Management Companies and Special Purpose Vehicles

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Management Company, Typical Fund Structures and Special

Purpose Vehicles Session

Hedge Funds and Alternative Investments Conference

Karen Kerby, Untracht EarlyChuck Beel, KPMGJoseph Fisher, Deloitte & ToucheTom Gengler, GoldenTree Asset ManagementJuly 30, 2008

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ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY GOLDTREE ASSET MANAGER LP, DELOITTE & TOUCHE, UNTRACHT EARLY AND KPMG GOLDTREE ASSET MANAGER LP, DELOITTE & TOUCHE, UNTRACHT EARLY AND KPMG TO BE USED, AND CANNOT BE USED, BY ANY OTHER PERSON OR ENTITY FOR THE TO BE USED, AND CANNOT BE USED, BY ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.ADDRESSED HEREIN.

The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultation with your tax adviser.

DATED MATERIALDATED MATERIAL

THE INFORMATION CONTAINED IN THESE COURSE MATERIALS IS CURRENT AS OF THE THE INFORMATION CONTAINED IN THESE COURSE MATERIALS IS CURRENT AS OF THE DATE PRODUCED. THE MATERIALS HAVE NOT BEEN AND WILL NOT BE UPDATED TO DATE PRODUCED. THE MATERIALS HAVE NOT BEEN AND WILL NOT BE UPDATED TO INCORPORATE ANY TECHNICAL CHANGES TO THE CONTENT SINCE THE PRODUCTION INCORPORATE ANY TECHNICAL CHANGES TO THE CONTENT SINCE THE PRODUCTION DATE, WHICH IS INDICATED AT THE BOTTOM OF EACH PAGE. YOU ARE RESPONSIBLE DATE, WHICH IS INDICATED AT THE BOTTOM OF EACH PAGE. YOU ARE RESPONSIBLE FOR VERIFYING WHETHER OR NOT THERE HAVE BEEN ANY TECHNICAL CHANGES FOR VERIFYING WHETHER OR NOT THERE HAVE BEEN ANY TECHNICAL CHANGES SINCE THE PRODUCTION DATESINCE THE PRODUCTION DATE

Management Companies

Joseph Fisher, Audit Partner, Deloitte & Touche LLP

July 2008

4Copyright © 2006 Deloitte Development LLC. All rights reserved.

Agenda

Definition Management company characteristics Registration Structures (LLC/LP/Corp) Basis of accounting Financial statements / example Accounting issues


What is a Management Company ?

Management companies provide investment advice, research services and certain administrative services to hedge funds.

Note: Many funds have a separate management company and general partner entity.

Funds with international offices usually have multiple management companies – at least one in each country (see chart).


Management company characteristics

Management fee income Incentive / performance fees Fixed assets / leasehold improvements Payroll expense / compensation Leases Deferred taxes Taxes – sales and use, Unincorporated

Business Tax (UBT), commercial rent Pay expenses on behalf of funds


Registration

Generally anyone “in the business” of providing investment advice must register as an “investment adviser” with the SEC. However, there are exemptions for “private” investment advisers who do not advertise or hold themselves out to the public as an investment adviser and do not have 15 or more clients – each hedge fund is considered a client, not each investor in the fund.


POSSIBLE MANAGEMENT COMPANY STRUCTURE WHEN THERE ARE OFFICES IN US & UK

Individual Partners

Individual Partners

GPEntity

Individual Partners

US Management Company

UK Corp(Disregarded for

US Purposes)

UKPartnership


Basis of accounting

Management company’s financial statements may be prepared under :

Generally accepted accounting principles in the United States

International Financial Reporting Standards Other comprehensive basis of accounting

Tax basis Cash basis Modified-cash basis


Illustrative financial statementsStatement of Financial Condition ASSETS

CURRENT ASSETS: Cash xxxx Accounts receivable xxxx Other receivables xxxx

Total current assets xxxxx

NON-CURRENT ASSETS: Fixed assets (Net of accumulated depreciation of $xxx) xxxx Security deposit xxxx Deferred tax asset xxxx

Total non-current assets xxxxx

TOTAL xxxxx

LIABILITIES AND SHAREHOLDER’S EQUITY

CURRENT LIABILITIES: Accrued compensation and benefits xxxx Accounts payable and other accrued expenses xxxx Due to affiliates xxxx

Total current liabilities xxxxx

NON-CURRENT LIABILITIES: Deferred compensation payable xxxx Retention awards payable xxxx Deferred rent liability xxxx

