy on co-investment with other funds managed by the GP or any of its associates.
- the term of the fund, the process for extending the fund and termination and liquidation procedures for the fund;
- the circumstances in which investments may be purchased from or sold to other funds managed by the GP or its associates;
- any restrictions on the circumstances in which the fundraising team or the GP will be permitted to establish any other fund with a similar investment strategy or objective.
- a summary of the risk factors that are relevant to investment in the fund, including a general warning to LPs of the risks that are inherent in investing in such funds, and also any particular risk factors that may adversely affect the fund’s ability to carry out the investment policy or to meet its return objectives.
- an outline of the tax structure of the fund and the key considerations for investors in the fund.
- in certain jurisdictions, regulation may require detailed disclosure on certain aspects of the investment mandate and ongoing operations of the fund.
- a summary of the key restrictions on who can invest in the fund in major jurisdictions where the fund is being marketed.
The fund documents (private placement memorandum or similar and constitutional documents) should be prepared and made available to LPs in sufficient time for them to consider these documents prior to closing and to allow time for negotiation with the GP. Appropriate subscription documents and confirmation of participation should also be circulated.
The fundraising team should take advice on whether the law in any jurisdiction where the documents will be sent requires any other legal or regulatory matters to be addressed.
Responsibilities with regard to the availability and use of additional credit finance within the fund structure
It is now typical for funds to be raised with additional bridging financing in the form of facilities secured on the LPs’ undrawn commitments. Such facilities, which are made available at the level of the fund (as opposed to facilities at the level of the fund’s individual assets) are typically established as a redrawable facility from a bank or other specialist lender and are used by the GP for a range of cash efficiency reasons including reducing the volume of drawdowns made to and from LPs and avoiding the need to draw funds from LPs for temporary investments. This kind of financing does not increase the investment capacity of the fund.
LPs need to understand the rationale for using the facility and the key terms associated with it, and may wish to put restrictions on how such a facility is used. As with the general requirements of the fund formation documents, the criteria for disclosure regarding such credit facilities may depend on the jurisdiction and applicable regulatory requirements and therefore should be checked by legal counsel.
Typically, the specific terms of the facility may not be in place until after the fund has been formed and therefore it may not be possible to disclose full details in the fund formation documents – in which case a statement indicating an outline of any proposed facilities will be all that is available. Once the facility is in place, LPs will need to be informed of the final terms.
LPs may wish to see the impact of the facility on the net IRR and net money multiple of the fund in order to be able to compare and benchmark the underlying net performance with other funds.
Occasionally, a facility is put in place to increase the investment capacity of the fund (i.e. the facility is expected to be long term and allow the fund to make investments in excess of 100% of LP commitments). In such circumstances LPs need to be informed of the size and scope of such borrowings and understand the implications. Such facilities give rise to fund leverage (which may have regulatory implications).
The fund formation documents should address the following items:
Intention to use a bridge facility during the fund life - if no facility is proposed or can be put in place then this should be disclosed
Reasons for using (and/or restrictions on the use of) the facility – for example:
to reduce the frequency of drawdowns (e.g. to enable a specified number of investments to be acquired at the same time)
to fund temporary investments
to avoid the need for rebalancing among LPs during fundraising by providing funding for all investments between first and final closing of the fund
to optimise cash efficiency
to provide letters of credit / bank guarantees in support of the fund’s portfolio
to accelerate distributions
The fund formation documents should also make it clear that the use of such a bridge facility will have an impact on the net IRR, net money multiple and, where relevant, the achievement of the hurdle for payment of carried interest.
If available at the time the fund formation documents are written, the following should be included:
Anticipated size of the facility
Proposed limits on the duration of the facility
Details of the permitted usage of the facility (e.g. for investments, for management fees and expenses, for temporary investments)
Where the specific terms of the facility have not been finalised until after the fund has been established, the GP should provide the details referred to above either in the next quarterly report or in a separate communication to LPs. Disclosure on the terms associated with facilities designed to increase the investment capacity of the fund should be disclosed separately from those applicable to bridging facilities.
Where a credit facility is to be used to increase the investment capacity of the fund (i.e. fund leverage), there should be a clear statement to this effect, and all disclosure relating to this facility should be made separately from that relating to bridging facilities.
Once the fund is up and running, ongoing reporting should ensure transparency for LPs on the usage and impact on returns of the facility, and should include the key terms of the facility as part of the fund overview. For details of the ongoing quarterly reporting requirements, see the Invest Europe Investor Reporting Guidelines.
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