Thinking about setting up your own fund? Going out on your own can be daunting, with a wide range of factors to consider. So we have put together practical and commercial considerations for first-time fund managers to help ease the transition to launching your first fund.
Preparation, preparation, preparation
Great things start with a well-thought-out plan. A debut manager should have a clear business plan outlining the steps needed to achieve the fund’s first close and beyond, the operating budget, a clear investment thesis and a well-considered timeline.
Cashflows – the team may need to finance an extended period of operations prior to first close and will need to consider how they finance their GP commitment to the fund. It is important to understand what costs remain with the team and what may be reimbursable by the fund as part of its ‘establishment costs’ provision.
Strategy and investment thesis
The fund’s investment thesis is the key reason why potential investors will back it. The strategy should set out the target industries, types of proposed investments and what makes the fund ‘unique’ (though your lawyers will say you can’t use this word in your marketing!). Investors will want to know whether there will be sufficient investment opportunities available and that there is a strong management team.
Are you forming your management team from a group of individuals leaving an existing group or larger institution? It is important to consider the terms on which you and other potential team members are leaving and whether any restrictive covenants apply. Common restrictions include notice periods and gardening leave – it is a best practice to service any contractually required notice period ahead of setting out on your own – and non-compete provisions. Restrictions on the type of fund you can set up are usually determined by strategy and limited to a certain period. You need to be on top of these before making the leap.
Good and bad leaver considerations
A good leaver is typically one who makes a consensual departure from their existing institution and will retain certain rights in respect of carry and/or deferred bonuses. When thinking about your new team, if a solicited colleague stands to lose bonuses or carry entitlements as a result of a bad-leaver resignation, this will need to be handled with sensitivity.
Team and track record
The team should be able to demonstrate the requisite skills, experience and relationships to successfully execute the investment thesis and be an appropriate size commensurate to the target fund size. If you are considering using track-record information from a previous employer in your new fund’s marketing materials, it is a best practice to request permission. You may need access to records and future data (such as exit amounts) from your prior employer, so a good working relationship is preferred. You may also end up co-investing with them.
Track-record considerations may come into play when contemplating your structure. Many new fund managers will make a series of standalone investments prior to raising a pooled fund. This provides a smaller group of investors with the flexibility to choose whether to participate in each investment and to get to know your group as a management team.
Structuring the fund and management group
Typically, a limited partnership will be used as the main fund vehicle. This type of vehicle can accommodate a wide range of interests, allow for investors’ limited liability and tax efficiency, and have a well-established regulatory infrastructure. The fund’s structure and jurisdiction will significantly impact how tax accrues within the fund and how much and where it is paid. Regulation will also be a key factor, often determining where and to whom the fund can be marketed.
In the UK many of the activities of fund managers are regulated and will require authorisation from the Financial Conduct Authority. Authorisation can take time and you may wish to consider using a regulatory umbrella. This is where an FCA-authorised entity extends its regulatory provisions to an unauthorised management team and supervises the fund’s investment and marketing activities – for a fee.
Key fund documentation and terms
Which legal documents are required will depend on the fund structure, but will typically include the limited partnership agreement for the fund vehicle, subscription documents for investors to subscribe to the fund, a legal opinion, management and advisory agreements, side letters for investors requesting additional rights, administration agreements and documents pertaining to the carried interest partner (including good- and bad-leaver provisions). Don’t worry, the fund’s lawyers will take the responsibility of drafting these documents.
In most jurisdictions there are strict regulatory requirements in respect of any offer of investment opportunities to investors. Jurisdiction-specific advice should always be sought before commencing the marketing process.
New fund managers may wish to focus their marketing efforts on finding a ‘cornerstone’ investor. A great cornerstone investor will help establish momentum for other investors and may provide initial funding sources for deals. Cornerstone investors will often receive special rights in respect of fees, carried interest rates and co-investment rights.
Which external advisors will I really need?
External advisors needed to bring the fund to life include:
(a) Placement agents, who advise on the marketability of the fund
(b) Fund accountants, who advise on fund domicile and provide audit services during the life of the fund
(c) Lawyers, who will advise on structure, jurisdiction and certain regulatory issues. They will also draft the legal documents, lead negotiations with investors and manage the first closing of the fund
(d) A fund administrator, who provides operational support to the fund and may be required under the Alternative Investment Fund Managers Directive (AIFMD) if the safe-keeping and asset-management functions are required to be separated
(e) A bank, to provide accounts to receive commitments and ensure the flow of proceeds through the structure
(f) Compliance consultants, who advise on acquiring the necessary regulatory permissions and the development of compliance programmes
(g) Insurance providers, as insurance is required for the life of the fund, in particular directors’ and officers’ liability insurance and professional indemnity insurance.
How long to first close?
New fund managers are justifiably keen to get to the ribbon-cutting moment of the first close. From appointment of the fund advisors through to first close can be completed in as little as four months; however, this period can be extended by regulatory approvals, the existence (or not) of a cornerstone investor and negotiation of fund terms with investors. Choosing the right fund advisors is a key consideration in ensuring a smooth and successful first fund’s first closing.
Robert Mailer, Oliver Rochman are partners at Morgan, Lewis & Bockius while Funke Omisore is an Associate. All are London based legal professionals.