Apr. 16, 2019

A Guide to Pledge Funds: Key Investment Management Agreement Provisions (Part Two of Three)

Years of widespread use have produced a clearly established market for the terms and structures of traditional blind-pool private equity (PE) funds. Pledge funds, on the other hand, are hybrid structures with unique features novel to both investors and PE sponsors. For those individuals that properly familiarize themselves with its features, the pledge fund structure can provide an enticing combination of benefits to investors (i.e., the soft commitment of the opt-in mechanics) and sponsors (i.e., faster carried interest payments that do not net losing investments against winning ones). This three-part series details some material considerations for sponsors deciding whether to adopt the pledge fund structure, including issues that arise when administering a fund. This second article analyzes key features to address in the investment management agreement when forming a pledge fund. The first article described benefits of the pledge fund structure that sponsors often find compelling, including ways the fee structure can yield enhanced carried interest to sponsors. The third article will critique the deal uncertainty issues sponsors can confront in an auction process, as well as ways to structure the fund’s investment vehicle. For more on alternative PE fund structures, see our two-part series on selling minority stakes in PE firms: “Recent Trends and Structural Considerations” (Apr. 2, 2019); and “The Appeal of Stable and Early Income Streams” (Apr. 9, 2019).

How PE Firms Can Mitigate Portfolio Company Cybersecurity Risk

Cybersecurity risks are growing daily as bad actors become better educated and cyber crime is a regular news occurrence. There is no quick fix to protect against increasingly complex cybersecurity risks, as companies of all sizes must find ways to strengthen their cyber practices. This involves improving their physical information technology infrastructure, their company procedures and their users’ human action. Private equity (PE) firms should understand that they have historically operated differently than the companies in which they invest. It remains up to PE firms to protect their investors and themselves by taking additional steps to fortify their portfolio companies. In a guest article, Jason Elmer, managing partner at Drawbridge Partners, explains the best first steps for a PE sponsor to proactively work with its portfolio companies to create a cybersecurity program that includes preparation, response and recovery steps. See “SEC Confirms Cyber Disclosure Expectations in New Guidance” (Apr. 26, 2018); and “SEC Tackles Internal Cybersecurity Issues While Sharpening Cybersecurity Enforcement Focus” (Oct. 5, 2017).

Three Types of SEC Examinations of Fund Managers and What Disclosures to Investors They Trigger (Part Two of Three)

One of the most stressful periods for any fund manager is when the SEC approaches it, sometimes without notice, to conduct an examination of its policies and practices. While navigating that encounter unscathed is the first priority for every fund manager, it is important to also be mindful of whether and how that examination needs to be disclosed to current or prospective investors. In that context, it is important for fund managers to properly consider all the contractual, statutory, legal and interpersonal factors that weigh on that decision. See our two-part series “Current SEC Examination Practices and Issues”: Part One (Dec. 20, 2018); and Part Two (Jan. 10, 2019). This second article in a three-part series outlines the differences between sweep, routine and cause examinations by the SEC, as well as when they necessitate disclosure to investors. The first article detailed five sources of a fund manager’s potential obligation to disclose the existence or results of an SEC examination. The third article will set forth various considerations that bear on whether a fund manager must disclose a deficiency letter from the SEC, as well general tips for communicating deficiencies to investors. For more on communicating with investors, see our two-part series “How Are Your Peers Responding to the Most Intrusive Requests From Private Fund Investors?”: Part One (Mar. 26, 2019); and Part Two (Apr. 2, 2019).

Investors Demand Variations to PE Management Fees and Distribution Waterfalls (Part One of Two)

Approximately ten years ago, Paul Weiss began an informal survey of the terms that middle-market private equity (PE) managers were agreeing to with investors. Covering approximately three dozen major recent PE fund launches, the survey provides valuable insight into the concerns of sponsors and the evolution of their push-pull relationship with investors over fund terms. The survey results were presented in a program hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA), and featuring Paul Weiss partners Marco V. Masotti, Matthew B. Goldstein, Conrad van Loggerenberg and Lindsey L. Wiersma. This first article in a two-part series generally describes the state of play with respect to the basic economic terms of PE funds – management fees and distribution waterfalls. The second article will explore the frothy PE fundraising environment, as well as trends in fund governance terms and the general PE marketplace. For more on issues pertinent to PE sponsors, see our two-part series on SEC examination topic trends: “Outside Business Activity Disclosure, Subscription Credit Facility Use and Cybersecurity Policies” (Mar. 19, 2019); and “Minority Stake Transactions, Co‑Invest Conflicts and Other Concerns” (Mar. 26, 2019). For coverage of a prior program hosted by MLA, see our two-part series offering perspectives on internal compensation arrangements for investment professionals: “Carried Interest and Deferred Compensation” (Mar. 15, 2018); and “Hedge Fund Compensation and Non-Competes” (Mar. 22, 2018).

KPMG Reports on AIFMD’s Efficacy Five Years After Implementation

It has been five years since the E.U. introduced the Alternative Investment Fund Managers Directive (AIFMD) to address risks in the global financial system by harmonizing requirements, extending regulations and enabling oversight of alternative investment fund managers at the E.U. level. While the industry was initially wary of its potential impact, AIFMD has been widely adopted and implemented more seamlessly than anticipated. See “AIFMD Is Easier for Non-E.U. Fund Managers Than Commonly Anticipated” (Oct. 22, 2015). KPMG was contracted by the European Commission to carry out a general survey and evidence-based study to evaluate whether AIFMD’s objectives have been met. KPMG’s report provides an in-depth assessment of AIFMD’s success at achieving its objectives, while also identifying areas of weakness where adjustments may be appropriate. The report is a detailed resource that will likely underpin decisions about the future of AIFMD. This article summarizes the key findings in the report. For a previous KPMG survey on compliance costs related to AIFMD, see “KPMG/AIMA/MFA Survey Quantifies the Impact of the AIFMD, FATCA, Form PF and Adviser/CPO Registration on Fund Manager Compliance Budgets” (Nov. 8, 2013).

PE Lawyer Alex Kaufman Joins Paul Hastings in Palo Alto

Paul Hastings announced that Alex Kaufman has joined the firm as partner in the private equity (PE) group. Based in Palo Alto, Kaufman advises PE funds and standalone technology companies on mergers and acquisitions, including leveraged buyouts, growth equity investments and divestitures, with an emphasis on the software and technology sectors. For commentary from another Paul Hastings partner, see “How Fund Managers Can Address End-of-Life Issues in Closed-End Funds” (Mar. 19, 2019).