Launching a Fund
We help clients launch closed-ended funds across multiple assets classed and in this short guide we set out a few of the things we have learnt along the way. It is by no means exhaustive, and we would welcome the opportunity to discuss specific considerations with you given your unique circumstances.
1. Investors
Cornerstone
As a Host Fund Manager, we find that identifying a Cornerstone Investor or group of Investors early is important. Often Cornerstone Investors will have Fund Structure or Fund Domicile preferences given their previous investing history and their own tax status.
Whilst there are many comparable jurisdictions from a cost and tax perspective, with the UK being high up on the list of many investors, it may be politically difficult to ask your Cornerstone to invest in a structure, managed by a Host Fund Manager, with which they are less familiar.
Jurisdictions
As a Host Fund Manager, we need to understand in which jurisdictions Investors will be located and this will help us to procure the necessary fund licences prior to any marketing activity commencing.
It is useful to identify a prioritised “Top 10” jurisdiction list and we can then work with you and potentially also your legal advisers on a compliance Marketing Strategy.
Minimum Investment Target
It is important to understand the potential returns you may achieve and the associated costs of operating the structure. This will then allow you to identify a minimum Investment Target that will make it economically variable for launch (with additional amounts to Final Close), noting that there may be certain Abort Costs charged by Service Providers.
Investor Terms
It will be important to agree the landing slot for the terms on which the Investors will commit capital to the fund. As the Host Fund Manager, we will review any Side Letters that are proposed to be entered into.
2. Fund structures
There are so many different types of fund structure to choose from across multiple different jurisdictions, each with different tax benefits and operating costs. However, these are some of the key things we tend to see when our clients are choosing their fund structure.
Tax efficiency
A good rule of thumb is that Investors should not be financial worse off tax-wise by investing via your chosen fund structure compared to if they investing themselves directly in a fund managed by us as a Host Fund Manager. For this reason, where returns from the underlying assets are likely to be mostly capital gains, which are generally taxed at lower rates than income, it is often beneficial to the investor to have a “tax transparent” structure (where the investor pays tax rather than the fund entity) to give them access to the capital gains directly. Partnerships are often used as fund vehicles because they are generally treated as “tax transparent”.
Limited liability
It is often preferable to have a structure that limits the liability of its members to the amounts they have committed to the fund. Often this means that a limited partnership vehicle is beneficial.
Limited partners in an English Limited Partnership cannot take part in the management of the partnership without putting its status as limited partner at risk of being converted into that of a general partner.
Carried interest and co-investment
Your fund structure should work alongside carried interest and co-investment vehicles. You will need to separately consider, due to the potential different investor constituents, the above matters for these vehicles. As a Host Fund Manager, we can manage these vehicles too if that is required by the local regulation.
Regulation
In each jurisdiction, the structure of your fund will determine how it is regulated. For example, in the UK, funds structured as limited partnerships are often classified as Alternative Investment Funds that must be operated by a Host Fund Manager.
In most cases, for private funds, these are not themselves regulated by the UK FCA but it is the Host Fund Manager that is regulated instead.
3. Fund domicile
How to choose?
In short, this can be incredibly difficult.
As a Host Fund Manager, we find that this comes down to a combination of three, potentially competing factors:
Investor preference: The pre-determined preference of one or more cornerstone investors.
Operating costs: The total annual drag on returns.
Marketing eligibility: Whether it is permissible to market the fund to the types of investors and in their own jurisdiction
Onshore of offshore?
Positives for offshore:
Preferred by certain investors who are investing through offshore vehicles
Details of limited partners may not be subject to public record
Potential VAT advantages
No requirement to register for HMRC tax reference number
No requirement to file fund accounts
Negatives to offshore:
Money laundering status
Offshore administrator and directors required
Transfer pricing risk
4. Marketing the fund
Types of investor
Different types of investors have different needs. As a Host Fund manager, we tend to think about the following main types of investor:
Pension Funds
Financial Institutions
Foundations and endowment funds
Sovereign wealth funds
Fund of Funds
Insurance companies
Family offices
High-net worth investors
Channels
It is important to identify in advance where you may be marketing the fund and through which marketing channels.
