Private Equity Fund Formation

Private Equity Fund Formation, Practical Law Practice Note 3-509-1324
Private Equity Fund Formation

by Scott
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... W. Naidech, Chadbourne & Parke LLP, with Practical Law Corporate & Securities
Law stated as of 01 Dec 2023 • USA (National/Federal)
This Note provides an overview of privateequity fund formation. It covers general fund structure, fund
economics, fundraising, fund closings and term, managing conflicts, and certain US regulatory matters.
It also examines the principal documents involved in forming a privateequity fund.
General Fund Structure

Investment Fund
General Partner or Manager
Management Company or Investment Adviser
Related Fund Vehicles
Fund Economics
Capital Commitments
Allocations and Distributions
Fund Fees
Fund Expenses
Fundraising and Fund Closing

Fund Marketing
Placement Agents
Fund Closings
Fund Term: Investment and Divestment Periods

Investment Period
Divestment Period
Early Termination Events
Managing Conflicts
Competing Funds
Transactions with Affiliates
Exclusivity
Investor Advisory Committee
© 2024 Thomson Reuters. No claim to original U.S. Government Works. 1

Certain US Regulatory Matters

Investment Company Act
Investment Advisers Act
Securities Act
Securities Exchange Act
ERISA
Principal Legal Documents

Private Placement Memorandum
Fund Partnership or other Operating Agreement
Subscription Agreement and Investor Questionnaire
Side Letters
Investment Management Agreement
Form D
Distinguishing Hedge Funds from Private Equity Funds
On August 23, 2023, the SEC adopted new rules under the Investment Advisers Act of 1940 for private fund advisers
(see Legal Update, SEC Adopts New Rules for Private Fund Advisers (the "New Rules"). The New Rules are generally
effective 12 to 18 months after publication in the Federal Register and will have a material impact on limited partnership
agreements for privateequity funds and may require revisions to this resource. Updates are planned in the near future.
For more information on the final rule, see Private Fund Advisers; Documentation of Registered Investment Adviser
Compliance Reviews, Fed. Reg. 88 FR 63206 (Sept. 14, 2023).
Private funds are investment vehicles formed by investment managers, known as sponsors, looking to raise capital to make
multiple investments under a specified investment mandate. Private funds are "blind pools" under which passive investors make
a commitment to invest a set amount of capital over time, entrusting the fund's sponsor to source, acquire, manage, and divest
the fund's investments.
The key economic incentives for sponsors of funds are management fees and a profit participation on the fund's investments.
The key economic incentive for investors is the opportunity to earn a high rate of return on their invested capital through access
to a portfolio of investments sourced and managed by an investment team that is expert in the target sectors or geographies
of the fund.
There are a variety of private funds with different investment types and purposes, such as:
• Venture capital funds that invest in early and development-stage companies (for more on these kinds of investments,
see Practice Note, Minority Investments: Overview).
• Growth equity funds that invest in later-stage, pre-IPO companies or in PIPE transactions with public companies
(for more on these kinds of investments, see Practice Notes, Growth Equity Investments and Practice Note, PIPE
Transactions).

• Buyout funds that acquire controlling interests in companies with an eye toward later selling those companies or
taking them public (for more on these kinds of investments, see Practice Notes, Buyouts: Overview and Going Private
Transactions: Overview).
• Distressed funds that invest in debt securities of financially distressed companies at a large discount (for more on these
kinds of investments, see Practice Note, Out-of-Court Restructurings: Overview and Article, Distressed Debt Investing: A
High Risk Game).
Funds may also be formed to invest in specific geographic regions (such as the US, Asia, Europe, or Latin America) or in specific
industry sectors (such as technology, real estate, energy, health care, or manufacturing).
This Note provides an overview of privateequity funds formed in the US, discussing the core considerations involved in forming
a privateequity fund, including:
• Their general structure and the key entities involved.
• Fund economics, including fund fees and expenses.
• Fundraising and fund closings, and the principal legal documents involved.
• Fund term and investment and divestment periods.
• Governance arrangements and managing conflicts.
• Certain US regulatory matters, including federal securities laws and other federal laws affecting fund formation and
operation.
This Note does not cover hedge funds, which are considered a distinct asset class from privateequity funds. Some of the topics
covered, however, are also relevant to a review of the core structure and governance arrangements of hedge funds (for more on
the distinction between hedge funds and privateequity funds, see Box, Distinguishing Hedge Funds from PrivateEquity Funds).
General Fund Structure

The structure of a privateequity fund generally involves several key entities, as follows:

• The investment fund (private fund), which is a pure pool of capital with no direct operations. Investors acquire interests
in the investment fund, which makes the actual investments for their benefit (see Investment Fund).
• A general partner (GP) or other managing entity (manager), which has the legal power to act on behalf of the investment
fund (see General Partner or Manager).
• A management company or investment adviser, which is generally affiliated with the GP or manager and is appointed
to provide investment advisory services to the fund (see Management Company or Investment Adviser). This is the
operating entity that employs the investment professionals, evaluates potential investment opportunities, and incurs the
expenses associated with day-to-day operations and administration of the fund.
• Other related fund entities, which may be formed to account for certain regulatory, tax, and other structuring needs of
one or more groups of investors (see Related Fund Vehicles).
Investment Fund
Privateequity funds are structured as closed-end investment vehicles. A fund's governing documents generally permit the fund
to raise capital commitments during a limited fundraising period (12 to 18 months is common), after which the fund may not
accept additional investor commitments. During the capital raising period, the sponsor seeks investors to subscribe for capital
commitments to the fund. The commitment is not usually funded all at once, but in separate capital contributions called by the
sponsor on an as-needed basis to make investments during the investment period (see Investment Period) and, if the fund's
operating agreement permits, to pay fees and expenses over the life of the fund (see Fund Fees and Fund Expenses). For an

example of a capital call provision in a fund's operating agreement, see Standard Document, Limited Partnership Agreement
(LPA) for PrivateEquity Fund: Section 6.03.
US funds usually raise capital in private placements of interests in accordance with exemptions from the registration
requirements of the federal securities laws (see Securities Act). For more on fund capital raising and capital commitments, see
Fundraising and Fund Closing and Timeline of a PrivateEquity Fund.
Privateequity funds are most often formed as limited partnerships (LPs) or limited liability companies (LLCs). The principal
advantages of using an LP or LLC as a fund vehicle include:
• LPs and LLCs are "pass-through" entities for US federal income tax purposes and, therefore, are not subject to
corporate income tax. The entity's income, gains, losses, deductions, and credits are passed through to the partners and
taxed only once at the investor level (for a discussion of the US federal income tax rules that apply to US pass-through
entities, see Practice Note, Taxation of Partnerships).
• LPs and LLCs are generally very flexible business entities. State statutes governing LPs and LLCs contain primarily
default provisions that apply only in the absence of agreement among the...
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... for example, 6 Del. C. § 18-1101). The default statutory provisions can be overridden, modified, or supplemented by
the specific terms of the LP or LLC agreement. This allows partners in an LP and members of an LLC flexibility in the
structure of economic and governing arrangements.
• The limited partners of an LP and the members of an LLC are not generally personally liable for the liabilities of
the LP or LLC. An investor's obligations and liabilities to (or otherwise in respect of) the fund are limited to its capital
commitment and its share of the fund's assets, subject to certain exceptions and applicable law.
For a more detailed discussion of the advantages of LPs and LLCs, see Practice Note, Choice of Entity: Tax Issues and Choosing
an Entity Comparison Chart.
Privateequity funds organized in the US are often formed as Delaware LPs or LLCs under the Delaware Revised Uniform
Limited Partnership Act (DRULPA) or the Delaware Limited Liability Company Act (DLLCA). Sponsors and their counsel
choose Delaware law for the following principal reasons:
• LPs and LLCs for large, complex transactions are often formed in Delaware and fund investors consider it a familiar and
safe jurisdiction.
• Delaware has specialized courts for business entities, with judges who have a great deal of relevant expertise in
economic and governance issues.
• Delaware has a highly developed and rapidly developing common law regime governing LPs and LLCs, which is
generally considered the most sophisticated in the US.
• Delaware has a relatively streamlined and inexpensive administrative process, and there are a number of established
service providers that can perform many required actions quickly and efficiently.