Total non-current liabilities xxxxx

Total liabilities xxxxx

SHAREHOLDER’S EQUITY: Common stock (1,000 shares at $xx per share) authorized, issued and outstanding xxxx Retained earnings xxxx

Total shareholder’s equity xxxxx

TOTAL xxxxx


Illustrative financial statementsStatement of Operations

REVENUES: Performance fee xxxx Management fee xxxx Consulting fee xxxx

Total revenues xxxxx

EXPENSES: Compensation and benefits xxxx Office rent and repairs xxxx Professional fees xxxx Travel and entertainment xxxx Market data research xxxx Communications xxxx Dues and subscriptions xxxx Utilities xxxx Office supplies xxxx Depreciation xxxx Other xxxx

Total expenses xxxxx

NET INCOME BEFORE INCOME TAXES xxxxx

INCOME TAX EXPENSE: Current xxxx Deferred xxxx

Total taxes xxxxx

NET INCOME AFTER TAXES xxxxx


Illustrative financial statements

Statement of Changes in Shareholders’ Equity

Retained Shareholder'sShares Amount Earnings/ Equity

(Deficit)

SHAREHOLDER'S EQUITY — April 1, 2006 xxx xxxxx xxxx xxxx

Net income after taxes - - xxxx xxxx

SHAREHOLDER'S EQUITY — March 31, 2007 xxx xxxxx xxxx xxxx

Common Stock


Illustrative financial statementsStatement of Cash Flows CASH FLOWS FROM OPERATING ACTIVITIES: Net income after taxes xxxx Adjustments to reconcile net income to net cash used in operating activities: Depreciation xxxx Deferred rent expense xxxx Deferred tax expense xxxx Changes in operating assets and liabilities: xxxx Increase in accounts receivable xxxx Increase in income taxes receivable xxxx Decrease in other receivables xxxx Increase in prepaid expenses xxxx Decrease in accrued compensation and benefits xxxx Decrease in accounts payable and other accrued expenses xxxx Increase in due to affiliates xxxx Decrease in income taxes payable xxxx Increase in deferred compensation payable xxxx Increase in retention awards payable xxxx

Net cash used in operating activities xxxxx

CASH FLOWS FROM INVESTING ACTIVITIES

Purchases of fixed assets xxxx

Net cash used in investing activities xxxxx

NET DECREASE IN CASH xxxx

CASH: Beginning of year xxxx

End of year xxxx

SUPPLEMENTAL CASH FLOW INFORMATION: Income taxes paid, net xxxx


Accounting Issues

Consolidation - ARB 51/EITF 04-05 FIN 46 Goodwill and impairment analysis Valuation Deferred compensation arrangements Deferred taxes Deferred rent (FTB 85-3) Transfer pricing (between countries)

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THE “SHAPES” OF HEDGE FUNDS

Chuck Beel, Tax Partner, KPMG LLP

Tom Gengler, CPA, MBA, Tax Director, GoldenTree Asset Management, LP

July 2008

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Agenda

I. Typical Fund Structures – Pros and Cons

1. Side by Side

2. Traditional Mini Master

3. Mini Master

4. Investor Fund

5. Pros and Cons of Each Structure

II. Special Purpose Vehicles – Pros and Cons

1. Aggregating Entity

2. Blockers for One Company Coupled with an Aggregating Entity

3. Blockers for More Than One Company Includes a Chain of Blockers (Foreign & Domestic) Coupled with an Aggregating Entity

The information above, are the personal views of Tom Gengler and Chuck Beel and not of any other entity

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KEY

Separate Investors, Including Individuals, US Corporations, Foreign Corporations, and Non-Profits

Corporation(s)

Partnership

Hybrid Entities (Partnership (US); Corp (Non-US))

Note: Colors of shapes may vary, but the meaning of the shapes themselves remains constant. These slides are available to view/download in color on the NYSSCPA website.

Disregarded Entity

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U.S. Taxable Investors

U.S. Tax Exemptand Non-U.S. Investors

Partners, Ltd.(Cayman Corp.)

Management Fee

Managem

ent Fee

Incentive Allocation

Incentive Fee

Typical Fund Structure 1:

SIDE BY SIDE

HYPO Fund

Management LP(Investment Manager)

GPLLC

(General Partner)

L.P.(Delaware

Partnership)

Investments Investments

The information above are the personal views of Tom Gengler and Chuck Beel and not of any other entity

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Purpose: Separate Funds are created to accommodate different investor needs by allowing multiple entry points.

