In one look
Here is the typical (and simplified) business model of the private equity / venture capital industry: The private equity firm creates a fund and seeks “capital commitments” from institutional and high net worth investors. During the first 5-6 years of the fund’s life, the company would seek attractive targets to acquire and leverage “capital contributions” from investors to fund these transactions, while collecting a management fee based on the total liabilities. For the remaining term of the fund, the company would seek to withdraw from investments by selling the acquired assets at a profit and generating returns for investors. Management fees are still levied during this exit period but can be calculated on a reduced basis (usually on “invested capital” then). Profits generated for investors above a certain threshold (“preferred return”) are shared with the company (“carried interest”). These arrangements are generally linked by a structure known as a “limited partnership”.
Although PE / VC investments in Thailand have been emerging and grabbing the headlines for quite some time, acquirers typically fund the investments with their own money through their own PE / VC arms. However, Thailand has recently seen a growing interest in PE / VC’s traditional business model of raising funds from third-party investors and earning money through management fees and deferred interest. Attention has shifted to a relatively new type of investment vehicle called a private equity trust (PE trust). In this article, we’ll explore several aspects of private equity trust, which we believe have recently gained traction and generated interest in the Thai capital market.
What is PE trust?
The PE trust is a type of investment vehicle under the Trust for Transactions in the Capital Market Act BE 2550 (the “Trust Act”) and is regulated by the Securities and Exchange Commission (the “SEC”) .1 Key Features legal defined by the SEC are that (1) the PE trust must raise funds from more than one eligible investor2 without intending to be a “private trust” and (2) the legal form of the investment is equity (or the provision of financial support in exchange for an option to acquire equity at a later stage) with an arrangement that allows participation in the management (or an active role in the operation) of the companies transmitters.
The SEC intends the PE trust to be a new type of investment vehicle for fundraising and private equity investment activities 3 in Thailand, much like what other countries have achieved with their vehicles. limited partnership.4 But despite its name, the PE trust can be used for a variety of investment strategies: private equity, venture capital, debt and other types of investments. Throughout this article, we’ll explore in more detail how the PE trust can mimic the typical private equity fund that takes the form of a limited partnership that can be found in places like Singapore, the Cayman Islands, Luxembourg and the United States.
Concepts borrowed from the foreign limited partnership
The content of a trust deed is regulated by the trust law and the relevant SEC notice.5 But as long as the trust deed meets the minimum content6 defined by law, the parties have ample control. opportunity to be flexible in their trade agreements as part of the trust deed. It’s by design. As mentioned earlier, the SEC Office hears that this type of investment vehicle resembles offshore private equity funds that take the form of a limited partnership. In fact, this drafting flexibility allows trust promoters to employ many of the mechanisms typical of foreign limited partnership agreements, which is an attractive feature of the PE trust. Here we will discuss two examples of such mechanics: capital commitment / contribution and the distribution cascade.
1. Capital commitment and capital contribution
One feature that distinguishes offshore private equity funds from typical Thai investment vehicles such as mutual funds and limited liability companies is when the capital is brought into the vehicles. Thai investment vehicles generally require the capital to be provided fully in advance without any additional commitment from investors. An exception could be the way in which shares of private companies can be partially prepaid (which must be paid at least 25%). On the other hand, offshore private equity funds generally do not require a contribution of capital when the fund is created, but investors undertake to contribute capital when called upon at a later stage, usually in installments. . At the root of this practice is the fact that most private equity funds do not deploy capital immediately after their formation, as well as the fact that fund performance is usually measured as an internal rate of return (IRR). ). By the way, the undrawn liabilities available to the fund manager are called, in industry jargon, “dry powder,” representing the acquisition ammunition available to the fund. As of June 30, 2021, according to Bain, the dry powder industry stood at a whopping $ 3.3 trillion.
