A THOROUGH UNDERSTANDING OF PRIVATE EQUITY

RETOUR SOMMAIRE

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - 2010

FISCAL AND OPERATIONAL ISSUES

U sing a limited partnership with a waterfall distribution model When choosing an investment structure, the limited partnership with a waterfall distribution model is still the favourite structure. The GP makes all decisions with a minimum investment into the vehicle, and LPs are not supposed to make decisions. However, LPs might be in- volved in the vehicle’s life thanks to committees organised like investment committees, audit committees, valuation committees and so on.

Figure 36: Illustration of an arrangement based on the limited partnership model

Partners

Limited Partners

Equity

General Partners (limited liabilities)

IRR until hurdle % of performance above hurdle (80%)

Ordinary shares

GP shares + Carried shares

Carried interest

Limited partnership

Investment adviser

Equity (1 to 5%)

Convertible preferred equity certificate

Net income at target 1 level

Target 1

Target 2

Copyright CACEIS, 2009

3.1.4

Financing the investments

3.1

Private equity collective investment vehicles investing in target companies need to determine and locate the financial instruments between the various entities: • Between investors and collective investment vehicles; • Between investment vehicles and intermediaries/SPVs; • Between the intermediaries/SPVs; • Between intermediaries/SPVs and the target companies following the need to locate debt and other financing instruments in the most appropriate structure; Equity stakes should grant security to the investment fund, thanks to the decision powers at the intermediaries/SPVs level, but the final goal is the exit of the target company or the SPV holding. The GPs sell their shares, report realised profit or loss on stocks and are taxed accordingly. Some hybrid instruments can give more flexibility to the GPs that may choose to convert the debt into shares of the financed company in order to take an additional equity stake, such as convertible bonds or convertible participating equity certificates. Moreover, for taxation pur- poses, these hybrid instruments can be seen as equity or as debt, depending on countries. Tax advisers can negotiate specific tax rulings for investment structures, thanks to this mix between equity and debt in the different domiciles of the intermediaries and SPVs. There is no general tax structure or tax rule. The instruments created are tailored in function of the type of final investment, the exit strategies, the countries, the type of company, the type of fund or the investors’ specificities. For tax efficiency, private equity houses generally use a mix of equity/debt instruments.

A thorough understanding of PE | page 57