Pros: U.S. tax exempt partners are able to invest in an entity that will block unrelated

business taxable income; Non U.S. Investors can invest in a non U.S. entity; The Delaware Limited Partnership and the Cayman Corp can invest side-by-side; The General Partner/Investment Manager can earn a promote/incentive fee from

all investors using a similar promote structure; The General Partner will earn the same character of income earned by the

Delaware Partnership; Foreign tax credits (if available) will pass through to the U.S. Taxable Investors; The General Partner’s earnings and investment management fees are in

separate entities; The Sponsor has a structure to control both funds.

Cons: The Investment Manager will receive ordinary income as opposed to capital gain

income due to the investment management fee being ordinary income in nature; Additional cost to administer – shareholder agreement, partnership agreement,

separate bank accounts, additional audits; Both Funds must invest side-by-side in all deals, creating additional burdens for

joint venture partners.


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Management Fee

Management Fee



TRADITIONAL MASTER FUND

HYPO Fund

Incentive Fee

GPLLC

(General Partner)


L.P.(Delaware

Partnership)

HYPO Master Fund, Ltd.(Cayman Corp., Treated as a Partnership

For U.S. Tax Purposes)


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Purpose: Same as Structure 1 but separate funds can use one investment vehicle as a focal point to make investments with third parties.

Pros: Generally, same as Structure 1; The two funds can use one investment vehicle to make all investments.

This may make it easier for third party joint venture partners and provide some anonymity as the General Partner will not need to explain the parallel fund structure to joint venture partners.

Cons: Generally, same as Structure 1; The creation of HYPO Master Fund, Ltd. creates an extra level of

accounting, compliance and potential for a financial statement audit; The U.S. investors investing in the Delaware LP can potentially lose tax

treaty benefits from foreign countries.


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MINI MASTER

HYPO Fund




Cayman Partnership

Management Fee

Management Fee



GPLLC

(General Partner)


L.P.(Delaware

Partnership)

HYPO Master Fund, Ltd.(Cayman Corp., Treated as

a Partnership for US Tax Purposes)


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Purpose: Same as Structures 1 and 2 except the General Partner now earns a promote from both parallel funds. This allows the GP to earn capital gain income from U.S. Tax Exempt and Non U.S. Investors

Pros: Generally, same as Structure 2, except; The GP can now earn capital gain income from investments made

indirectly by the Cayman Partnership through the HYPO Master Fund Ltd. If structured properly, the economics to all partners should be the same as in Structure 2.

Cons: Generally, same as Structure 2; except; The creation of the Cayman Partnership creates an extra level of

accounting, compliance and a potential financial statement audit; There is now a need to have two agreements in relation to the U.S. Tax

Exempt and Non-U.S. Investors group, a partnership agreement for the Cayman Partnership and a management agreement for the Cayman Corp.


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INVESTOR FUND

HYPO Fund



HYPO Master Fund, Ltd.(Cayman Corp.)


Cayman Partnership

Management Fee



Management Fee

GPLLC

(General Partner)


L.P.(Delaware

Partnership)


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Purpose: Same as Structures 1, 2 and 3 except the Investment Manager now earns a management fee from one entity, HYPO Master Fund LP, In addition, HYPO Master Fund, Ltd. is classified as a corporation for U.S. tax purposes and will be treated as a passive foreign investment company (“PFIC”).

Pros: The Investment Manager can now earn its fee directly from one entity (HYPO Master Fund

LP) as opposed to two entities (Delaware Limited Partnership and the Cayman Partnership); There is one management contract instead of two as required by the other structures; Assuming the Delaware Limited Partnership makes a QEF election, U.S. Taxable Investors

investing indirectly in a PFIC will receive allocations of ordinary income and capital gain income;

Costs that are normally classified as expenses for the production of income (subject to the 2% floor limitation) are netted with income at the PFIC level;

PFIC reporting is generally easier to comply with then partnership reporting; The Cayman Corp will block UBTI income for the U.S. Tax Exempt Investors.

Cons: If the Investment Manager wants to charge varying management fees based on committed

capital, this structure becomes cumbersome as usually these expenses are specially allocated to the investors who bear such costs. In this case, special records will need to be kept to track this allocation;

Foreign tax credits (if available) will not pass through to the U.S. Taxable Investors; Unlike a partnership, losses from the PFIC will not pass through to U.S. Taxable Investors.


