In a nutshell
Private equity and investment companies operate funds that pool the investments of anybody prepared to part with their money for a sustained period of time. The private equity firm takes this cash – often alongside a large portion of bank debt (making it a ‘leveraged buyout’, or ‘LBO’) – to buy companies or other assets with the goal of selling them on at a massive profit. Investment management lawyers, therefore, have two primary functions: they form the funds (which are typically structured as limited partnerships) and help the private equity firm negotiate the terms on which investors contribute their money, and they act for the private equity fund when it buys and sells its investments.
Venture capital is a subset of private equity that sees investors put money into startup companies or small businesses in the hope they will be sold to a private equity firm or taken public. Although this typically entails high risk for the investor, it has the potential for above-average returns. The higher risk compared to private equity proper is offset by investing smaller amounts over a shorter timespan, typically.
Investment management is the professional management of various securities (shares, bonds, etc) and assets in order to meet the specified investment goals of investors. Investment management lawyers may work in any of the specialist areas described below, but ultimately advise on the structuring, formation, taxation and regulation of all types of investment funds.
A hedge fund is a private, actively managed investment fund. It aims to provide returns to investors by investing in a diverse range of markets, investment instruments and strategies. Hedge funds' investment strategies aim to make a positive return on investment regardless of whether markets are rising or falling. Expertise on the derivative markets helps hedge funds achieve this.
A mutual fund is a collective investment vehicle that pools money from many investors to purchase securities. The term is most commonly applied to collective investments that are regulated and sold to the general public.
A real estate investment fund/trust is a publicly traded investment vehicle that uses investors' money to invest in properties and mortgages.
Both hedge funds and mutual funds generally operate as open funds. This means that investors may periodically make additions to, or withdrawals from, their stakes in the fund. An investor will generally purchase shares in the fund directly from the fund itself rather than from the existing shareholders. It contrasts with a closed fund, which typically issues all the shares it will issue at the outset, with such shares usually being tradable between investors thereafter.
What lawyers do
- Advise clients on how to structure new funds.
- Help private equity firms negotiate the terms on which investors contribute their money.
- Act for the private fund when it buys and sells its investments.
- Assist clients throughout the fund-raising process. This includes the preparation of offering materials, the preparation of partnership agreements, advising on and documenting management and compensation arrangements, and closing fund formation transactions.
- Draft the numerous organizational documents necessary to form an investment fund, including a private placement memorandum, a limited partnership agreement (if the fund is a limited partnership) or an operating agreement (if the fund is a limited liability company), and investor subscription agreements.
- Conduct diligence and negotiate contracts.
- Inform and advise clients on the constantly changing regulatory and compliance issues arising under US and international securities, tax and ERISA laws.
- Provide day-to-day advice with respect to issues such as performance and advertising, and brokerage and portfolio trading practices.
Realities of the job
- Funds lawyers often work for clients in very small teams, meaning there is the chance for even the most junior associates to gain great experience. “When you start out, you will work on private placement memos, draft key documents and review the transfer agreements,” says Bruce Ettelson of Kirkland & Ellis. “In funds, you may negotiate with hundreds of parties at the same time so typically you get the chance to work in negotiations as a young associate.”
- Structuring funds requires an intimate familiarity with relevant securities and investment company rules. Understanding and being able to apply knowledge of key legislature, such as the Securities and Exchange Commission (SEC) guidelines as well as federal and state laws, is a vital skill.
- Setting up funds also requires a significant amount of tax, ERISA and industry knowledge. Funds lawyers often work in close collaboration with their tax and finance colleagues to realize the best value for clients.
- Private placement memoranda must contain risk factors and material disclosures about the investment manager and the strategy to be employed by the fund.
- Form ADV is the uniform form used by investment advisers to register with both the SEC and state securities authorities. It consists of two parts: part one requires information about the investment adviser’s business, ownership, clients, employees, business practices, affiliations, and any disciplinary events of the adviser or its employees; part two requires investment advisers to prepare narrative brochures written in plain English that contain information such as the types of advisory services offered, the adviser’s fee schedule, disciplinary information, conflicts of interest, and the educational and business background of management and key advisory personnel of the adviser.
- Being responsive to client needs and understanding the time-sensitive nature of fund organization is essential. “A lot of work involves helping clients to understand what the market is and how they can best use such information. As private funds attorneys, we often play a strategic counseling role,” says Bruce Ettelson.
- “I would recommend taking a securities regulations course,” says Lisa Schneider of Fried Frank. “Having a basic understanding of securities law is an important foundation for the practice of asset management and other areas of corporate law.”
- “A key personality trait often overlooked that you need in this practice area is emotional intelligence – people skills. One of the things I love about this practice is that in fund-raisings I don't really do one-on-one negotiations, and in terms of large private securities offerings you will be dealing with numerous different law firms. Finding a common denominator and getting everyone to agree to pretty much the same terms means that being able to read, understand and gently move people helps tremendously,” explains Jordan Murray of Debevoise & Plimpton.
- “Attention to detail and the ability to take a step back and understand the big picture” are key attributes for success, according to Lisa Schneider.
