Fundamentals of Private Equity and Venture Capital - PEI Media

GETTING THE MOST OUT OF THIS MODULE
Welcome to Module 10 in the Fundamentals of private equity series. This module
focuses on running a private equity firm. It is designed to work both as a stand
alone section and as part of the whole series. The module necessarily draws upon
topics reviewed in earlier modules, and seeks to avoid repetition of their content.
However, for the benefit of the stand alone reader, a comprehensive glossary has
been incorporated, which explains the background and use of private equity terminology.
All terms which may require explanation or expansion are printed in
bold, to indicate that there is a glossary entry for them.
The institutionalisation of private
equity and its meaning for a
general partner
Private equity has long since ceased to be the nascent
industry it was when the first venture capital
pioneers made it a recognisable business
more than quarter of a century ago.
Institutionalisation has been defined as “to make
part of a structured and usually well-established
system” and throughout this module there is an
undercurrent of what are, in reality, institutional
imperatives that are fashioning the way general
partners (GPs) go about their business. Limited
partners (LPs) and GPs alike are becoming more
sophisticated in their approach to the structuring
of the product and the business process required
to maximise returns on capital.
Investors, especially the largest who are institutions
in their own right, have turned the formation
of a fund into a highly complex operation
requiring greater assistance (and consequently
expense) of specialist legal and tax professionals
to develop a structure and a set of fund documents
to help manage the high risks attached to
private equity investments. This is typified by the
range and number of vehicles that now comprise
a fund and the complexity of clausing in the fund
partnership agreement; dealing with such matters
as tapering management fees, carried interest
hurdles and clawbacks, environmental
policies, corporate governance and conflict of
interest resolution, among others.
Fuelling this trend is the drive by financial services
regulators around the world, especially
those in certain jurisdictions formerly known as
“tax havens” anxious to improve their reputations,
to impose more and more regulation on
the private equity industry. Many of these regulators
now require practising professionals to
pass specialist tests and exams leading to GPs to
incur the expense of more formal training programmes
before being licensed to operate.
Training programmes have also had to be
extended to include anti-money laundering procedures
which can look like maddening bureaucracy
to a GP dealing with world-renowned
institutional investors.
Freedom of Information legislation is in a similar
way feeding a media frenzy for disclosure of
fund performance data, previously subject to
restricted access by GPs, especially from
investors in the public sectors as their investment
of pensioners funds come under closer
scrutiny. Major investors, private equity associations
and other trendsetters are at the same
time seeking greater transparency in fund
reporting. All this is presenting GPs with a
greater challenge to their obligations under
confidentiality undertakings to portfolio companies
and competing legislation such as insider-trading
laws which is taking up more
management time in designing systems that
provide a happy medium.
These disclosure demands have also led to the
creation of industry guidelines such as the International
Private Equity and Venture Capital Guidelines
and the Corporate Governance and
Professional Standards and Reporting Guidelines
endorsed by the European Venture Capital
Association, among others. Market and peer
pressure on GPs to adopt such guidelines means
greater investment in systems and procedures
and an increase in the demand for private equity
specific software to facilitate reporting.
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THE FUNDAMENTALS OF PRIVATE EQUITY 5