The Cayman Islands has long been the most prominent offshore jurisdiction through which to structure offshore private equity and venture capital funds.
Why the Cayman Islands?
The attractions for international managers, sponsors and investors of the Cayman Islands as the jurisdiction in which to domicile such funds include the stable political environment, the ability to raise and deploy capital efficiently through a tax neutral environment with no capital gains, income, withholding, estate or inheritance taxes, and the ability to implement structures to achieve their commercial objectives without giving rise to unnecessary levels of regulatory compliance or disclosure.
In addition, the predictable and ethical court system that is renowned for its sensible approach to commercial disputes provides a degree of comfort in the event that disputes between managers, sponsors or investors arise.
Benefits of a limited partnership structure
Most private equity and venture capital funds formed in the Cayman Islands utilise the well-developed and widely-understood limited partnership structure (an ELP) that exists pursuant to the Exempted Limited Partnership Law (the ELP Law). Whilst companies are sometimes used to structure such funds this is uncommon. For the purposes of this article we will focus on the key features of the ELP structure.
There are no restrictions on the number of investors that may be admitted to an ELP, and each investor on admittance becomes a limited partner. Generally, private equity and venture capital funds are structured on the basis that the limited partners make a "commitment" to provide a certain amount of capital to the fund, and this capital is then drawn down by "capital contributions" being made over time. The limited partners in an ELP generally benefit from limited liability status so that their maximum loss is limited to the amount their capital commitment.
The general partner (the GP) is the legal entity affiliated with the sponsor or manager of the ELP that assumes responsibility for managing the business of the ELP in accordance with the terms of the limited partnership agreement (LPA). The GP will sign all contracts on behalf of and in the name of the ELP. In addition, as an ELP does not have a separate legal personality, any assets of the ELP are technically held on trust for the ELP by the GP.
The GP may be a Cayman Islands resident individual, a Cayman Islands registered company, a foreign company or limited partnership registered in the Cayman Islands or another ELP. If the GP is a Cayman Islands registered company, which is the most common structure, the GP may have any number of directors. These directors are not required to be resident, or to hold meetings, in the Cayman Islands. An ELP must maintain a "registered office" in the Cayman Islands for the service of process and to which notices and correspondence can be sent. This requirement is typically satisfied by engaging a corporate services provider in the Cayman Islands to act in this capacity.
An ELP must maintain a register of limited partners, a record of contributions and payments representing returns of contributions, a register of mortgages over limited partnership interests and books of account which give a true and fair view of the business and financial condition of the ELP and explain its transactions. Books of account must be maintained for a minimum period of five years from the date on which they have been prepared. There is no requirement for an ELP to file any financial statements with any regulatory agency in the Cayman Islands or to have those accounts audited in accordance with any particular accounting standards.
As private equity and venture capital funds are invariably structured as "closed-ended" funds they are not subject to regulatory oversight by the Cayman Islands Monetary Authority. In addition, the GP does not require any form of approval or licensing in the Cayman Islands.
Registration of an ELP and GP can generally take place on a same-day basis, with the certificates of registration following within three to five working days (or, if required, an express filing process is available by payment of an additional filing fee to the Registrar). Similar to the position for Cayman exempted companies, ELPs have the ability to use a dual foreign name which can be particularly useful for ELPs carrying on business in China.
The arrangements as to the internal governance of an ELP are essentially a matter of contract as set out in the relevant LPA governing the operation of the ELP. As a result, the scope for crafting of these arrangements to meet the specific commercial terms desired is extremely broad and flexible. The GP and the limited partners may agree between themselves the terms governing the partnership, subject to a relatively light overlay of statutory provisions contained in the ELP Law.
This flexibility allows for highly tailored provisions to deal with matters including, amongst others, payment of carried interest on either a "whole of fund" or "deal by deal" basis (with a number of further variations within these two approaches regarding treatment of income earned by the fund), indemnification of the GP and other relevant parties, key man provisions, and the consequences of a limited partner defaulting on its obligations to pay any required capital contribution in respect of its commitment.
Provided that this is contemplated in the LPA, the GP of an ELP may enter into "side letters" with individual investors to provide for arrangements additional to those contained in the LPA. These arrangements are acceptable under Cayman Islands law, and provide yet further flexibility to the ELP structure, but review must be undertaken to ensure that the terms of a side letter are not in contravention of, or inconsistent with, the terms of the LPA.
As can be seen, the tax-exempt, non-regulated and highly flexible nature of the ELP combine to create an ideal vehicle for the establishment of offshore private equity and venture capital funds. The Cayman Islands' position as the leading jurisdiction for the creation of such fund structures is well deserved.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.