Private Equity Fund Structure - Best Practices

June 24th, 2014

Private Equity – OverviewPrivate Equity investors raise capital from limited partners, and the investment professionals (who serve as the General Partner) deploy that capital by investing in private investments into (typically) private companies

Private Equity generally encompasses the following types of investment strategies:

Buyouts Growth Capital Restructuring Special Situations

Over the last dozen years, Private Equity has greatly outperformed both Venture Capital and Public Markets (stock market) investing

Less volatile (not looking at daily market fluctuations) Actively managed Higher historical returns

Private Equity Investing does have some drawbacks: Investments in private equity are not immediately liquid Ability to invest through retirement accounts mitigates this drawback Once you commit, you are committed

There are some hallmarks of good Private Equity firms: Alignment of interests Experienced General Partners who know the market Reasonable fee structure A strategy that is differentiated and makes sense

What It Is

Types

Benefits

Drawbacks

What To Look For

Private Equity Fund Structure - Best Practices

Strong General Partner

• Personal Characteristics• Honesty

• Integrity

• Transparency

• Strong communication skills

• Experience

• Willingness to put Investors’ interests before the GP’s interests• Complementary skill sets among General Partner team• Experience working together as a team• Operational experience and management expertise• Ability to generate proprietary deal flow• Strong advisory board• Portfolio company references• Limited partner references

Track Record

• Prior track record does not insure continued and future success

• Demonstrated performance over time

• Top quartile performance of prior funds

• Ability to manage through difficult economic periods or portfolio company performance

• Board seat(s) at the portfolio companies

• Participation in audit, compensation, and executive committees

• Successful exits of prior portfolio companies

Best Practices

• LP Governance Committee• Quarterly and annual reporting• Annual audit• Mark-to-market valuation of portfolio• Key-man life insurance on GP principals• Professional advisors (experienced attorneys and accountants)• Advisors with industry related subject matter expertise• Disciplined and consistent investment thesis• Formal due diligence process• ILPA Guidelines• GP consideration of Environmental, Social and Governance

issues• United Nations Global Compact• United Nations Principles for Responsible Investment (PRI)• Private Equity Growth Capital Council’s Guidelines for Responsible

Investment

Clear Investment Objective and Thesis• Type of target portfolio companies (stage)• Type of investment security preferred• Range of investment size• Anticipated holding period• Sector specific vs. geographic focus• Approach to generating returns• Size of investment• Use of co-investor syndicates• Likely or preferred exit strategies• 100 Day Plan• Annual Operating Plan

Patience

• Investments are illiquid – limited cash flow over initial years – a “J” curve return model

• Financial commitment extends over a period of years

• Penalties for failing to make capital calls

• Partnership interests are not readily transferable

•Management influence limited

Expected LP Agreement Terms• Minimum investment amount• LP minimum annual preferred return• LP co-investment opportunities• Management Fee - 1.0% - 2.5% of committed capital (reduced

over time)• GP Carried Interest – 20%• Vesting of GP carry over 5+ years• GP capital commitment >1% of total equity• GP capital commitment made in hard dollars i.e. cash• Return of capital and expenses to LPs before distribution to GP• Claw-back provision for GP distributions• Investment committee authorizes investment• Limit on next fund activities until 70% deployed or committed• Provision a “Key Person” event (i.e. suspension of investing)• Prohibition against LP borrowing except on a short-term basis

In SummaryLook for:

• a General Partner you can trust…

• with a track record of working successfully as a team…

• With solid investor and CEO references…

• And a history of generating above market returns.

Make sure they are committed to:

• putting your best interest ahead of their own…

• and operating in accordance with industry best practices…

• and ethical standards.

Questions?