For example, will you be:
Putting boots on the ground in a particular jurisdiction to have in-person meetings
Will you be using the services of a placement agent or Fund Platform?
Will you be only calling people you have a pre-existing relationship or venturing our on fresh powder?
Will you be using social media or other public forums?
All these questions and more will drive the arrangements that will need to be in place prior to marketing commencing.
Teaser deck
What will you say in an initial teaser deck and will this be categorised as a financial promotion in the UK? You may need to include certain disclaimers and limited distribution as advised by your fund lawyers.
You should check what licences you need to distribute the teaser deck.
PPM
This is not strictly required in the UK but we find that some form of PPM is often produced and is sometimes an expectation for institutional grade investors.
Marketing Licences
Whilst Khepri can assist with marketing licences in the UK, since Brexit we do not have the ability to passport our licence in the EU.
We find that engaging with a suitably qualified law firm will hep you identify whether there are any exemptions from registration in the EU or USA.
5. Fund documents
We tend to find that these are some of the key legal documents that your law firm will help you draft. In our role as AIFM we will review and approve these documents, working in parallel with your advisers.
Limited Partnership Agreement (“LPA”)
This is the main document for the Fund.
It establishes the agreed legal structure and sets out the rights of the investors, their arrangements with the Manager and the operation of the Fund. Also need for LPA the carry vehicle. It will typically provide for the:
investment objectives of the Fund and any investment restrictions
allocation of profits and losses, carried interest and management fees, and other economic terms
distribution waterfall of the Fund and any other distributions
payment of Fund expenses
administration and resolution of conflicts of interest
obligations of capital contribution and any variance of those obligations
provisions for investors who default on their capital obligations and in particular punitive penalties such as the forced sale of their current holdings, interest payments or the loss of certain rights as an investor
financial reporting
transfer and exit provisions.
Subscription booklets
These are completed by the investors to commit to the Fund and will set out their individual capital contributions together with representations and warranties by both the Manager and the investor. The investor will also be required to fill out a questionnaire to confirm their eligibility to invest in the Fund under applicable laws and to provide other information required by the Manager.
Side letters
A side letter is a separate agreement between the Manager and an individual investor. Such an agreement will set out a variation of the standard terms of the Fund.
The reasons for side letters vary: they are frequently used to accommodate a particular investor’s regulatory or tax requirements.
Another reason may be that a particular investor’s contribution allows it to command better terms on which to invest.
The LPA will usually contain a ‘Most Favoured Nation’ clause which prevents more advantageous terms being offered to a single investor (unless for tax or regulatory reasons) without those terms being offered to all investors, or at least, all investors with equal or greater commitments to the Fund.
6. Service providers
Choosing the right partner is crucial for the long-term success of the fund. Some of the key service providers include
Legal Adviser
A fund legal provider may offer a range of services tailored to the specific needs of investment funds, including:
Fund Formation: Assisting in the creation and registration of investment funds, including drafting the necessary legal documents like the fund's prospectus or offering memorandum.
Compliance and Regulatory Matters: Ensuring that the fund complies with all relevant securities laws, regulations, and reporting requirements. This can include helping the fund manager stay up-to-date with changing regulatory environments.
Contractual Agreements: Drafting and reviewing contracts and agreements related to fund investments, such as limited partnership agreements, subscription agreements, and service provider contracts.
Investor Relations: Providing legal support for interactions with investors, including handling inquiries, disputes, and the distribution of fund-related documentation.
Risk Management: Advising on risk management strategies and helping funds navigate legal issues that may arise during their operations.
Corporate Governance: Assisting with governance matters, such as board meetings, voting procedures, and compliance with corporate governance best practices.
Litigation and Dispute Resolution: Representing the fund in legal disputes or litigation, if necessary.