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Member 1 2 3 TOTAL

Equity 9,000 6,000 3,000 18,000

Debt Total 0 0 0 0

Total 9,000 6,000 3,000 18,000

Special Purpose Vehicle 1:

AGGREGATING ENTITY

Aggregating Entity

Master 1

Master 2 Master 3


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Special Purpose Vehicle 1

Purpose: Allows several Master Funds to use one aggregating vehicle to act as a focal point for making investments.

Points to Consider: Generally the aggregating vehicle dose not incur debt. The aggregating vehicle will require a separate partnership or operating

agreement, will most likely require a financial statement audit and will require a cash management function to collect and distribute cash.

The sponsor will generally have control of the aggregating vehicle. The aggregating vehicle’s operating agreement can have contain provisions to

specially allocate cash and income among the Master Funds.


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OffshoreFeeder (1)

DomesticBlocker

I

Debt: 3,000

Equity: 1,500

D to E: 2 - 1

Total: 4,500


BLOCKER FOR ONE COMPANY COUPLED WITH AN AGGREGATING ENTITY

Aggregate Entity

M1

Domestic Blocker: 4,500

Offshore Feeder: 4,500

Total: 9,000

M2 6,000

M3 3,000

Total: 18,000

Debt 3,000

Equity 1,500

Total 4,500

BlockerAggregating Entity

OnshoreFeeder (1)

Master 2

Master 3

Potential Investments in U.S. Real Estate

Note: Master 1 invests indirectly through its feeder.


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Special Purpose Vehicle 2 Purpose: Allows several Master Funds to use one aggregating vehicle to act as a focal point for making investments and allows non U.S. investors to avoid U.S. effectively connected income.

Points to Consider: If the aggregating vehicle were to invest in U.S. real estate, it could have U.S.

effectively income. This could result in the non U.S. investors being subject to U.S. federal and state income taxes and filing requirements.

By inserting a U.S. blocker corporation, the U.S. blocker corporation becomes subject to U.S. federal and state income taxes as well as filing requirements.

U.S. blocker corporations generally involve double taxation, once at the entity level and again when dividends are distributed.

The sponsor of Offshore Feeder (1) may have a harder time earning its promote if the promote calculation is based on after tax cash.

There are techniques that can be used to reduce U.S. federal and state income taxes. One such technique is the use of intercompany debt when capitalizing the U.S. offshore blocker. However, care must be taken to avoid the interest stripping and Applicable High Yield Discount Obligation rules.


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Foreign Blocker

Offshore1

Offshore2

Offshore3

DomesticBlocker

Debt: 0

Equity: 3,000

Debt: 6,000

Equity: 3,000

Total: 9,000

D to E: 2 - 1

Debt: 0

Equity: 1,500 (1/2)

Debt: 0

Equity: 1000 (1/3)

Debt: 0

Equity: 500 (1/6)


ONE CHAIN OF BLOCKING (FOREIGN & DOMESTIC) FOR MULTIPLE COMPANIES &

AGGREGATING ENTITY

Aggregate Entity

Domestic Blocker: 9,000

Onshore 1: 4,500

Onshore 2: 3,000

Onshore 3: 1,500

Total: 18,000

Debt Equity Total

Offshore 1

3,000 1,500 4,500

Offshore 2

2,000 1,000 3,000

Offshore 3

1,000 500 1,500

Total 6,000 3,000 9,000

Blocker Aggregating Entity

Onshore 1Onshore 2

Onshore 3

Potential Investments in U.S. Real Estate

Note: Masters 1,2 and 3 invest indirectly through their feeders.


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Special Purpose Vehicle 3 Purpose: Allows several Master Funds to use one aggregating vehicle to act as a focal point for making investments and allows non U.S. investors to avoid U.S. effectively connected income. In addition, the introduction of a foreign blocker allows for transfers.

Points to Consider: Same points as for Special Purpose Vehicle 2 . If a U.S. corporation is a U.S. real property holding corporation (generally if U.S.

real property interests held equals or exceeds 50% of the FMV of real property and assets used in a trade or business) , the sale of such corporation could trigger U.S. taxable income.

However, the sale of a foreign blocker that holds a U.S. real property holding corporation generally will not result in U.S. taxation.

Potential buyers may ask for a discount on the purchase price due to the ultimate U.S. federal and state income taxes that would be payable on sale of U.S. real estate.


Management Companies and Special Purpose Vehicles

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