• Delaware statutory and common law provides for extensive freedom of contract.
Privateequity funds formed to invest outside of the US are often formed as LPs or LLCs (or the applicable jurisdiction's equivalent
form of entity) in offshore jurisdictions with favorable tax regimes and well-established legal systems, such as the Cayman Islands,
the Channel Islands, and Luxembourg. When these jurisdictions are undesirable, either for reasons of perception or because
they are blacklisted by countries in which prospective investors or anticipated investments are located, alternatives may include
the provinces of Ontario, Quebec, or Alberta in Canada or other jurisdictions providing pass-through tax treatment.
General Partner or Manager
The sponsor of a privateequity fund creates a special purpose vehicle to control and administer the fund, and take actions
on the fund's behalf. The specific type and function of this vehicle depends on the form of the investment fund. For example, in
accordance with applicable US state statutes, an LP is controlled by a GP and an LLC is generally controlled by a manager or
managing member. For investment funds organized as LPs, the GP is normally a special purpose entity to insulate the sponsor
from general liability for claims against the fund because the GP entity is generally subject to this liability in accordance with
applicable US state LP statutes (for more on LP entities, see Choosing an Entity Comparison Chart).
Management Company or Investment Adviser
In addition to the...
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... manager or management company). The fund, or its GP or manager, normally enters into an investment advisory agreement
(or management agreement or similar services agreement) with the investment adviser (see Principal Legal Documents). Under
this arrangement, the fund pays management fees to the investment adviser in exchange for the investment adviser's agreement
to employ the investment professionals, evaluate potential investment opportunities, and undertake the day-to-day activities
associated with a variety of investment advisory services and activities (see Management Fees). A single management company
often serves in this capacity for additional funds raised by the same sponsor, which can result in economies of scale.
Related Fund Vehicles
Structures for privateequity funds may involve the formation of other related investment fund vehicles to account for certain
regulatory, tax, and other structuring needs of one or more groups of investors. In some cases, these entities are formed after
the fund itself is established as the need for them arises. These vehicles can include parallel funds, alternative investment funds,
feeder funds, and co-investment vehicles, and are generally structured as represented in the following chart:

Parallel Funds
Parallel funds are parallel investment vehicles generally formed to invest and divest in the same investments at the same time
as the main fund. They are formed under substantially the same terms as the main fund, with specific differences in terms to
the extent required to...
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..., do not necessarily have the same investment terms or fees as the fund. They are formed to accommodate investments made
by particular investors outside of the fund on a deal-by-deal basis, and may have investors:
• Which are not necessarily investors in the main fund.
• Which are investors in the main fund, but to whom the sponsor wants to allocate an increased share of a particular
investment.
For example, a co-investment vehicle may be used by a sponsor when the amount of a particular investment is too large for
a fund to consummate alone or when the participation of a particular outside investor (such as a strategic partner) facilitates
the investment opportunity.
For further discussion of co-investments and the structuring of co-investments, see Practice Notes, PrivateEquity Co-
Investments and Structuring PrivateEquity Co-Investments.
Fund Economics
The economic terms of privateequity funds differ widely depending on a number of factors, including:

• The expertise and track record of the sponsor.
• The overall fee structure of the fund taking into account factors such as:
• the structure of the sponsor's profits interest (see Carried Interest and Catch-up);
• the investors' preferred return (see Return of Capital Contributions and Preferred Return);
• the management fee and other fund-level fees, and any offsets (see Management Fees); and
• portfolio company fees paid to the sponsor management company on a deal-by-deal basis (see Portfolio Company
Fees and Management Fee Offset).
• The investment purpose and structure of the fund.
• General market dynamics.
Although the specific economics vary from fund to fund, there are certain basic elements of fund economics common to all
privateequity funds, including:
• Investor capital commitments (see Capital Commitments).
• Allocations and distributions of profits and losses of the fund (see Allocations and Distributions).
• Fees paid to the fund's investment adviser (see Fund Fees).
• Expenses of the fund (see Fund Expenses).
Capital Commitments
An investor generally becomes a participant in a fund by subscribing for a capital commitment. In most cases, the commitment
is not funded at subscription or even all at once, but in separate installments, which the sponsor designates (by making "capital
calls") on an as-needed basis to make investments and to pay fees and expenses over the life of the fund. Investors like to see
that the sponsor has "skin in the game" as well by making its own commitment to the fund. A...
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... commitment by a sponsor and its key executives is an attractive marketing element because fund investors believe it better
aligns the interests of the sponsor with those of the investors, since sponsors that make significant commitments share in losses
as well as profits. Investors believe this mitigates the incentives for sponsors, which receive a disproportionate share of profits,
to take excessive (or unwarranted) risks.
Investors commit to invest an agreed amount in the fund (the investor's capital commitment). The sponsor's right to call for capital
contributions from its investors is limited at any time to the extent of each investor's unfunded commitments (the investor's total

commitment less contributions already made). When considering a prospective privateequity investment, investors pay close
attention to:
• The provisions of the fund agreement governing their obligations to make (and possibly reinvest) capital contributions to
the fund.
• Whether (and to what extent) they recoup their invested capital in ongoing investments before the sponsor receives a
distribution of profits from investments that are liquidated first (see Carried Interest and Catch-up and Allocations and
Distributions).
Recycling of Capital Commitments

The fund's operating agreement may permit the fund to "recycle" capital that is returned to the investor, often by adding the
amount of the capital returns to an investor's remaining commitment. Recycling provisions in the fund's operating agreement
may cover the following types of capital returns:
• ...
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... waterfall are contained in the operating agreement of the fund, which requires the fund to track allocations and distributions
through book entry capital accounts created for each investor. To the extent possible, the allocation provisions (and each
investor's share of taxable income and losses) should reflect the economics of the distribution waterfall.
For more on the different approaches to drafting income and loss allocation provisions in operating agreements and the
relationship of allocation provisions and distribution waterfalls, see:
• Article, Understanding Partnership Target Capital Accounts.
• Practice Note, Structuring Waterfall Provisions: Relationship of Partnership Allocations to Distribution Waterfall.
• LLC Agreement (Multi-Member, Board-Managed) (PrivateEquity Buyout).
• Standard Document, Limited Partnership Agreement (LPA) for PrivateEquity Fund: Section 6.04, Article VII, and Article
VIII
Distribution Waterfalls
In setting out the agreed-on economic arrangement between the sponsor and the investors, a fund distribution waterfall provides
that the proceeds from investments are paid in a specified order of tiered priority. This is necessary because privateequity funds
generally distribute excess cash as it is generated, although the distributions of investment proceeds are made by the fund to
its investors net of fund level expenses, liabilities, and other required reserves.
At each tier of the waterfall, distributions are made in a specific ratio (which may be 100% to the sponsor, 100% to the investors,
or anywhere in between) until either:

• The current tier is satisfied and the next tier is reached.
• The fund is wound up and the remaining assets distributed in a manner that reflects the agreed-on economics.
The layering of waterfall tiers, and the apportionment of distributions among them, is a matter of negotiation and has a wide
variety of options, although certain approaches generally prevail for privateequity funds. The following describes a common
distribution waterfall used for privateequity funds, in which distributions are made:
• First, to the investors until they have received all of their capital contributions for the investment giving rise to the
distribution (see Return of Capital Contributions and Preferred Return).
• Second, to the investors until they have received an allocable percentage (tied to the first tranche) of all of the capital
contributions in respect of fund expenses, including management fees (see Return of Capital Contributions and
Preferred Return).
• Third, to the investors until they have received a preferred return on their capital returns in the first and second tranches
(see Return of Capital Contributions and Preferred Return).
• Fourth, to the sponsor until the sponsor has received 20% (or other carried interest percentage) of the distributions
of profits (meaning, 20% of those amounts distributed under the third tranche and this fourth tranche). This tranche is
known as the "catch-up" (see Carried Interest and Catch-up).
• Fifth, 20% (or other carried interest percentage) to the sponsor as its profit participation, and 80% (or other remaining
percentage) to the investors (see Carried Interest and Catch-up).
For an example of an actual privateequity fund waterfall provision and a discussion of negotiating and structuring distribution
waterfalls for privateequity funds, see Practice Note, Structuring Waterfall Provisions: Waterfalls in PrivateEquity Funds.
Return of Capital Contributions and Preferred Return

