Introduction
The constant change in regulation globally and the increasing demand from investors has resulted in some key rethinking in private equity fund terms and structures for emerging markets. Fund Managers currently face the dilemma of creating the right structure to meet the ever-evolving needs of investors. They are thus constantly looking for the best structure which can meet the requirements of investors while also delivering on the chosen investment strategy.
In fact, groups of investors, depending on their respective jurisdictions, may have specific tax and/or regulatory requirements that cannot be accommodated through a traditional single main Fund. Many Fund Managers in such circ*mstances prefer to opt for the Master/Feeder structure.
The master/feeder structure brings in various advantages in terms of reduced trading and administrative costs and burden. More details on the Master/Feeder structure are provided at:http://focus.abaxservices.com/2014/09/30/master-feeder-fund-structure/#more-1117
Advantages of the Master/Feeder structure
The Master/Feeder structure presents a number of advantages including the following:
- The structure provides investors with the choice of investing in a tax-opaque structure catering for investors who would either prefer a partnership feeder or a corporate feeder. For instance, in the example above, the Domestic Fund can be created as a partnership while the Offshore Fund is created as a Company, with both Feeders investing into the Master Fund being also set up as Company.
- Additional feeder funds can be established for other purposes (such as for individual investors or to cater for specific regulatory requirements) while still maintaining a single trading entity.
Administrative costs associated with establishing and operating a Master/Feeder structure – with a Master/Feeder structure, the administrator will generally base its fees upon the combined assets in the Master Fund. In addition, there will be incremental costs associated with the annual audit, additional directors’ fees and additional fees required to create and maintain the existence of the entity serving as Master. For a large fund, these incremental costs will be immaterial. However, for a small start-up, the incremental costs can be burdensome.
Operational complexity in dealing with excused investors – dealing with Excused investors via a Master/Feeder structure can be difficult as the investments tend to be made by the Master Fund while the investors are at the level of the Feeder Fund and all allocations are made by the Master Fund and are passed on to the Feeder Fund through the net asset value allocated to the relevant feeder by the Master Fund.
The Parallel Fund as an alternative to the Master/Feeder structure
An alternative to the Master/Feeder structure is the Parallel Fund structure which has the benefit of being more cost effective (creation of two Parallel Funds as opposed to 3 entities in the Master/Feeder structure) and with the ability to deal effectively with excused investors. For instance a parallel Fund can be set up to accommodate likeminded excused investors (shariah compliant investors for example).
Parallel Funds are different from Feeder Funds. While Feeder Funds “feed” into the main “Master Fund” which carries out all the investing activities, Parallel Funds invest alongside each other in the same portfolio investments.
Parallel investment vehicles are generally formed to invest in and divest from the same investments at the same time as the main fund. They are formed under substantially the same terms as the main fund, with specific differences to the extent required to accommodate the regulatory, tax, or investment requirements applicable to the investors in the Parallel Funds.
The Parallel Fund include features that are common in traditional fund structures and, therefore, amongst other things, it (i) is managed by the same Fund Manager; (ii) offers interests with the same or substantially the same economic terms and voting rights; (iii) invests in almost the same portfolio investments, on a pro rata basis; (iv) shares the same investment process and governance structures (including the sharing of an investor representative body); and (v) shares liabilities, including contribution for investor defaults, indemnification, fund expenses, credit facilities and carried interest.
By using a parallel structure, excused investors, depending on their specific requirements, would be segregated from the fund’s other investors. Similarly, all income, expenses, gains and losses will be allocated separately to the main fund and the parallel fund, subject to their entitlement. For instance, private equity managers commonly encounter the difficult situation when pooling Shariah non-compliant investors and Shariah compliant investors (“Pooling”) in the same fund due to the various restrictions for investments and utilisation of debt instruments under the Shariah Law. Fund Managers have attempted to reconcile this inherent Pooling dilemma by establishing a Shariah-compliant parallel vehicle which invests in parallel with the main fund. Shariah-compliant investors will be excused from participating in a Shariah non-compliant investment. Such an investment will be solely done by the main fund and accordingly any income/gain derived from or any expense/loss incurred for this investment will be allocated exclusively to the main fund. Dealings are thus facilitated, as compared to the Master/Feeder structure.
As illustrated above, for single country funds that are investing capital on behalf of both international and domestic investors, and wherelocal investors are subject to limitations on “round-tripping” via a third country jurisdiction, the use of two parallel vehicles are typically appropriate. The offshore parallel vehicle will be used as the pooling vehicle for the international investors ensuring the most optimum structure, whilst the onshore parallel structure will accommodate the domestic investors.
In view of the above, the type of structure that provides optimisation, for both the Fund Manager and for the investors, needs to be thought through carefully.
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