2. Distribution cascade
An essential feature of most private equity funds, a distribution cascade is the method by which distributions are made by a fund to various parties (notably, investors and the fund manager). A topic that easily justifies a dedicated article, a distribution cascade, in layman’s terms, determines when and how much, if any, the general partner or fund manager must take a share of investors’ profits – called “interest held” or ” carry ”- generally after investors have received a repayment of their contributed capital and a preferred return8 (sometimes called a“ hurdle ”or“ hurdle rate ”). A distribution cascade, however, varies in terms and complexity. For example, some funds may specify multiple levels of obstacles and carry.
The flexibility of documenting PE trusts allows for the mechanics of a distribution cascade, however complex, to be incorporated to allow the return on investment to be distributed between the trust manager and investors in a predetermined order.
Here is a simple illustration.
In this illustration, the investor (LP) will get all the proceeds from the investment until he has received all of his contributed capital9 plus an IRR of 8% per annum. Thereafter, the fund manager (PM) will take 20% of every dollar of profit that would otherwise belong to the investor until the investor has received a return which represents an IRR of 12% per annum, at which point the fund manager’s profit sharing percentage will increase to 30%.
Key legal concepts
1. Parties concerned
The parties involved in any PE trust include the trustee, the trust manager, the settlor and the investors.
a) Trustee as legal owner and settlor
As the PE trust is still considered a form of trust, a chartered trustee should be involved as the sole legal owner of the trust assets. Only trustees with a specific license for the PE trust can act as a trust for the PE. As of this writing, there are three Trustees with such a license posted on the SEC website. In addition to holding the assets of the trust, the trustee, as a licensed business operator, is responsible for ensuring that the trust under his management is managed in accordance with the trust deed and relevant laws and regulations.10
As for the formalities, you need a settlor who transfers a first asset in the form of cash to the trustee in order to set up a PE trust. A settlor must either be the trustee itself or a duly registered trust manager. Typically, particularly in cases where the trust manager is not duly registered with the SEC office to act as a settlor, the trustee assumes both the roles of trustee and settlor.
b) Trustee as manager of the fund
In what the SEC sees as a check and balance mechanism, the trustee is required to appoint a third party “trust manager” to manage the affairs of the trust. Acting as a trust manager of a trust does not require a license from the SEC. In the real world, the trust manager is the transaction sponsor (or general partner, or GP, in the context of a foreign limited partnership) who engages a licensed trustee to act as both trustee and settlor. to set up a PE trust. Day-to-day and investment responsibilities, including perks such as management fees and carry, will rest with the trust manager while the roles of the trustee will be limited to supervisory tasks such as overseeing the trust manager. to manage the trust in accordance with the trust deed and those directly related to the regulator such as routine deposits.
c) Investors as beneficiaries
Finally, there must be beneficiaries who will reap the benefits of the returns generated by the trust. While the law does not require the beneficiaries to be the trust’s funding provider, in reality it is the trust investors who provide the funding and reap the profits as the trust beneficiaries. The terms are therefore often used interchangeably.
2. Setting up a PE trust
Unlike other types of trusts such as REITs (Real Estate Investment Trusts), setting up a PE trust does not require approval from the SEC office. In fact, as soon as the following actions are taken, a PE trust is said to be set up: 11
(a) the initial cash is transferred by the settlor to the trustee as the initial asset of the trust;
(b) the deed of trust is entered into between the settlor and the trustee; 12 and
(c) where the trustee also acts as settlor, a declaration of incorporation (issued by the trustee) is filed with the office of the SEC.
We see the PE trust as a very flexible and attractive vehicle alternative that has the potential to generate great interest in the private equity / venture capital space in Thailand. This structure offers investors the opportunity to invest in promising companies by relying on the management of experienced trust managers and licensed trustees. It could also benefit private equity / venture capital firms as a means of attracting finance and securing privileged economic deals. In fact, we’ve seen a growing number of industry customers seek to understand this vehicle in depth.
Aspiring fund sponsors looking to set up a PE trust will need to find legal advisors who genuinely understand the ins and outs of PE trust and foreign limited partnerships to help them navigate transactions properly.
The content is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This may be termed a “lawyer advertisement” requiring notice in some jurisdictions. Past results do not guarantee similar results. For more information, please visit: www.bakermckenzie.com/en/disclaimers.