The first tranche of a privateequity fund waterfall generally provides that all capital contributed for a particular investment must
be returned to the investor who provided it before any other distributions are made from the proceeds of that investment. This
tranche is sometimes expanded to require a return of:
• The portion of unrelated investments that have been permanently written down.
• All unreturned invested capital in previously realized investments.
• All unreturned contributed capital.
Following a return of capital contributions, a privateequity fund distribution waterfall next provides a preferred return (known as
a hurdle) on the capital contributions (see Distribution Waterfalls). The hurdle rate:

• Is often a 7% to 9% rate of return, using either a simple interest calculation or, more often, a cumulative compounded
rate of return.
• Accrues from the time the capital contributions are made.
The purpose of the preferred return is to guarantee investors a minimum return on their invested capital before profits are shared
with the sponsor. The preferred return is merely a priority of return, and is subject to a catch-up by the sponsor if aggregate fund
profits on capital contributions exceed the hurdle (see Carried Interest and Catch-up). Although it is still relatively rare, some funds
have elected not to include a preferred return in their waterfall. Funds that choose not to provide investors with a preferred return
generally have a well-known and established sponsor and existing investors who are willing to forego a guaranteed preferred
return for the opportunity to continue to invest with that sponsor.
For more on the priority of capital contributions and the preferred return in distribution waterfalls, see Practice Note, Structuring
Waterfall Provisions: Priority Return of Capital Contributions and Preferred Return.
Carried Interest and Catch-up

The sponsor of a privateequity fund is entitled to a profits participation (also known as carried interest, carry, or success fee)
that is usually a set percentage of profits (20% is standard, but it can be higher or lower). The timing and calculation methodology
of the carried interest is set out in the distribution waterfall, with the carried interest usually lower in priority to the return of capital
contributions and the preferred return to investors (see Return of Capital Contributions and Preferred Return).
After investors receive their capital contributions and a preferred return, the distribution waterfall provides for distributions of
carried interest to the sponsor through a catch-up tranche. The catch-up distribution:
• Can be made either 100% to the sponsor or allocated between the sponsor and the investors in a fixed proportion (for
example, 80/20 or 50/50, although 100% is more common).
• Continues until the carry distributions to the sponsor equal the sponsor's negotiated percentage of overall profits.
Once this catch-up is fulfilled, the distribution waterfall splits any remaining distribution of profits in accordance with the same
agreed-on carried interest split (a ratio equal to 80% of profits to the investors and 20% of profits to the sponsor is common).
Different methodologies for calculating the carried interest for privateequity funds are used, including:
• Deal-by-deal carry (also known as an "American style" carry). Under a deal-by-deal carry structure, the GP or
manager receives carry on profitable deals regardless of losses on unsuccessful deals. This structure has become
less common because investors are concerned that this fee structure requires them to bear a disproportionate share
of the fund's risk. Specifically, the sponsor's share of profits on successful investments is not offset by losses on other
investments. Deal-by-deal carry is now only generally used when it makes sense to isolate fund profits and losses on an
investment-by-investment basis (for example, when investors can opt out of later investments).
• Deal-by-deal carry with loss carryforward. Deal-by-deal carry...
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...s.

Performance Fee Prohibitions for Certain Funds

Sponsors who are registered investment advisers under the Investment Advisers Act of 1940 (Advisers Act) are generally
prohibited from charging carried interest to investors who do not meet certain high net worth tests (see Investment Advisers
Act). Section 205(a)(1) of the Advisers Act prohibits an investment adviser from entering into an investment advisory contract
that provides for compensation to the adviser based on a share of capital gains on, or capital appreciation of, the funds of a
client, such as performance fees or carried interest (15 U.S.C. § 80b-5(a)(1)). The Advisers Act provides an exception to this
general rule, however, by allowing an investment adviser to charge performance fees to a private fund that is excepted from
the definition of an investment company under the Investment Company Act of 1940 (ICA) (15 U.S.C. § 80b-5(b)(4) and see
Investment Company Act). In addition, Rule 205-3 of the Advisers Act permits an investment adviser to charge performance fees
to a fund investor that is a qualified client who meets one or more of the following qualifications:
• Assets-under-management-test. The client has at least $1,100,000 total assets under management with an
investment adviser immediately after entering into the advisory contract.
• Net worth test. The adviser reasonably believes either the client:
• has a net worth of more than $2,200,000 when the advisory contract is entered into; or
• is a qualified purchaser under the ICA, generally defined as a...
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... to be qualified clients so that carried interest can be charged to all of the fund's investors.
Section 205(a)(1) does not apply to investment advisers who are not required to register under the Advisers Act (see Investment
Advisers Act). Therefore, investment advisers who are exempt from the registration requirements of the Advisers Act may charge
carried interest to investors who are not qualified clients.
Section 205(a)(1) also does not apply to an investment advisory contract with a person who is not a resident of the US (15 U.S.C.
§ 80b-5(b)(5)). Therefore, a non-US fund managed by a US registered investment adviser may charge carried interest to all of
its non-US investors and to its US investors who are qualified clients.
Clawback
Operating agreements for privateequity funds often provide for a "clawback" provision relating to the sponsor's carried interest.
A clawback is an adjustment payment that the sponsor must make to the fund at the end of its term when the fund's remaining
assets must be liquidated, and in some cases, on an interim basis or at other designated times during the life of the fund.
A clawback payment is triggered if, on calculating the fund's aggregate returns, including events occurring after distributions
have been made to the sponsor, the sponsor has received more than its share of the fund's economics (for example, the overall
return to the investors is less than the hurdle rate or, even if the hurdle rate is exceeded, is less than 80% of the total fund
profits). The clawback payment is limited to the amount of carried interest distributions received by the sponsor, net of their
associated tax liabilities.

Because the clawback is a mechanism to reverse excess distributions of carry to the GP or manager, it is not generally required in
funds with a back-end loaded or European style carry structure. For more on clawbacks, see Practice Note, Structuring Waterfall
Provisions: Clawbacks.
Investor Givebacks
Operating agreements for privateequity funds require investors to return previously-received distributions to meet their share
of any fund obligations or liabilities, including:
• Indemnification and other obligations relating to liabilities in connection with the purchase or sale of investments.
• Other fund liabilities.
The requirement to return distributions is often subject to certain caps or limitations, which may be based on:
• The timing of distributions (for example, investors may only be required to return a distribution within three years of the
date of distribution).
• The aggregate amount of distributions that may be required to be returned (for example, the fund's operating agreement
may limit the return of distributions to 50% of an investor's commitment).
Tax Distributions
Most fund operating...
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...h basis to the GP or manager for its carried interest even though the cash is only distributed to the investors (see Investment
Fund and Allocations and Distributions).
Because the owners of the carry recipient are subject to current taxation on phantom income, the fund agreement generally
provides for a special tax distribution to the carry recipient each quarter, to the extent that the fund has cash to distribute. This
distribution is made in an amount intended to approximate US federal, state, and local taxes on the phantom income so that the
owners can pay estimated taxes as required each quarter. For an example of this type of tax distribution provision in the fund's
operating agreement, see Standard Document, Limited Partnership Agreement (LPA) for PrivateEquity Fund: Section 8.02.
Tax distributions made to the carry recipient are considered an advance against (and reduce dollar for dollar) future carried
interest distributions under the distribution waterfall. Tax distributions also factor into any clawback payment due from the GP or
manager when the fund is liquidated (see Clawback).
Fund Fees
In connection with forming an investment fund, a sponsor usually establishes an entity to act as the investment adviser or
management company unless it has already done so (see Management Company or Investment Adviser). The management

