Private Equity Funds, Syndicates, and Crowdfunding are all different platforms contrived by investment operators to raise money from capital investors to be utilized in a deal or an investment strategy. As an equity/capital partner, you should analyze four key terms associated with any offerings to help filter the investment opportunities that are higher risk. The goal of this article is to help capital investors adequately analyze investment offerings prior to committing their capital into any opportunity.
Equity investors should review the following key items prior to deploying capital into any future syndicate or fund investment:
Alignment of Interest: Aligning the interests of the investment operator/manager and the capital investors in ensuring performance of the fund or investment is vital to the long-term success of the investment opportunity. Methods to achieve a better alignment of interests include the following:
- Requiring a capital contribution by the manager;
- Ensuring that the management fee stream is not so significant a profit center that the performance of the fund is deemphasized;
- Recouping excess carried interest, with a clawback; and
- Creating an escape hatch from unsatisfactory management through use of for-cause (and in some cases also no-fault) general partner removal clauses;
Management Team: Typically as a capital investor you invest in as much as the manager as the investment opportunity. Hence it is important to ensure that there is continuity of the management team given that an investment performance is as good as its investment manager/operator. Provisions to address this may include the following:
- Providing provisions (known as “key person” provisions) allowing investors to terminate investing or to dissolve the fund if certain personnel leave;
- Requiring key man insurance on the manager of the investment opportunity/fund to ensure that you are paid in full in the event the manager dies; and
- Forcing a clawback of all fees paid by the fund/investment if the manager terminates their position at the fund within a specified time period.
Bad Performance Safety Valve: Obtaining a safety valve is critical especially if things go wrong. The clearest way to achieve this is through provisions allowing removal of the general partner, dissolution of the fund or, at the very least, requiring the general partner to stop making new investments.
Investment Capital Raise Size: Fund or Investment Size is a concern that needs to be watched closely as a capital investor. The size fear arises for an excessively small fund. Investors should fear that the portion of their capital that will be used to pay expenses (as opposed to being invested) will be excessively large as compared to capital used for investing if the fund does not reach a certain minimum size. In addition, a very small fund may lack sufficient capital to pursue its intended investment strategy. If the fund’ s management team does not make a sufficient profit, they may not be motivated to manage the fund or to support a robust back office. Hence it critical to make sure that they are a minimum target capital size that is be raised before any capital is drawn from escrow account.
Locating Key Term Information
The most commonly used terms in a private equity offering will ultimately be embodied in a combination of the following documents:
- Investment offering memorandum;
- Investment governance documentation i.e. operating agreement;
- Subscription documentation; and
- Side letters if applicable
Capital investors are encouraged to read these documents in depth to better understand how the key terms play out in their investment opportunity.
Capital investor can use the above highlighted terms to make certain that their next investment is a success in the long run.