Private Equity 20 Lectures (15) Private Equity Cross-Border Structures in Detail US

Private Equity 20 Lectures, Legal Essentials for Silicon Valley Investors, I'm U.S. Attorney Xiaoxiao Liu.

The previous issues we mainly introduced are the most conventional U.S. domestic U.S. dollar funds, but when the fund is bigger and needs to be involved in the cross-border structure, we will see some of these concepts, Master-Feeder Fund Structure (Master-Feeder Fund Structure), Paralell Fund, Alternative Investment Vehicle (Alternative Investment Vehicle). Alternative Investment Vehicle).

So what do all these seemingly lofty terms mean? What are the differences and connections between them? Which structure should be used under what circumstances? Today we will introduce the cross-border structure of private equity funds.

First, let's take a look at a common U.S. fund structure, which consists of a General Partner (GP), a Limited Partner (LP) investing in a series of Portfolio Companies, the same kind of structure we've been talking about in previous issues.

On this basis, let's take a look at the more complex cross-border structure of private equity funds.

People must be dizzy at first glance.

I. Master-Feeder Fund Structure (Master-Feeder Fund Structure)

Master-Feeder Fund Structure (Master Fund Structure), which is referred to as Feeder Fund, usually serves to accumulate funds raised by U.S. Taxable Investors, U.S. Tax-exempt Investors and Non-U.S. Investors into a centralized vehicle, the Master Fund, through which the funds raised by Non-U.S. Investors are accumulated into a centralized vehicle, the Master Fund. U.S. Taxable Investors, U.S. Tax-exempt Investors, and Non-U.S. Investors into a centralized vehicle, the Master Fund, and through this sorting and aggregation, the critical mass of tradable assets can be increased.

What does "critical mass" mean? That is, when you are hungry, eat the first bun critical mass is very high, because at that time you are very hungry, and then eat the second feeling is not so obvious, that is, the critical mass is not so big, after eating the third you will be full, this time there will be no new critical mass, you eat the fourth will be vomited.

Investment in the critical mass is also the meaning of this, the beginning of the critical mass of investment is very high, but because most of the income tax is super progressive, that is, the more you earn, earn more of that part of the tax will be higher, you earn the first 100,000 may be as long as the payment of 10% of the tax, but you earn 400,000 to 500,000 between 100,000 may be 50% of the tax paid. The first $100,000 you make may only be 10% taxed, but the $100,000 you make between $400,000 and $500,000 may be 50% taxed. So making money also takes physical, mental, energy, if the tax rate is so high like the latter case, all the money earned to contribute to the country, then I have the effort to make money would be better to go home and sleep.

So back to the master fund (Master Fund), the role of its existence is to be as far away as possible to improve the critical mass of investment, so that the investment efficiency of the entire fund is maximized.

The companies used as Master Funds in this structure are usually incorporated in tax neutral offshore jurisdictions such as the Cayman Islands or Bermuda. I'm going to say a few words about tax neutrality here, I thought Cayman wasn't tax efficient? Yes, I have mentioned in many different programs that Cayman is no longer tax efficient and the BEPS signed by more than 135 signatories at the OECD meeting in October 2021 has made it clear that there will be no backdoor for Cayman, but that only means that Cayman is not Tax Free, but it is still Tax Neutral. ), that is to say, it does not have a tax nature or special tax rules, but are based on the tax policy of other countries in the transaction to determine. So Cayman or Bermuda, the biggest role of these places is that it is a blank sheet of paper, will not affect the whole transaction to add new factors to be considered. So the Cayman Islands as the main company listed is no longer feasible, but in the cross-border fund structure, but still the Master Fund (Master Fund) of the company set up the place of choice.

After the Cayman Master Fund is in place, some Feeder Funds will be injected into the Master Fund. What is the concept of Feeder Funds? Feeder Funds, its role is to package the money of various investors and then feed it into the Master Fund.

For the U.S. taxable investors (U.S. Taxable Investors), then set up a U.S. Limited Partnership Feeder Fund (U.S. Limited Partnership Feeder Fund) for them, which has a low establishment cost and is a tax-penetrating body because these U.S. Taxable Investors (U.S. Taxable Investors) are not able to hide anyway. Investors) can't be avoided anyway, so just pay the tax you need to pay.