company generally enters into an investment advisory agreement (or management agreement) with the fund, or its GP or
manager, to act as the investment adviser or manager of the fund. Under this...
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... (generally taxed at ordinary income rates). This may be problematic for certain non-US investors (for instance, requiring the
investor to file US federal tax returns and pay US income tax) and should be taken into account in considering whether non-US
investors should be permitted to elect out of receiving the benefit of certain fee offsets.
Regardless of whether there is any management fee offset or its size, the fund's operating agreement generally requires that
any specialized service fees charged by the sponsor and its affiliates to either portfolio companies or the fund be on arm's length
terms and at competitive rates.
For an example of a fee offset provision in the fund's operating agreement, see Standard Document, Limited Partnership
Agreement (LPA) for PrivateEquity Fund: Section 4.08.
Fund Expenses
There are a variety of expenses associated with a privateequity fund, including expenses relating to:
• Establishing and organizing the fund and its infrastructure (see Organizational Expenses).
• The operation of the fund (see Operating Expenses).
• The sponsor's management company (see Manager Expenses).
Organizational Expenses
The operating agreement of a privateequity fund includes provisions requiring the fund, and therefore its investors, to cover
the costs of establishing the fund. The organizational expenses of the fund generally include the out-of-pocket expenses of
the sponsor incurred in forming the fund and any related vehicles, such as printing, travel, legal, accounting, filing and other
organizational expenses.
Organizational expenses are borne by the fund's investors out of their capital commitments, but are generally capped in the
fund's operating agreement depending primarily on the size and complexity of the fund. The sponsor is responsible for any
organizational expenses in excess of the cap.
Operating Expenses
In additional to the organizational expenses, the fund bears all other costs and expenses relating...

... fees (see Management Fees).
• The purchase, holding and disposition of the fund's investments.

• Third-party service providers to the fund (such as the expenses of any administrators, custodians, counsel, accountants,
and auditors).
• Printing and distributing reports to the investors.
• Insurance, indemnity, and litigation expenses.
• Taxes and any other governmental fees or charges levied against the fund.
As with the fund's organizational expenses, the operating expenses of the fund are borne by the fund's investors out of their
capital commitments. Unlike organizational expenses, however, operating expenses are not generally capped.
For an example of an expense provision in the fund's operating agreement, see Standard Document, Limited Partnership
Agreement (LPA) for PrivateEquity Fund: Section 3.08, Operating and Organizational Expenses.
Manager Expenses
The fund's manager is expected to bear the cost of its own ordinary administrative and overhead expenses incurred in managing
the fund. These costs include the costs and expenses associated with running the business of the manager, as opposed to
specific expenses directly related to the operation of the fund and its investments, such as employee compensation and benefits,
rent, and general overhead.
Fundraising and Fund Closing

The success of any fundraising by a privateequity sponsor and the time it takes to raise a fund and get to an initial closing
depends on a variety of factors, including:
• General economic outlook.
• Economic outlook of the target sectors of the fund and of the geographic region in which the fund will invest.
• Track record of the sponsor.
• Strength of its (or its placement agent's) relationships with prospective investors.
For a detailed timeline of the fundraising period of a privateequity fund, see Timeline of a PrivateEquity Fund.
Fund Marketing
Fund capital raisings in the US are nearly always made as private placements of securities (in accordance with exemptions from
the registration requirements of the federal securities laws) to:

• Institutions, including:
• government and corporate pension plans;
• financial institutions;
• university endowments;
• foundations;
• sovereign wealth funds;
• funds of funds;
• insurance companies; and
• family offices.
• In some cases, high-net-worth individuals (see Securities Act).
Private placements are generally made through a series of one-on-one presentations to investors with whom the sponsor or its
placement agent has a pre-existing relationship. The sponsor provides these investors with marketing materials and a private
placement memorandum (PPM) describing, among other things:
• The fund and its structure (see Related Fund Vehicles).
• The sponsor's investment team and track record.
• The fund's investment objectives, strategy, and legal terms.
(See Private Placement Memorandum.)
Under Regulation D, sponsors were once restricted from any general solicitation of investors or general advertising of the fund
offering during the capital raising period in order to avoid having to register the offering with the Securities and Exchange
Commission (SEC) (see Securities Act). General advertising or general solicitation can be deemed to include:
• Advertisements, articles, notices, or other communications published in any newspaper, magazine, or similar media.
• Broadcasts over television or radio.
• Seminars or meetings if the attendees were invited by general solicitation or advertising.
(17 C.F.R. § 230.502(c).)

In general, any activity that might be construed as conditioning the US market for an offering might be seen as violating these
restrictions. (For more on this topic, see Practice Note, Section 4(a)(2) and Regulation D Private Placements: No General
Solicitation or Advertising of the Offering).
To avoid general solicitation during the fundraising period, the best practice is not to communicate with the press at all regarding
the fund or its offering and not to address any communication to a general audience. For example, avoid speaking about the fund
at an industry conference if the attendees have not been pre-screened and avoid leaving offering documents at an unattended
booth at an industry conference. These kinds of communications may be regarded as general solicitations even if it is reasonable
to believe that all recipients of the communications are qualified under the federal securities laws (see Securities Act). Marketing
related communications should include an appropriate legend on any written materials to ensure that it is clear to whom the
materials are directed.
Section 201(a)(1) of the Jumpstart Our Business Startups Act of 2012 (the JOBS Act), enacted April 5, 2012, directed the
SEC to revise Regulation D to permit general solicitation and general advertising for offerings and sales made under Rule 506
that meet certain conditions. The prohibition on general solicitation and advertising remains under Rule 506 for those offerings
that do not meet the conditions. (17 C.F.R. § 230.506(b), (c) and see The JOBS Act and Regulation D).
Funds conducting capital raisings in non-US jurisdictions should consult with local counsel to ensure compliance with applicable
local securities laws.
Placement Agents
Many privateequity funds use placement agents to market and sell interests in the fund. A placement agent acts as the fund's
agent in the marketing process, introducing the sponsor to potential investors who are qualified to invest in the fund under the
applicable securities laws of the country in which the offer is being made. A placement agent agreement between the sponsor
and the placement agent sets out basic terms relating to the engagement, including:
• The compensation of the placement agent.
• The scope of the engagement, including whether or not the placement agent is retained as the exclusive placement
agent or for certain specific jurisdictions or types of investors.
Most entities engaged in brokering the purchase or sale of securities for issuers, such as placement agents...
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... under the Exchange Act when placement agents are conducting certain activities related to securities sold under Rule 506
(15 U.S.C. § 77d(c) and see The JOBS Act and Regulation D).
Fund Closings
A first closing of the fund occurs when the sponsor identifies investors who are ready to commit sufficient capital to the fund (based
on the sponsor's capital raising target). A fund is often only permitted to hold an initial closing after a minimum amount of capital
has been raised. After the first closing, subsequent closings may be held throughout the fundraising period, which ends either:

• 12 to 18 months after the fund's initial closing.
• When the fund has reached its fundraising cap on commitments (as set forth in the fund's operating agreement).
(See Timeline of a PrivateEquity Fund.)
At each closing, investors submit their capital commitments by executing a subscription agreement, the fund's operating
agreement, and any other ancillary documents required to be executed by investors (see Principal Legal Documents).
For an example of a provision in the fund's operating agreement regarding subsequent closings and the fundraising period, see
Standard Document, Limited Partnership Agreement (LPA) for PrivateEquity Fund: Section 6.10.
Fund Term: Investment and Divestment Periods