- The private equity market had another solid year in 2015. Despite the slightly sluggish economic outlook, investment multiples reached new peaks.
- However, the number of deals and their value were only incrementally higher than previous years.
- Global fundraising dropped by 15.4% from the 2014 total of $339 billion, to $287 billion in 2015 according to Prequin.
- Of that $287 billion, $151 billion was made up of buyout strategies. $47.5 billion was from venture capital. $49.264 billion was contributed by asset owners, such as US public defined benefit plans.
- The three largest funds that closed in 2015 raised $40.1 billion. They were Blackstone Capital Partners VII, Warburg Pincus Private Equity XII and Lexington Capital Partners VIII.
- Private equity-backed IPOs fell to roughly half of 2014's record breaking year value. But this still means that 2015 was the second most active year on record. Only 155 deals were recorded compared to 2014's 211. Which accounted for a 74% decline in the number and value of private equity-backed deals in the Americas.
- IPOs accounted for only 14% of total private equity exit value, compared to almost 25% in 2014.
- IPO follow-on activity however had an increase of about 2% in value and 24% in volume, raising $107.1 billion.
- Following 2010's Dodd-Frank Act, the SEC is concerned with regulating private equity and hedge funds. The level of disclosure concerning fund fees and expenses, as well as their allocation into different methods of investment, has come under increased scrutiny recently. “Private equity has become less private,” says Jordan Murray.
- Private equity managers are now required to register under Dodd-Frank with the SEC. The SEC's enforcement work in this area, along with the Presence Examination Initiative carried out by the Office of Compliance Inspections and Examinations (OCIE) increased in 2014 and 2015.
- President Barack Obama signed into law the Jumpstart Our Business Startups (JOBS) Act in April 2012 with bipartisan support from Congress. This allows hedge funds to advertise responsibly to investors through normal channels. Hedge funds had been banned from soliciting or advertising their private offerings to the general public in exchange for being exempt from having to register their interests or shares with the SEC under Rule 506 of Regulation D. More investors will therefore be allowed to enter a single fund.
- The Private Fund Investment Advisers Registration Act eliminated the so-called private adviser exemption for advisers with fewer than 15 clients, upon which most private fund managers relied to avoid registration under the Investment Advisers Act of 1940. That provision provided an exemption from registration for any adviser that did not hold itself out as an adviser and had fewer than 15 clients during the preceding twelve-month period. Now, hedge funds and private equity funds of over $150 million are required to register with the SEC.
- A new Bill was proposed in March 2016 to close the 'carried interest loophole,' which has allowed partners at private equity firms and hedge funds to pay drastically reduced federal tax rates on their income. Until now, a large portion of their income has been treated as capital gain, entitling them to pay at the capital gains rate of 20% (19.6% less than the rate taxed on normal income.) Despite urges from President Obama to close the loophole sooner, this new Bill has strong support now.
Advice from the gurus of private equity and investment management
Bruce Ettelson, head of the private funds group, Kirkland & Ellis:
“A real benefit of funds work is that you meet very senior people at the clients early on in your career and become a general corporate counsel to those clients. You're able to represent clients from cradle to grave. You're not only doing the transfers, but also helping them with reports, regulatory compliance, structuring transactions within a fund’s permitted transaction parameters and other issues. A wealth of challenges will come up over ten years of working with a client. It's a very dynamic and challenging practice. The work doesn't end with structuring and closing a fund.”
Lisa Schneider, corporate partner, focused primarily on the structuring and representation of hedge funds and other alternative investment products, at Fried Frank:
“One of the great things about this area of law is that the role of a junior associate is not that different from that of a senior associate or partner. In many fields, junior associates are often relegated to lower-level tasks, such as diligence, and are not exposed to high-level deal negotiations. Juniors in this practice really get exposure to the whole picture. Transactions are leanly staffed, so that junior associates are able to be involved in all aspects of a transaction, including drafting and negotiations.”
“The private fund space is dynamic and is continuously evolving. As the client businesses and products adapt to changes in the market, our practice must change and evolve as well. This is what keeps the private funds practice both challenging and rewarding. It's great to be at the cutting edge of the industry.”
Jordan Murray, deputy chair of the firm’s corporate department and member of the private equity funds and investment management groups, Debevoise & Plimpton:
“I really view myself as a commercial business lawyer who does everything for these private investment firms other than their acquisitions and dispositions. We handle their private securities offerings – which could be viewed as the sexy part of the job – and deal with a whole range of projects, including opening non-US offices, high-level personnel changes, firm restructurings and liquidity events, securities filings, investor reports and communications, incentive arrangements and regulatory and compliance issues, which have become ever more burdensome. My job often involves marshaling the right teams within Debevoise for our clients. It's like being the quarterback who directs everything.”
“For me the real reward is that our clients are so easy to work with. So many of the folks I work with are so entrepreneurial and smart and grasp onto issues and concepts so quickly that it really is quite fun. They are also the type of people who recognize the good work and loyalty we bring to the table – they let you know they appreciate that. For most of my clients I feel like I’m an extension of their organizations. When I speak of my clients it's about 'we'. We enjoy our clients' successes and, thankfully with less frequency, suffer and fight through their challenges as well.”