Bermuda: Structuring Private Equity Co-Investment Opportunities In Bermuda

Last Updated: 1 May 2014
Article by Sally Penrose

A properly structured co-investment vehicle offers both the fund and its co-investors the ability to effectively manage, deliver and return economic benefit from identified investment opportunities. Bermuda's legal and governance framework, together with its experienced and knowledgeable professional service providers, facilitates the creation of flexible and economically viable co-investment vehicles within a stable and business friendly jurisdiction.

Co-investment deal flow tends to track overall private equity market deal flow, with volumes gradually increasing since the 2008 crisis period. A report by Preqin tells us that of the LPs tracked on Investor Intelligence, 43% are actively seeking co-investment rights when committing to funds, and a further 11% are considering such opportunities, with fund of funds managers accounting for the largest proportion of the coinvestors (23%). The Hedge Fund Insight 'Hot 100' report released in April 2014 which captures emerging trends in the hedge fund industry, placed co-investment by fund of funds as number 52 in its list, reporting that "as one of the initiatives to demonstrate engagement by funds of hedge funds there is a trend to offering coinvestment opportunities to clients". Therefore we expect to see a rise in the number of funds looking to structure co-investment opportunities.

Co-investment rights give an investor the ability to make a minority investment, directly or indirectly, in a portfolio company. Rather than making a capital commitment to the fund an investor is given the opportunity to invest on the same terms as the fund.

Selecting the right legal and governance framework for the co-investment vehicle is one of the key considerations in implementing a successful co-investment structure. The optimal structure will depend on a number of factors including where and to whom the co-investment opportunity is to be marketed, the nature of the potential co-investor base and the identified portfolio investment assets. Tax and regulatory issues will of course also be important in determining the structure. Where an offshore structure is to be implemented, Bermuda offers key advantages as a jurisdiction for establishing a co-investment structure as the primary pieces of company legislation (being the Companies Act and the Segregated Accounts Companies Act (SAC)) allow for the creation of bespoke governance and economic arrangements within a single entity. Options exist to 'opt in' to the amount of regulation a fund requires based on its investor base.

Utilising a newly formed special purpose vehicle (SPV) with separate classes of shares is often preferred where there are multiple co-investors. Under this structure the fund and the co-investors invest on a side by side basis into a newly formed legal entity which will hold the portfolio investment.

An SPV formed in Bermuda may take the form of a Bermuda exempted company with limited liability (which can initially be established with a single shareholder, any amount of authorised share capital, unrestricted objects and the powers of a natural person); or a Bermuda mutual fund company (which can be closed ended and therefore falls outside of the scope of the Investment Funds Act).

Alternatively a co-investment may be structured using a limited partnership structure. The advantages of forming a limited partnership in Bermuda include less regulatory scrutiny as the partnership acts do not look to regulate the affairs of limited partners; the general partner can be based outside of Bermuda; and a Bermuda limited partnership can elect (in a similar way to Delaware limited partnerships) to have separate legal personality.

Applications for incorporating an SPV or a limited partnership in Bermuda can usually be approved on a same day basis so when a co-investment opportunity is time sensitive the speed and relative simplicity of the incorporation process is another advantage of establishing a co-investment structure in Bermuda.

Once incorporated, the SPV is then registered as a segregated accounts company under the SAC. An SPV registered as an SAC company will enjoy statutory divisions between each segregated account. A 'segregated account' is an account containing assets and liabilities that are legally separated from the assets and liabilities of the company's general account. The assets and liabilities that would be held within or in respect of a segregated account are then 'linked' to a class of shares. Each class of shares linked to a segregated account will represent a portion of the particular investment or be linked to a separate investment (depending on whether the SPV has a single or multiple investments). The effect of this statutory division is to protect the assets of one account from the liabilities of other accounts. In addition, payments in respect of distributions and redemptions to co-investors will only be paid out of the assets of the segregated account in respect of which the relevant shares are linked.

The provisions of the SAC have recently been tested by the courts in Bermuda in respect of the purported insolvency of segregated accounts and the rights of creditors and shareholders in relation thereto. The provisions of the SAC in respect of the segregation of assets and liabilities were upheld in these decisions. This legal separation of assets and liabilities within the same company results in lower administrative and set-up costs as there is no need to incorporate and manage multiple investment companies.

The governing document of a Bermuda incorporated SPV is the bye-laws which typically is supplemented by a (short-form) offering document or term sheet and a subscription agreement. Bermuda company legislation allows for great flexibility in the content of the bye-laws which in turn allows for the crafting of bespoke byelaws which set out co-investor rights and the co-investment deal terms. Under Bermuda law, bye-laws are a private document which is useful for those funds and investors wishing to keep the substance of their deal terms out of the public arena.

The fund manager or one of its affiliates will generally maintain control of the SPV which is typically achieved by issuing the fund manager with a class of non-participating voting shares with the co-investors subscribing for non-voting participating shares.

Unlike in some other offshore jurisdictions there is no requirement, or intention, for directors to be licensed or registered in Bermuda. Directors owe duties (statutory, fiduciary and at common law) to the company.

Another key advantage of forming a private equity co-investment vehicle in Bermuda is the tax neutrality of the jurisdiction. Private equity fund vehicles are not subject to any tax, as there is no Bermuda income, capital gains or withholding tax, corporation or profits tax applicable to a fund or to its shareholders. An exempted company (or exempted partnership) is able to obtain from the Minister of Finance an assurance that in the event that any legislation is enacted in Bermuda imposing withholding or other tax computed on profits or income, or computed on any capital assets, gain or appreciation, such tax will not be applicable until 31 March 2035.

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.

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