There are multiple ways to set up a private equity fund. The most common types are described here.
FUND STRUCTURES
Whole Fund Model
Under the “Whole Fund” or “Blind Pool” model, investors purchase interests in a pooled investment fund (the Fund), which is usually formed as a limited liability company (LLC) or a limited partnership (if you are including Non-U.S. investors). For purposes of this article, we will assume the structure is a Manager-managed LLC with two classes of members (Class A and Class B Members). The Fund will be the sole or partial owner of multiple assets (Assets).
The Fund will form a new, subsidiary entity to hold title to each new Asset in which the Fund invests. Bank loans will occur at the Asset level, which is also where all operating expenses and debt services will be paid and any required lender reserves will be held. Periodically, excess cash will be swept from the Asset bank account to the Fund bank account, where cash from all Assets are pooled prior to determining “Distributable Cash” (after-expense cash flow) to the Fund’s Class A and Class B Members. Asset Management Fees may be paid to the Fund Manager at the Asset level or from the Fund as described in the respective Operating Agreements for the Fund and each Asset. In the Whole Fund model, investors share in profits and losses associated with all of the Fund’s Assets, and distributions are calculated after aggregating cash from all of the Assets.
Deal-by-Deal Model
The “Deal-by-Deal” model is similar to the Whole Fund model in that all investors invest in the Fund; however, instead of aggregating cash prior to making distributions, Distributable Cash is calculated separately for each Asset and then aggregated. This could create a situation where the Fund Manager receives distributions from performing Assets, even while other Assets are not performing. To mitigate this effect on Fund investors, a “clawback” of excess Manager distributions may be required if certain preferred returns or other investor returns haven’t been met in the aggregate.
Advantages of Both Fund Models
The above models offer diversity to investors and allow you to raise money before you have an Asset identified. However, private equity companies and family offices seem to be reluctant to invest in a pooled investment fund. To overcome this objection, a correctly structured Whole Fund or Deal-by-Deal Fund should offer sufficient flexibility that private equity and family office investors can co-invest with the Fund at the Asset level without becoming Members of the Fund.
From a cost perspective, each of the above Fund models will require initial setup fees for a PPM, Fund Operating Agreement, Subscription Agreement and the “Investment Summary” describing your business model; plus, you will need new single-purpose entities set up for each Asset, as well as securities notice filings. As these documents are significantly more complex than a Specified Offering (described below), it will cost more to set up a Fund than to set up a Specified Offering.
Specified Offering Model
The Specified Offering Model is based on raising funds to acquire a specific Asset. For this model, each Asset will have a separate PPM (if needed), an LLC Operating Agreement that will hold title to the Asset and sell interests to investors, a Subscription Agreement, and securities notice filings. Funds are raised for a specific deal, with separate investors in separate Assets, although it is possible to do a multi-Asset specified offering when the Assets have been identified prior to launching the offering. The advantage of this model is that it is the easiest way to raise money, as investors like to invest in tangible things versus investing in your business model and trusting you to invest in Assets that meet your criteria.
From a cost perspective, you will incur initial setup fees for the PPM, LLC Operating Agreement, Subscription Agreement, and securities notice filings for each Asset you acquire. Despite the additional costs, this model works because it is often easier to get investors to invest in specific Assets than it is to get them to invest in a Fund. Thus, it is the easiest way to raise money. And don’t forget, your legal and organization expenses are reimbursable if you build them into your fund raise.
New Fund Models for More Flexibility
SeriesFlex Fund Model (Series LLC)
The SeriesFlex Fund is based on the use of a Series LLC, where each new Asset is held in a separate “Series” under a master LLC. Each Series has its own books, bank accounts, and membership interests, and is treated as legally distinct from the other Series under applicable state law.
In this model, investors can invest in one or more individual Series, which corresponds to specific Assets, allowing deal-by-deal investment options under a single Fund structure. Each Series can have its own business terms, distributions, and timelines, while reducing the need for setting up a new LLC for each Asset. From a legal standpoint, however, investors in different Series are still considered part of the same issuer for purposes of securities law, so proper disclosure and tracking are critical.
This structure provides administrative efficiencies and reduced filing and setup costs compared to forming separate LLCs for each Asset, though it may not be ideal in states or with lenders that don’t recognize the liability separation of Series LLCs.
FlexClass Fund Model (Multiple Classes in a Single LLC)
The FlexClass Fund structure utilizes separate membership classes within a single LLC, where each class corresponds to a different Asset or investment strategy. This is often used for “fund of funds” clients who are not taking title to Assets, but instead investing in other syndications or funds.
Each class may have its own capital commitments, economics, and rights, while the parent LLC holds all investments. This setup allows for a centralized management structure and ease of administration, while maintaining separation between investors in different deals or strategies.
This model is attractive for investment sponsors who want to run multiple offerings under one LLC with a single Operating Agreement and PPM, amending these documents with deal-specific supplements for each new class. It also provides flexibility in managing investor expectations, especially when investing into other sponsors’ deals rather than owning hard assets directly.
Summary
In summary, the best deal structure is the one that allows you to raise money for your stated business purpose. Those who are starting out should consider doing a series of Specified Offerings to build a track record. Those with substantial experience in a specific Asset class or with previous securities offerings can do successful Fund Offerings. SeriesFlex and FlexClass Funds provide additional structuring options that combine elements of both pooled and specified deal strategies while offering administrative and cost advantages in the right circumstances.
We can help with any of these structures; and we can help you choose the Fund Structure that is best for you.