For Non-U.S. Investors and U.S. Tax-exempt Investors, a separate Offshore Feeder Funds is created to avoid direct access to the U.S. tax regulatory network applicable to U.S. Taxable Investors. Investors) to avoid direct access to the U.S. tax regulatory network applicable to U.S. Taxable Investors.

This is like what, the Shanghai Hongqiao transportation hub, what's here? People coming from Jing'an Temple on Metro Line 2, people coming from Xintiandi on Line 10, people taking high-speed trains from Nanjing and Hangzhou to Hongqiao Railway Station. What do all these people do when they arrive? And then take a plane out of Hongqiao Terminal 1.

So the Hongqiao transportation hub plays the role of a Master Fund, and investors from all walks of life come through different means of transportation according to their different circumstances, and these different means of transportation are the Feeder Funds.

And the fund's management fee (Management Fee) and performance fee (Performance Fee/Carried Interest) can also be paid according to the level of different feeder funds (Feeder Funds). For example, if you have those in Jing'an Temple or Xintiandi, you will have to pay more Management Fee and Performance Fee/Carried Interest, while those in Nanjing and Hangzhou who have traveled a long way by high-speed train will have to pay less Management Fee and Performance Fee/Carried Interest. Carried Interest).

For a long time, U.S. multinational funds like to use the results of the Master-feeder Fund (Master-feeder Fund Structures), because the U.S. taxable investors (U.S. Taxable Investors) and non-U.S. investors (Non-U.S. Investors) or U.S. tax-exempt investors (U.S. Tax-exempt Investors) tax treatment is different. S. Taxable Investors and Non-U.S. Investors or U.S. Tax-exempt Investors are treated differently. But usually these Asian countries on the west coast of the Pacific Ocean have lower tax rates, while on the contrary, the U.S. on the east coast of the Pacific Ocean has a much higher tax rate, after using the Master-feeder Fund Structures (Master-feeder Fund Structures), that is to say, U.S. Taxable Investors (U.S. Taxable Investors) have to pay a high tax, and you don't want to drag us into the low tax rate! The place where the tax rate is low. If the investors are all from Asia, the use of Master-feeder Fund Structures (MFS) is not common, because most Asian countries and regions have relatively low taxes.

U.S. Tax-exempt Investors and Non-U.S. Investors typically invest through Offshore Feeder Funds, which are not subject to U.S. taxes. U.S. Tax-exempt Investors typically choose Offshore Corporations, while Non-U.S. Investors typically choose Offshore Limited Partnerships. Partners), which is mainly an unrelated business taxable income (UBTI) effect that we will not expand on.

II. Parallel Fund (Paralell Fund)

There is another type of structure called a Paralell Fund. For example, a fund program may include both a Master Fund in the Cayman Islands and a Paralell Fund in Delaware. Typically, these Paralell Funds and the Master Fund invest and divest together on the same terms and in the same proportion as the Capital Commitment.

The fund agreement of a Paralell Fund is usually substantially the same as the fund agreement of a Master Fund, but may be modified as appropriate for regulatory, tax, structural or other reasons. Therefore, it should be said that, compared to the Master-Feeder Fund Structure (Master Fund), which is primarily designed to satisfy the tax optimization of the investor's Limited Partner/LP, the Paralell Fund (Paralell Fund) is more designed to satisfy the regulatory compliance requirements of the fund's principal company.

III. Alternative Investment Vehicles (AIVs)

If the Paralell Fund is not able to fulfill the regulatory and compliance requirements, there is another possibility, which is Alternative Investment Vehicles (AIVs).

Unlike Master Funds and Paralell Funds, which typically invest in all projects together, Alternative Investment Vehicles are typically used for specific portfolio companies. In other words, Alternative Investment Vehicles are often set up not due to the tax requirements of the investor's Limited Partner/LP or the regulatory compliance requirements of the fund's main company, but due to the characteristics of the portfolio in which they are invested. It is due to the characteristics of the portfolio being invested in.

Private Equity Fund 20 lectures, Silicon Valley investors of the law must learn, I am the United States attorney Liu Xiaoxiao.