Privateequity funds have long lives. The term of a fund begins following the first fund closing and often continues for 10 to 12
years, subject to:
• Limited extensions when necessary to provide the sponsor more time to liquidate the fund's remaining assets.
• Early termination triggered by certain events (see Early Termination Events).
Shorter or longer terms may be required depending on the time it takes to source, acquire, harvest, and exit investments. The
term of a fund generally consists of an investment period and a divestment period (see Timeline of a PrivateEquity Fund).
Investment Period
An investor's capital commitment is not usually funded all at once, but in separate capital contributions on an as-needed basis.
The sponsor sources new investments for the fund during an investment period (or commitment period) and calls capital on a
deal-by-deal basis as required to fund new investments or to cover the fund's management fees and other fund related expenses
(see Fund Fees and Fund Expenses).
The provisions of a fund operating agreement generally permit the fund to enter into new investments only during a limited
investment period, often four to six years from the end of the fund's fundraising period or the closing of its first investment.
After the investment period, the fund is permitted to acquire new investments only to the limited extent set out in its operating
agreement (see Divestment Period).
For an example of a capital call provision in the fund's operating agreement, setting forth the purposes for which capital may be
called, see Standard Document, Limited Partnership Agreement (LPA) for PrivateEquity Fund: Sections 6.03(a)(i) and 6.03(a)(ii).
Divestment Period
Fund investments are not generally liquidated all at once, but separately as and when directed by the sponsor primarily during a
divestment period ending four to six years after the end of the investment period. For a discussion of a privateequity sponsor's
main strategies for exiting its control investments in portfolio companies purchased in leveraged buyouts, see Practice Note,

PrivateEquity Strategies for Exiting a Leveraged Buyout. The terms of the fund generally only require investors to contribute
capital after the end of the investment period (subject to the amount of their respective commitments), as and when called, for:
• Investments under limited circumstances, including:
• investments for which the fund made a binding commitment before the end of the investment period;
• follow-on investments in existing investments; or
• new investments to the extent permitted under the fund's operating agreement.
• Fund fees and expenses, including management fees (see Fund Fees and Fund Expenses).
At the end of the fund term, the fund's remaining investments must be liquidated and the proceeds distributed to investors in
accordance with the distribution waterfall...
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... and its investments. The operation of the fund is often tied to the involvement of these individuals who are deemed to be "key
persons." Key person triggering events vary from fund to fund, but generally cause a suspension of the fund's investment period.
If triggered, the fund is prevented from making new investments until a sufficient number of new key persons are appointed to
the satisfaction of the investors. If the suspension continues for an extended period (for example, six months), then the fund's
operating agreement often requires that either the investment period be permanently suspended or the fund be liquidated.
For an example of a key person provision in the fund's operating agreement, see Standard Document, Limited Partnership
Agreement (LPA) for PrivateEquity Fund: Section 4.05.
Removal for Cause

Fund operating agreements may contain early termination events that allow the investors to remove and replace the sponsor or
elect to liquidate the fund for cause. Cause is often limited to highly material events calling into question the manager's ability
to manage the fund, such as fraud or willful misconduct, gross negligence, or major securities violations. For an example of a
removal for cause provision in the fund's operating agreement, see Standard Document, Limited Partnership Agreement (LPA)
for PrivateEquity Fund: Section 4.11.
Removal Other than for Cause

Fund operating agreements may also contain provisions that permit a supermajority (often 75% or more of total capital
commitments) of the investors to remove and replace the sponsor or otherwise dissolve the fund other than for cause. The theory
behind this kind of provision is that, even if no adverse event has occurred to call into question the manager's ability to operate
the fund, investors should not be required to continue to contribute capital to the fund when an overwhelming proportion of the
investors do not wish to continue the fund's operations. An alternative is to permit a supermajority of investors to elect to end the
investment period, but not allow an early dissolution of the fund without cause.
For an example of a provision in the fund's operating agreement providing for no-fault removal, see Standard Document, Limited
Partnership Agreement (LPA) for PrivateEquity Fund: Section 4.11(b).

For a more complete discussion of early termination events and the associated remedies, see Practice Note, Key Person, For
Cause, and No-Fault Triggers in PrivateEquity Funds.
Managing Conflicts
Sponsors of privateequity funds frequently manage multiple investment vehicles or otherwise engage in a number of asset
management and other related services that can potentially create conflicts of interest. The fund operating agreement often
specifies how the sponsor must address certain conflict situations.
Competing Funds
Fund operating agreements usually require the sponsor to offer suitable investment opportunities it sources to the fund before
offering the opportunity to other managed funds or sponsor accounts. During the investment period, the fund:
• May have a right of first look on investments within the fund's target objectives.
• May not receive priority for certain investments. For example, the operating agreement may list potentially competing
funds managed by the sponsor that will either be given priority over the fund or be permitted to co-invest with the fund.
For an example of a provision in the fund's operating agreement addressing conflicts with competing funds, see Standard
Document, Limited Partnership Agreement (LPA) for PrivateEquity Fund: Section 4.06.
Transactions with Affiliates
Fund operating agreements typically contain provisions governing affiliated transactions between the sponsor or its affiliates, and
the fund or its portfolio investments. Certain affiliated transactions described in the operating agreement must often be brought
to the attention of an investor advisory committee for review or approval, or both (see Investor Advisory Committee). The types
of transactions requiring approval may include situations in which the sponsor (or one of its affiliates) is:
• Engaged to act as a service provider for the fund or one of its portfolio companies.
• Buying an investment from or selling an investment to the fund.
• Acting as a creditor of or lender to the fund or one of its portfolio...

... of its portfolio companies.
In addition, Section 206(3) of the Advisers Act specifically prohibits an investment adviser (such as the sponsor) or any of its
affiliates from selling any security to its client (such as the fund), or buying any security from its client, without obtaining prior
consent for the specific transaction (15 U.S.C. § 80b-6(3)). Purchases or sales of portfolio investments or other fund assets

between the sponsor or its affiliates, and the fund or its portfolio investments, therefore often requires the approval of the fund's
investor advisory committee (or the fund investors).
For an example of a provision in the fund's operating agreement addressing transactions with affiliates, see Standard Document,
Limited Partnership Agreement (LPA) for PrivateEquity Fund: Section 4.02.
Exclusivity
Fund operating agreements often contain exclusivity terms, preventing the sponsor from forming competing funds with the same
investment objective until the end of the fund's investment period, or until all or substantially all of the fund's commitments have
been deployed or reserved for deployment.
Investor Advisory Committee
Fund agreements often establish an investor advisory committee appointed by the sponsor, but comprised of members
representing certain of the fund's investors. The fund's operating agreement states the role of the investor advisory committee,
which usually involves:
• The resolution of certain conflict of interest situations.
• Waiver of certain provisions of the fund operating agreement.
• Certain matters or transactions that require review by or the consent of the committee (see Transactions with Affiliates).
The investor advisory committee is created by contract. It is not a board of directors and, unless otherwise required by law or by
contract, its members do not owe fiduciary duties to the fund or its investors when making decisions. For an overview of the
fiduciary duties of a board of directors of a corporation, see Practice Note, Fiduciary Duties of the Board of Directors.
For an example of provisions in the fund's operating agreement addressing an investor advisory committee, see Standard
Document, Limited Partnership Agreement (LPA) for PrivateEquity Fund: Article XV.
Certain US Regulatory Matters

Privateequity funds may be subject to a myriad of US federal legislation. As with any investment vehicle, fund counsel should
analyze the fund's structure and its potential investors to ensure proper compliance with US federal statutes and regulations
before the sponsor forms any entities or commences any fund activities.
Investment Company Act
The ICA regulates mutual funds and other companies that engage primarily in investing, reinvesting, and trading in securities
and offer their own securities to the investing public. Companies subject to the ICA are required to either register with the SEC as
an investment company or qualify for an exemption from registration. Sponsors of privateequity funds formed in the US or with
US investors generally try to qualify for an exemption from registration because registration would make it impracticable for a

