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Q&A on innovation in private equity structuring – Commentary

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What structuring trends can be observed in the private equity market?
How and why are the private equity and hedge fund industries blending?
What other early-stage trends can be observed?
What about independence and governance trends?

This article is a Q&A on different structuring models for private equity funds. It looks at how private equity firms are adapting their strategies and planning for the future.

What structuring trends can be observed in the private equity market?

Historically, fund structure has been something that managers have not wanted to use to showcase innovation or uniqueness. There is a tried and tested formula as to how to structure private equity funds, and while managers want to show how their strategy is different or how they have developed a proprietary deal flow, the fund’s structure is not typically something managers want to differentiate. In fact, an unusual structure could unnecessarily prolong investor due diligence. Investors are very familiar with the exempted limited partnership for Cayman private equity funds, so why reinvent the wheel and introduce the need to explain the differences, for example, between a share, a limited partner (LP) interest and a unit in a unit trust?

However, over the past few years, more innovative structuring has emerged, which is, in no small part, connected to the blurring of the once clear distinction between hedge funds and private equity funds, and those two previously quite separate industries.

How and why are the private equity and hedge fund industries blending?

This is a trend that has been driven both by managers and investors; hedge fund managers have been looking to more illiquid asset classes for alpha generation and investors have been willing, or even eager, to lock up capital to get better returns.

The result is that some of the structuring tools used in one industry are now being used in the other. For example, master-feeder structures (originally a hedge fund construct) are now being used for some private equity structures. Similarly, there is increasing popularity of the use of side letters in hedge funds (originally used more in private funds). There has been an increase in the use of platforms to create maximum flexibility around strategies and portfolios and even to afford investor opt-in or opt-out mechanics. This is more typically through the use of Cayman segregated portfolio companies, but recently there has been an uptick in using partnerships with separate special purpose vehicles underneath them to house different investment opportunities.

Perhaps the biggest convergence of all is the use of “hybrid” vehicles. These can be very bespoke and allow some creativity in the structuring; they usually resemble both a closed-ended vehicle and an open-ended vehicle.

What other early-stage trends can be observed?

Other trends in structuring are also being driven by regulation. For example, some larger managers are using Luxembourg parallel funds, alongside their Cayman funds, to raise capital in Europe. These parallel funds typically invest and divest at the same time as each other in a common portfolio of assets. Sponsors like the ability that these structures provide to customise fund offerings for large investors.

There also seems to be a shift in terms of what both general partners (GPs) and LPs are looking for in a GP-LP relationship. In many instances, it is not just cash that LPs are looking to (or are able to) contribute. Broader and more involved relationships are being sought and the negotiation of co-investment rights will often consider this wider GP-LP relationship (eg, LPs may offer and provide valuable ESG-related support to the GP).

What about independence and governance trends?

This ties into the convergence of the private equity and the hedge fund industries. Hedge fund investors have for a long time expected to see independence on the board of the funds in which they invest, but this has not been a requirement in private equity funds. As more hedge investors move to investing in closed ended funds, there has been a gradual increase in requests for independent representation in private fund governance; this can be via a management committee baked into the limited partnership agreement or through independent managers or directors at the GP level.

As private funds have become regulated funds in Cayman, with new and evolving Cayman Islands Monetary Authority rules – as well as other regulatory regimes such as anti-money laundering, economic substance, and the US Foreign Account Tax Compliance Act or the Common Reporting Standard – it can be useful to have a director or manager on the ground in Cayman to help oversee compliance, although this is not a statutory requirement.

For further information on this topic please contact Joanne Huckle at Ogier by telephone (+1 345 949 9876) or email ([email protected]). The Ogier website can be accessed at www.ogier.com.

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