; A pledge of allegiance
Documents
Resources
Learning Center
Upload
Plans & pricing Sign in
Sign Out

A pledge of allegiance

VIEWS: 69 PAGES: 2

  • pg 1
									PA G E   40                                            P R I VA T E E Q U I T Y I N T E R N A T I O N A L                                APRIL   2 010



GUEST COMMENTARY


FU N D ST RU C T U RE S




A pledge of allegiance
With some LPs hesitant to give GPs carte-blanche with their money, the popularity of the
pledge fund has resurged. Fadi Samman of law rm Akin Gump highlights some issues to
keep in mind when negotiating the terms and conditions for such a vehicle

Is the private equity and real estate fund                                                                  M A N A G E M E N T FE E S
raising market poised for a “back to the
future” moment? With an increasingly                                                                        In order to properly motivate the spon-
dif cult fundraising environment for                                                                        sor to actively source transactions and
fund managers, the market has seen a                                                                        ensure that investors are serious about
resurgence of interest in an old concept:                                                                   participating in the programme and
the so-called “pledge fund.”                                                                                making investments, a pledge fund
    Most notably, Brookfield Asset                                                                          sponsor and its potential investors will
Management recently raised a $4 bil-                                                                        need to agree on an appropriate fee
lion real estate investment consortium                                                                      structure. Given the nature of the soft
in late 2009 to take advantage of dis-                                                                      commitment and ability to participate
tressed real estate opportunities. Pledge                                                                   in deals on a selective basis, investors
funds are usually structured as limited                                                                     typically seek to allocate as much of
partnerships and in many respects                                                                           the upfront costs and broken deal cost
look and feel like a traditional private                                                                    risk to the fund sponsor as possible
equity fund. However, in contrast with                                                                      by requesting a management fee pay-
the traditional “committed” or “blind                                                                       able only on invested capital. Spon-
pool” model where an investor makes          Samman: poor structures = missed
                                                                                                            sors on the other hand will typically
a rm commitment and has no invest-           opportunities                                                  seek some level of fee on the pledge
ment discretion, a pledge fund is a non-                                                                    commitment in order to fund up-front
committed fund where investors make a                                                                       deal sourcing and fund administration
soft commitment and retain a degree of                                                                      expenses. In an effort to bridge this
investment discretion, deciding whether                                                                     gap, fund sponsors should consider a
to invest on a deal-by-deal basis. This                                                                     variety of approaches that combine
  exibility makes pledge funds poten-                                                                       both a fee based on a percentage of
tially attractive for fund sponsors who                                                                     each investor’s “pledge amount,” often
encounter dif culty raising a committed                                                                     at a signi cantly lower percentage than
vehicle in the current environment, but                                                                     a committed fund, with an additional
would prefer to avoid the approach of                                                                       fee on invested capital. Alternative
“fund-less” sponsors who raise capital                                                                      approaches could also include a xed
on a pure deal-by-deal basis.                                                                               monthly or quarterly “membership
    The terms for a pledge fund can vary                                                                    fee” which is then offset against the
greatly from fund to fund, as they tend                                                                     fee on invested capital or some form
to be highly negotiated based on the                                                                        of expense reimbursement mechanism
sponsor’s investment goals and needs                                                                        with budgets and negotiated caps.
of the investor base. In evaluating and                                                                        Carried interest
structuring a pledge fund, sponsors will                                                                       In a pledge fund, distributions
want to bear in mind several key con-                                                                       typically follow the traditional private
siderations, including the management                                                                       equity model: distributions are made
fee and carried interest terms, and the                                                                     upon the disposition of an invest-
investment and due diligence process.                                                                       ment (or as proceeds are otherwise
APRIL   2 010                                   P R I VA T E E Q U I T Y I N T E R N A T I O N A L                                     PA G E   41