sponsor to properly administer a fund. For example, a registered investment company can only borrow money or issue securities
with the approval of a majority of its outstanding voting securities (15 U.S.C. § 80a-13(a)(2)). For an overview of the exemptions
under the ICA and why it is important for privateequity funds to avoid becoming registered investment companies, see Practice
Note, Investment Company Act of 1940 Exceptions: Guide for Transactional Lawyers.
Privateequity funds seeking to raise capital from US investors commonly rely on one of two primary registration exemptions
under the ICA:
• Section 3(c)(1) excludes a privateequity fund from the definition of an investment company if:
• it is not making a public offering of its interests; and
• it is beneficially owned by not more than 100 persons.
(15 U.S.C. § 80a-3(c)(1).)
• Section 3(c)(7) excludes a privateequity fund from the definition of investment company if:
• it does not make a public offering of its interests; and
• it is beneficially owned exclusively by qualified purchasers (generally, a person owning at least $5 million or more
of investments, or an entity with at least $25 million or more of investments).
(15 U.S.C. § 80a-3(c)(7).)
The Section 3(c)(1) and 3(c)(7) exemptions are complex, including a number of rules requiring the fund to look through certain
investors to determine their ultimate beneficial owners. For example:
• Each exemption requires a fund to disregard and look through to the beneficial owners of any entity formed for the
purpose of investing in the fund.
• Section 3(c)(1) requires a fund to look through any investor that is itself an investment...
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... of the purposes of the Act is to relax the regulatory burden on smaller companies and expand opportunities for raising capital
by easing the prohibition on general solicitation and general advertising in offerings exempt from SEC registration under Rule
506 of Regulation D (17 C.F.R. § 230.506 and see The JOBS Act and Regulation D). The JOBS Act added Section 4(b) to the
Securities Act of 1933 (Securities Act) providing that offers and sales of securities exempt under the JOBS Act's new Rule
506(c) (allowing general solicitation and advertising in offerings under certain conditions) will not be deemed public offerings
under the federal securities laws as a result of general advertising or general solicitation (15 U.S.C. § 77d(b)). This new provision
clarifies for private funds that they can continue to rely on the Section 3(c)(1) and Section 3(c)(7) ICA registration exemptions
when conducting offerings of fund interests using general solicitation in compliance with the revised rule. For more on Rule
506(c), see Practice Note, JOBS Act: Regulation D and Rule 144A General Solicitation Summary.
Investment Advisers Act

Federal Investment Adviser Registration and Regulation

The Advisers Act regulates investment advisers by requiring them to register as an investment adviser with the SEC unless
an exemption from registration is available (see Article, US Investment Adviser Registration: Overview). Unlike the ICA, which
regulates the fund itself, the Advisers Act regulates the sponsors and advisers to the fund.
Many sponsors of privateequity funds once avoided registration with the SEC under the Advisers Act by relying on an exemption
for investment advisers with fewer than 15 clients (with each fund advised counting as only one client) and that do not hold
themselves out to the public as investment advisers (often referred to as the private investment adviser exemption) (see Article,
US Investment Adviser Registration: Overview: Advisers Exempt from Registration). The Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (Dodd-Frank Act) eliminated the private investment adviser exemption, requiring advisers
to privateequity funds to register with the SEC unless they can rely on an alternative registration exemption (see Practice Note,
Summary of the Dodd-Frank Act: PrivateEquity and Hedge Funds).
The Dodd-Frank Act expands the number of privateequity fund sponsors that must register with the SEC under the Advisers
Act. Most US managers of privateequity funds with assets under management of $150 million or more must register with
the SEC as investment advisers. For advisers required to register, the Dodd-Frank Act imposes additional recordkeeping and
reporting requirements as well as new examination and audit obligations (see Practice Note, Summary of the Dodd-Frank Act:
PrivateEquity and Hedge Funds: Recordkeeping and Reporting Requirements).
The Dodd-Frank Act created an exemption for foreign private advisers that do not have a place of business in the US, have
fewer than 15 US clients and US investors in the private funds it advises, and have less than $25 million in aggregate assets
under management from its US clients and US private fund investors. (15 U.S.C. §§ 80b-2(a)(30), 80b-3(b)(3) and see Practice
Note, Summary of the Dodd-Frank Act: PrivateEquity and Hedge Funds: Foreign Private Advisers).
US State Investment Adviser Registration and Regulation

In addition to federal regulation under the Advisers Act, investment advisers may be subject to US state registration and conduct
regulation requirements. Under the prior Advisers Act rules, investment advisers with less than $25 million in aggregate assets
under management were not generally required to register with the SEC (but were subject to applicable US state regulation).
The Dodd-Frank Act amends the Advisers Act to also require mid-sized investment advisers (with assets under management
between $25 million and $100 million, subject to adjustment by the SEC) to register in the US state in which their principal office
and place of business is located if the adviser is subject to registration and examination as an investment adviser with that US
state (15 U.S.C. § 80b-3a(a)(2) and see Practice Note, Summary of the Dodd-Frank Act: PrivateEquity and Hedge Funds:
Federal and State Jurisdiction Over Investment Advisers).
The Dodd-Frank Act potentially expands the jurisdiction of US state regulators over investment advisers to privateequity funds
with assets under management of $100 million or less. Many states have their own exemptions from state registration, however,
so a privateequity fund manager with assets under management of $100 million or less may be exempt under both US federal
and state laws.
Other Applicable Investment Adviser Act Regulations

Even if not required to register as an investment adviser with the SEC, investment advisers are subject other requirements under
the Advisers Act, including:

• A fiduciary duty to the fund, in addition to any fiduciary duties that exist under US state common law.
• A prohibition from engaging in any act or practice that is fraudulent, deceptive, or manipulative with respect to the fund
(15 U.S.C. § 80b-6(2)).
Securities Act
Offers and sales of securities in the US (including privateequity fund offerings) may only be made pursuant to a registration
statement filed with, and declared effective by, the SEC as required under the Securities Act, or in accordance with an exemption
from the registration requirements (see Practice Note, US Securities Laws: Overview: Securities Act). SEC registration is a costly
and time-consuming process that requires a significant level of disclosure, so interests in privateequity funds are usually offered
to US investors under one of the private placement exemptions from registration (see Practice Notes, Unregistered Offerings:
Overview and Section 4(a)(2) and Regulation D Private Placements).
To qualify as private offerings exempt from registration, privateequity fund interests may only be offered to sophisticated
investors who have the knowledge and experience in financial and business matters to evaluate the risks and merits of the
proposed offering (see Practice Note, Unregistered Offerings: Overview: Who Can Buy Unregistered Securities?).
When offering securities within the US, sponsors of privateequity funds often rely on the registration exemption provided by
Section 4(a)(2) of the Securities Act (15 U.S.C. § 77d(a)(2) and see Practice Note, Section 4(a)(2) and Regulation D Private
Placements: Section 4(a)(2) Issuer Private Placements). Section 4(a)(2) is a private placement exemption available to issuers
for sales of their securities to a limited number of sophisticated investors and not to the general public. To qualify for an exemption
under Section 4(a)(2), among other things:
• The number of offerees and purchasers must be limited.
• There should be no general solicitation of purchasers or general advertising of the offering (see Fund Marketing).
• Offers and sales should only be made to institutions and individuals that qualify as qualified institutional buyers (QIBs)
or accredited investors.
In addition to relying on the Section 4(a)(2) private placement exemption, a sponsor may try to qualify for one of the private
placement safe harbors provided by Regulation D (see Practice Note, Section 4(a)(2) and Regulation D Private Placements:
Regulation D Safe Harbor Requirements). Regulation D contains multiple regulatory safe harbors from the Securities Act
registration requirements, each with its own offeree qualifications and limitations. To ensure that a private placement falls within
the black letter of Regulation D, a fund issuer files Form D with the SEC no later than 15 days after the first sale of securities
made under Regulation D (see Form D and Practice Note, Form D: Notice of Exempt Offering of Securities).
An issuer should also check that the offering complies with US state securities law requirements (known as blue sky laws), which
may require a notice filing or other filing with the state (see Blue Sky Laws for Regulation D Rule 506 Offerings: State Q&A Tool).
The JOBS Act and Regulation D