Exit Strategies: Providing legal guidance when it comes to fund liquidation, dissolution, or the sale of fund assets.
Host Fund Manager
A Host Fund Manager or Host AIFM is a person that is responsible for managing your Alternative Investment Fund, either on a permanent basis or until the investment adviser has obtained their own licence with the FCA.
Khepri Fund Management acts as a Host AIFM.
Principal Firm
An Appointed Representative carries on regulated activity under the responsibility of an authorised firm, known as 'the principal'.
In the context of a fund, the investment adviser is often initially an AR of a Principal Firm for the purposes of providing investment advice to the fund manager and for marketing the fund.
The principal is responsible for making sure the AR is fit and proper and complies with relevant rules.
A principal firm must:
have a written agreement with the AR, setting out what business they can do
assess an AR before appointing them to ensure they're fit and proper, financially stable and suitable to carry out business
review information on ARs’ activities, business and senior management regularly
ensure data on ARs is up to date
take reasonable steps to ensure ARs act within the scope of their appointment
provide complaints data and revenue information for ARs on an annual basis
ensure an AR continues to meet the necessary standards
Fund Administrator
A fund administrator is a financial services company or organisation that specialises in the administrative and back-office functions of investment funds. These functions can include a wide range of tasks related to fund operations, record-keeping, reporting, and compliance. Fund administrators play a crucial role in supporting the smooth operation of various types of investment funds, including mutual funds, hedge funds, private equity funds, and more. Their responsibilities often include:
Accounting and Valuation: Calculating the Net Asset Value (NAV) of the fund, which represents the per-share value of the fund's assets. This involves pricing and valuing the fund's investments
Record Keeping: Maintaining accurate records of all fund transactions, including purchases, sales, and redemptions of fund shares
Financial Reporting: Preparing financial statements and reports for the fund's investors and regulatory authorities
Investor Services: Handling subscriptions (investor contributions) and redemptions (investor withdrawals), as well as providing investor account statements and reports
Compliance: Ensuring that the fund complies with regulatory requirements and reporting obligations
Tax Reporting: Handling tax-related matters for the fund and its investors, including providing necessary tax documents
Corporate Actions: Managing corporate actions, such as mergers, acquisitions, and reorganisations, that may affect the fund's holdings
Depositary
A depositary is required for each AIF that is managed by a Full-Scope AIFM. They are responsible for undertaking the following functions:
Cash monitoring: Ensuring that all payments made by, or on behalf of, investors upon the subscription of units or shares of an AIF have been received and that cash accounts have been opened with certain types of reputable institutions (i.e. banks)
Safekeeping – custody assets: A depositary must hold in custody all AIF custodial assets. The depositary must ensure that all AIF custodial assets that can be registered in a financial instruments account are registered in the depositary's books within segregated accounts opened in the name of the AIF, or the AIFM acting on behalf of the AIF, so that they can be clearly identified as belonging to the AIF at all times in accordance with the applicable law
Safekeeping – other assets: They should verify that the AIF, or the AIFM acting on behalf of the AIF, is the owner of the assets based on information or documents provided by the AIF or the AIFM and, where available, on external evidence; and maintain, and keep up to date a record of those assets for which it is satisfied that the AIF, or the AIFM acting on behalf of the AIF, is the owner
Oversight:
ensure that the sale, issue, repurchase, redemption and cancellation of units or shares of the AIF are carried out in accordance with the applicable national law and the instrument constituting the fund;
ensure that the value of the units or shares of the AIF is calculated in accordance with the applicable national law, the instrument constituting the fund and FUND 3.9 (Valuation);
carry out the instructions of the AIFM, unless they conflict with the applicable national law or the instrument constituting the fund;
ensure that in transactions involving the AIF's assets, any consideration is remitted to the AIF within the usual time limits; and
ensure that an AIF's income is applied in accordance with the applicable national law and the instrument constituting the fund.