generated), and the manager earns a               “Pledge funds are                                  them from investing in the company
carried interest once capital has been                                                               in question while the fund pursues the
returned and a preferred return hurdle            ultimately highly                                  investment. Both of these measures may
achieved. However, the key issue for            customised and highly                                be necessary in order to preserve the
pledge funds is the degree to which                                                                  investment opportunity for the fund.
investment performance is aggregated            negotiated structures”
across all of the fund’s investments.                                                                HY B RI D ST RU C T U RE S
Sponsors will typically advocate that
each deal should stand on its own with                                                               Pledge funds are ultimately highly cus-
no aggregation based on the theory that                                                              tomised and highly negotiated struc-
investors had the discretion whether                                                                 tures. Their terms are dependent on
or not to participate. On the contrary,                                                              and directly in uenced by the nature of
investors will typically seek aggregation,                                                           the sponsor’s target investment oppor-
with the carried interest determined on a                                                            tunities, the relationship and level of
fund-wide basis and a clawback of any                                                                comfort between the sponsor and the
excess carried interest paid. A common                                                               investors and each individual inves-
potential compromise is to provide                                                                   tor’s needs in terms of underwriting
investors with a degree of aggregation       ultimately lead to missed opportunities,                and approving an investment. A variety
based on the level of actual participa-      a frustrated sponsor and disappointed                   of hybrid approaches have been devel-
tion in transactions, effectively reward-    investors.                                              oped that combine both committed and
ing those investors who participate in                                                               pledge fund features. For example, funds
more deals.                                  D U E D I L I G E N C E A N D D I S C L O S U RE        have been structured that combine both
                                                                                                       rm and soft commitments, giving the
STRUCTURING THE INVESTMENT                   Unlike a committed fund, in a pledge                    sponsor a committed pool of capital as
P RO C E S S                                 fund investors are, to varying degrees,                 well as a pre-identi ed and presumably
                                             active participants in the due diligence                willing source of additional capital for
The investment process needs to be           process. In connection with a prospec-                  larger transactions. Other funds have
carefully structured to match the            tive investment, each investor will typi-               been structured whereby the investment
nature of the investment opportuni-          cally receive a package containing the                  decision is made based on an investor
ties, the sponsor’s transaction process      necessary diligence to decide whether                   vote (majority or other percentage)
and the investors’ approval process.         to invest. The scope and timing of dili-                as opposed to an investor-by-investor
The process needs to ensure that inves-      gence can vary and depends primarily                    basis, making it easier for the sponsor
tors receive suf cient information and       on the amount of review the investors                   to pursue and consummate transactions.
have an appropriate amount of time           want to undertake and the amount of                     Also, as discussed previously in greater
to underwrite and make an invest-            diligence the sponsor is willing to pro-                detail, the management fee and carried
ment decision while at the same time         vide. Some investors will want the abil-                interest can be structured in ways that
allowing the fund to bid and compete         ity to do direct diligence on the target                combine committed fund and pledge
effectively for transactions. Too short      company. Sponsors should carefully                      fund concepts.
a period and the sponsor may nd that         evaluate the level of diligence to be                      The degree to which pledge funds will
investors cannot suf ciently evaluate        provided and should bear in mind their                  become a viable alternative to the tradi-
and approve a deal; too much time              duciary duties and obligations under                  tional fund model in light of the fragile
and other bidders with readily avail-        applicable securities laws in preparing                 fund raising market remains to be seen.
able capital will have an advantage.         investor disclosure materials since, in                 However, for rst-time fund sponsors
Also, in the event a particular invest-      essence, each investment constitutes a                  and other managers having dif culty
ment is under-funded due to a lack of        separate investment decision. Finally,                  raising capital, the pledge fund, when
investor participation, the sponsor will     due to the extent and potentially sensi-                properly designed, can provide a degree
want to ensure it has enough time and        tive nature of the diligence materials,                 of investment discretion that is more
  exibility to go back to participating      the investors may be asked to agree                     attractive to investors, while simultane-
investors to take up the unallocated         to con dentiality obligations directly                  ously providing the sponsor with a more
amount or pursue third party co-inves-       with the target companies as well as                    structured reliable source of capital than
tors. A poorly structured process will       non-compete obligations preventing                      pure deal-by-deal fundraising. ■

								
To top