To implement Section 201(a)(1) of the JOBS Act, the SEC created a new subsection (c) of Rule 506 of Regulation which permits
Rule 506 offerings using general solicitation and general advertising if three conditions are met:
• Each investor in the offering is an accredited investor.
• The fund takes reasonable steps to verify that each investor is an accredited investor.
• All other terms and conditions of Rule 501, 502(a), and 502(d) under Regulation D are satisfied.
(17 C.F.R. 230.506(c).)
The existing private placement safe harbors of Rule 506 continue as separate exemptions so that fund issuers conducting Rule
506 offerings without using general solicitation and general advertising can continue to conduct their offerings in the same manner
as past Rule 506 offering practice. For more on Rule 506(c) and these conditions, see Practice Note, JOBS Act: Regulation D
and Rule 144A General Solicitation Summary.
The JOBS Act changes to the Securities Act and Regulation D have important capital raising implications for private funds.
Sponsors to private funds that meet the new safe harbor are now able to market new funds to potential investors through general
solicitation and advertising, including print, broadcast and internet advertisements, website notices and press releases, media
interviews and seminar presentations, and other forms of solicitation (see Fund Marketing). Sponsors are still subject to the
antifraud provisions of federal securities laws, however, and any applicable state blue sky securities laws that restrict general
solicitation and advertising.
Securities Exchange Act
The Exchange Act requires an issuer with total assets exceeding $10 million to register any class of equity securities with the
SEC if:
• The issuer is not a bank or bank holding company and the securities are held of record by either:
• 2,000 or more persons (this threshold was significantly increased from 500 or more persons under provisions of
the JOBS Act (see Practice Note, JOBS Act: Exchange Act Registration Thresholds Summary)); or
• 500 or more persons that are not accredited investors.
• The issuer is a bank or bank holding company and the securities are held of record by 2,000 or more persons.
(15 U.S.C. § 78l(g).)
To avoid registration under the Exchange Act, most US privateequity funds try to limit the number of record owners to below the
applicable threshold. This is not generally an issue for private funds, particularly following the increase in the registration threshold
to up to 2,000 persons. If the fund has to register its securities, it becomes subject to onerous reporting and recordkeeping
requirements, as well as Sarbanes-Oxley Act of 2002 compliance requirements (see Practice Notes, Periodic Reporting and
Disclosure Obligations: Overview and Corporate Governance Standards: Overview).

Under Rule 10b-5 of the Exchange Act, it is unlawful to make any material misrepresentation or omission in the fund's offering
materials (15 U.S.C. § 78j(b), 17 C.F.R. § 240.10b-5, and see Practice Note, Liability Provisions: Securities Offerings: Section
10(b) of the Exchange Act and SEC Rule 10b-5). Investors (and the SEC itself) have a private right of action against the fund and
any sponsor of the fund, as well as any individual who makes an oral misrepresentation or omission to investors (for example,
in statements by sponsor personnel at a road show presentation). The party seeking civil liability under Rule 10b-5 must be
able to show:
• A misrepresentation of a material fact, or a failure to disclose a material fact that there was a duty to disclose.
• The misrepresentation or omission was committed with intent to deceive or was reckless.
• Reasonable reliance on the misrepresentation or omission.
• In the case of investor claims, resulting damages proximately linked to the misrepresentation or omission.
(See Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258, 267 (2014)
A fund investor may be unable to prove that a misrepresentation or omission occurred or that it reasonably relied on a
misrepresentation or omission, however, if the fund's PPM fully and adequately disclosed the potential risks that supposedly led
to the investor's loss (see Private Placement Memorandum).
The Exchange Act also requires that anyone engaged in the business of effecting transactions in securities for an issuer must
be registered as a broker with the SEC (for an overview of broker-dealer registration requirements in the US, see Practice Note,
Broker-Dealer Registration: Overview). The SEC has noted that anyone who gets paid on a commission basis for raising capital
for an issuer, including for a privateequity fund, must be a registered broker. A fund investor may have the right to rescind the
investment and receive a return of its capital contributions, possibly plus interest, if a person raising capital for the fund is not
registered as a broker, but should be (15 U.S.C. § 78cc(b).). For example, if an employee of the sponsor is paid a commission
for finding investors for the fund, that employee could be deemed to be acting as an unregistered broker, which could subject
the employee and the sponsor to sanctions. The SEC has increased its focus in recent years on whether privateequity fund
managers should be required to register as broker-dealers based on the fund's fees in connection with portfolio company sale
transactions or incentive compensation paid to fund employees for marketing the fund's LP interests. Fund managers and their
counsel should consider these issues when structuring fund fees and employee compensation.
For more on Exchange Act registration, see Practice Note, Exchange Act Registration: Overview.
ERISA
The Employee Retirement Income Security Act of 1974 (ERISA) may place restrictions on privateequity funds if the fund is
deemed to hold plan assets under the ERISA plan asset rules (see Practice Note, ERISA Plan Asset Rules). ERISA treats the
sponsor, rather than the fund, as directly managing the plan assets of any benefit plan investors unless the fund meets one of
the exceptions from the ERISA look-through rules and applicable regulations.
Privateequity funds usually try to meet one of the three most well-known exceptions to the ERISA look-through rules:
• Less than 25% of the value of any class of the fund's equity is held by benefit plan investors (the 25% test).

• The fund qualifies as a venture capital operating company (VCOC).
• The fund qualifies as a real estate operating company (REOC).
(29 C.F.R. § 2510.3-101.)
For an overview of these exceptions, see Practice Note, ERISA Plan Asset Rules: Exceptions to Look-Through Rule. If one of
the exceptions applies, the underlying assets of a privateequity fund in which a benefit plan investor makes an investment are
not considered plan assets under ERISA. Most privateequity funds are structured to comply with the 25% test or, for private
funds other than hedge funds, to operate as a VCOC or REOC.
If the fund is not exempt from ERISA and is deemed to hold plan assets subject to ERISA, the fund's investment adviser (the
sponsor) may be deemed to be a fiduciary with respect to the ERISA plan assets invested by benefit plan investors (those
investors' capital commitments to the fund) (see Practice Note, ERISA Plan Asset Rules: Effect of Look-Through Rule on Plan
Investments).
A sponsor who breaches its fiduciary duties under ERISA is subject to substantial penalties, including:
• A requirement to restore losses to the investors or to disgorge profits earned by the sponsor as a result of the breach of
fiduciary duty.
• Personal liability.
• Equitable remedies, such as removal of the sponsor from the...
*** Start Section

... plan investors in a fund may:
• Require representations, covenants, legal opinions, or periodic certifications that the fund is exempt from ERISA.
• Negotiate special withdrawal rights and other remedies in the event that the fund does become subject to ERISA.
Fund sponsors who want to ensure that the fund is exempt from ERISA can include provisions in the operating agreement that
restrict, or reduce investment by, benefit plan investors to the extent necessary to avoid the application of ERISA (for example,
by including in the operating agreement mandatory distribution rights and prohibitions on transfers to benefit plan investors).
For an example of ERISA provisions in the fund's operating agreement, see Standard Document, Limited Partnership Agreement
(LPA) for PrivateEquity Fund: Article XIV.
Principal Legal Documents

Certain principal investment documents and other ancillary documents are standard in the formation of a privateequity fund.
Private Placement Memorandum

The private placement memorandum is the primary marketing document through which the fund markets its interests to
prospective investors. The US federal securities laws do not require PPMs to be delivered to sophisticated investors such as QIBs
and accredited investors in connection with a private offering of fund securities (see Securities Act), although it is generally market
practice to provide a PPM to prospective investors. Regulation D of the Securities Act governs the information requirements
for nonaccredited investors in connection with a private placement of fund interests. Because the information requirements are
onerous, however, privateequity fund interests are not usually marketed to nonaccredited investors (see Practice Note, Section
4(a)(2) and Regulation D Private Placements: Information Requirements for Non-Accredited Investors).
The Securities Act and its related rules do not mandate any specific content, however, PPMs generally contain the following
information:
• Business sections. From a business and marketing perspective, the sponsor wants the PPM to describe:
• the target investments of the fund;
• the background of the sponsor and its investment team, including its performance track record; and
• the target industries and geographic regions in which the fund will invest.
• Summary of terms. Describes the key legal terms to be contained in the operating agreement of the fund.
• Risk factors and conflicts of interest. Describes the key risk factors involved in making an investment in the fund to
apprise the investors of the...
•
... in which the fund expects to invest;
• the management team; and
• other material considerations and risks of which a reasonable investor would expect to be apprised.
In addition, the PPM often includes a description of the primary conflicts of interest involved in making an investment in
the fund, or in the management and operation of the fund by the sponsor and its investment team. For example, sponsor
conflicts when managing the fund along with other funds, ventures, projects, or businesses managed by the sponsor.
• Other key legal and tax considerations. Often, PPMs targeting a particular investor base include a summary of key
tax considerations for an investor making an investment in the fund (for a discussion of the common form of entity
and tax treatment of a privateequity fund, see Investment Fund). For example, a US fund may include a summary of
material US tax consequences that a US or non-US investor would want to take into consideration before making an
investment. Other PPMs may include a description of other key regulatory restrictions on investors who might not be
otherwise qualified to invest or key regulatory considerations for investors before making an investment (such as filing
requirements or potential liability under applicable law).

