IN last week’s fourth part of our ten-part article series on private equity in Tanzania, we discussed about the structuring of private equity (PE) funds. In this week’s fifth part, we look at the nuts and bolts of a new PE fund’s offering of its interests to investors, and the “closings” of the fund. By “investors”, we mean the limited partners (LPs), such as, pension funds, endowment funds, sovereign funds, insurance companies, and high net worth individuals, etc.
Given the broad definition of “securities” and “dealing in securities” under Section 2 of the Capital Markets and Securities Act, 1994 (“the Act”), the sale of a Tanzania-domiciled PE fund’s interests to investors will highly likely amount to an offering of securities that requires registration with the Capital Markets and Securities Authority (CMSA) unless exempted from registration under the Act and regulations made thereunder; in particular, the Capital Markets and Securities (Collective Investment Schemes) Regulations, 1997.
For this reason, engaging legal counsel to help you understand the Act and make consultations with the CMSA is important in order to carefully and properly negotiate and prepare the basic documentation for offering a PE fund’s interests to investors.
When starting a new PE fund, the general partner (GP), also known as the “sponsor”, will at the outset require a private placement memorandum (PPM), sometimes referred to as “offering memorandum” or “offering document” to attract investors. The PPM is a crucially important document that discloses the objectives, risks and terms of a proposed investment in the PE fund.
After the PPM is sent to prospective investors, the GP has to work on the limited partnership agreement (which governs the PE fund) and the subscription documents. Care must be taken when negotiating contracts for placement agent services (the “placement agency agreement”/PAA). A placement agent, hired to assist in the raising of capital swiftly by introducing the PE fund’s manager to investors, may draft its own version of the PAA which the PE fund can review.
Investors will certainly conduct strong due diligence before deciding to invest in the PE fund. Here, the GP will need to avail copies of the PPM, PAA, fund formation documents, and other agreements the PE fund has entered into with key external service providers. Additional requests may extend to material contracts, such as, shareholder agreements, share purchase agreements, and third party vendor agreements.
Investors may also request to review the compliance and operational frameworks of the PE fund, as are the key clauses in the limited partnership agreement (LPA). There’s the possibility of an investor asking the PE fund to enter into a side letter to vary the terms of the LPA with regard to that investor (almost always to the investor's benefit) as a prerequisite to investing in the fund.
After securing capital commitments from a sufficient number of investors (with each investor committing, say, $1 million), the PE fund will be moving towards its “initial closing” or “first closing”. This basically means that when a given threshold of money has been raised, the PE fund can start making investments and, in fact, close deals and new LPs can still join in the fund by committing capital for a specified time from the initial closing. But, as new investors join in, the GP may need the consent of existing investors before amending the LPA.
The process of closing mainly entails investors presenting executed subscription agreements, side letters, and capital commitments that are due and payable to the PE fund, which then accepts the commitments by countersigning and returning the agreements, together with the notice of closing. This process likewise involves the creation of an operating agreement and the appointment of the investment manager (a legal entity).
Subsequent or additional closings do happen following the initial closing. Thus, a “subsequent investor” or “additional investor” in private equity industry parlance means an investor joining after the first closing date of the new PE fund. However, if an existing investor increases its commitment in the fund such investor becomes a subsequent investor only in respect of its increased commitment.