• Advisers Act compliance. The Advisers Act contains numerous rules regarding the content of marketing materials
that may be provided by registered investment advisers to investors which are reflected in a fund PPM (see Investment
Advisers Act). Even for unregistered investment...

... investor, such as:
• forced sale of the defaulting investor's capital account to other existing investors at a discount;
• interest penalties;
• automatic reduction of the defaulting investor's capital account to cover owed amounts and penalties; or
• the loss of all or certain rights as an investor, including participation in future investments or voting determinations.
• The delivery of annual and quarterly financial reports and other informational reports to the investors.
• Provisions limiting transfers of interests by the investors unless permitted under the provisions of the operating
agreement or with GP consent.
• Other standard legal terms, depending on the form of the vehicle and its jurisdiction of incorporation.
For an example of a limited partnership agreement for a privateequity fund, see Standard Document, Limited Partnership
Agreement (LPA) for PrivateEquity Fund.
Subscription Agreement and Investor Questionnaire
An investor subscribes to a fund as a limited partner, member, or other equity holder by executing a subscription agreement,
which sets out the investor's capital commitment to the fund. By executing the subscription agreement, the investor also agrees to
the rights and obligations of the investors in the fund's operating agreement (by including a joinder signature page to the operating
agreement) and makes representations and warranties to the fund, including representations and warranties confirming that
is it qualified to invest.
In connection with the subscription of interest, investors are typically required to fill out an investor qualification statement or
other investor questionnaire:
• Confirming that the investor is qualified under applicable laws to invest in the fund.
• Providing other supplemental information and appropriate...
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... investor alters the terms of that investor's agreement with respect to its investment in the fund, and its rights and obligations
under the operating agreement. Certain investors require side letters because of their special regulatory or tax needs. Other
investors may command additional or special economic, informational, or other benefits as a condition to their investment. The

extent to which a fund may be permitted to enter into a side letter, or otherwise alter the terms of an investment in the fund with
respect to one of more investors, is set out in the operating agreement of the fund. For an example of a provision in the fund's
operating agreement allowing the fund to enter into side letters, see Standard Document, Limited Partnership Agreement (LPA)
for PrivateEquity Fund: Section 16.01(e).
Investment Management Agreement
The management company or investment adviser of the fund is often retained directly by the fund, or its GP or managing member
pursuant to a separate investment management or investment advisory agreement (see Management Company or Investment
Adviser). The agreement contains the general terms under which the investment adviser is authorized to act as the fund's
manager or other agent in connection with fund investment in exchange for the fund's management fee (see Management Fees).
Form D
If a sponsor is relying on the specific private placement safe harbor of Regulation D to avoid registration with the SEC when
offering interests in the fund (see Securities Act), a SEC Form D notice of the sale of fund interests must be filed with the SEC
within 15 days of the first sale under Regulation D to ensure that the private placement falls within the black letter of Regulation
D. Form D requires certain basic information such as:
• The offering price of the interests.
• The number and location of purchasers.
• Details of offering expenses (including sales commissions).
• A description of the use of proceeds raised from the sale of the interests.
Issuers of fund interests (primarily ones conducting institutional offerings) do not always choose to file a Form D to perfect the
Regulation D safe harbor, and an issuer is not necessarily disqualified from using the private placement exemption if it fails to
file a Form D (see Securities Act). For more on Form D, see Practice Note, Form D: Notice of Exempt Offering of Securities.
Distinguishing Hedge Funds from PrivateEquity Funds

The distinction between hedge funds and privateequity funds is imprecise. There are hybrid funds that
exhibit both hedge fund characteristics and privateequity characteristics. Hedge funds are distinguished from
privateequity funds by the following features:
• New investors can buy into a hedge fund, and existing investors can add to their fund interest,
periodically.
• Investors are entitled to have their hedge fund investments redeemed periodically, in whole or in part,
although limitations may apply.

• Hedge fund investments are generally funded immediately in cash, whereas privateequity fund
investors make capital commitments that are drawn by the fund manager as needed (see Capital
Commitments).
• Hedge fund investors generally participate in all fund investments from the time they acquire an interest
in the fund based on the fund's net asset value at that time, whereas privateequity fund investors
generally participate only in investments made after they join the fund and, in some cases, those made a
relatively short period before their investment (subject to an interest charge).
• Hedge funds generally sell assets and reinvest the proceeds on an ongoing basis, whereas
privateequity funds are generally required to distribute proceeds to investors after an investment is
liquidated (see Recycling of Capital Commitments). Accordingly, hedge funds tend to be appropriate
for investment strategies involving frequent trading in liquid assets with easily ascertainable fair
market values (such as the stock of publicly-traded companies), while privateequity funds tend to be
appropriate for investment strategies involving infrequent trading or investment in illiquid assets whose
interim valuations may be difficult to establish (such as a leveraged buyout of a private company or a
going private transaction (see Practice Notes, Buyouts: Overview and Going Private Transactions:
Overview).
* The author wishes to recognize the assistance of his colleagues, partners Morton E. Grosz, Marjorie M. Glover (on ERISA
matters) and Edouard S. Markson (on tax matters), counsel Adam D. Gale (on regulatory matters), and...

Private Equity Fund Formation

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Private Equity Fund Formation, Practical Law Practice Note 3-509-1324

Private Equity Fund Formation

General Fund Structure

General Partner or Manager

Management Company or Investment Adviser

Related Fund Vehicles

Allocations and Distributions

Fundraising and Fund Closing

Fund Term: Investment and Divestment Periods

Early Termination Events

Transactions with Affiliates

Investor Advisory Committee

© 2024 Thomson Reuters. No claim to original U.S. Government Works. 1

Certain US Regulatory Matters

Investment Advisers Act

Securities Exchange Act

Principal Legal Documents

Fund Partnership or other Operating Agreement

Subscription Agreement and Investor Questionnaire

Investment Management Agreement

Distinguishing Hedge Funds from Private Equity Funds

© 2024 Thomson Reuters. No claim to original U.S. Government Works. 2

• Their general structure and the key entities involved.

• Fund economics, including fund fees and expenses.

• Fund term and investment and divestment periods.

• Governance arrangements and managing conflicts.

General Fund Structure

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© 2024 Thomson Reuters. No claim to original U.S. Government Works. 4

• *** Start Section

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General Partner or Manager

Management Company or Investment Adviser

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Related Fund Vehicles

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• Which are not necessarily investors in the main fund.

© 2024 Thomson Reuters. No claim to original U.S. Government Works. 7

• The expertise and track record of the sponsor.

• The investment purpose and structure of the fund.

• General market dynamics.

• Investor capital commitments (see Capital Commitments).

• Fees paid to the fund's investment adviser (see Fund Fees).

• Expenses of the fund (see Fund Expenses).

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Recycling of Capital Commitments

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• Article, Understanding Partnership Target Capital Accounts.

• LLC Agreement (Multi-Member, Board-Managed) (PrivateEquity Buyout).

© 2024 Thomson Reuters. No claim to original U.S. Government Works. 9

• The current tier is satisfied and the next tier is reached.

Return of Capital Contributions and Preferred Return

• All unreturned invested capital in previously realized investments.

• All unreturned contributed capital.

© 2024 Thomson Reuters. No claim to original U.S. Government Works. 10

• Accrues from the time the capital contributions are made.

Carried Interest and Catch-up

• Deal-by-deal carry with loss carryforward. Deal-by-deal carry...