Structuring A Cayman Islands Closed-Ended Fund

Introduction

This article provides an overview of common structures for investment funds in the Cayman Islands.

Investment funds in the Cayman Islands must be registered either under the Private Funds Act or the Mutual Funds Act, depending on whether the fund strategy is closed-ended or open-ended.

The key issue to consider in structuring a Cayman Islands fund is liquidity. If the underlying portfolio of the fund is illiquid, allowing investors to redeem when they want to may require underlying investments to be sold prematurely to meet redemption requests, affecting the ultimate performance of the fund. Such funds should therefore be structured as closed-ended funds (i.e. with no redemption rights being granted to investors). This allows the fund to better manage the timing of the sale of its underlying investments, maximising return to all investors. A PE/VC type fund would typically fall within this category and would generally need to be registered under the Private Funds Act.

Conversely, where the underlying investments are liquid and easily sold, timing the sale of the underlying investments – and the consequent need to lock in investors – are not so important. This is your classic open-ended hedge fund and would generally be registered under the Mutual Funds Act.

Structuring Choices for Closed-Ended Funds

Before a closed-ended fund in the Cayman Islands is registered under the Private Funds Act, a decision will need to be made on the form that fund should take.

Investment funds can be set up in the Cayman Islands as Limited Partnerships, corporate structures (including traditional Companies and Segregated Portfolio Companies), and, less commonly for closed-ended funds, unit trusts. The structure selected will depend on a number of factors, including tax treatment (both at the level of the fund and investor), regulatory treatment, cost of setting up and operating the structure, and investor and manager familiarity.

More often than not, these decisions will be driven by onshore issues. Conyers is happy to assist in structuring funds in any of these forms.

Two of the most popular forms of closed-ended funds that Conyers sets up are Limited Partnerships and, increasingly, Segregated Portfolio Companies.

1. Limited Partnerships

The Cayman Islands currently has around 16,000 funds registered as private funds under the Private Funds Act. The majority of these are set up as Limited Partnerships, with a Cayman exempted company also being set up to act as the General Partner to the Limited Partnership ("GP/LP structure").

The Cayman Islands GP/LP structure is a popular choice amongst investors and this familiarity makes capital raising easier.

The terms of a GP/LP structure can be flexible. As these funds invest in illiquid investments, there is no need to unitise investor interests (e.g. by issuing shares) and each investor's economic interests can be represented by way of individual partnership accounts. This allows for a more accurate apportionment of costs, revenues, gains and losses between investors. The fund may have a number of closings, but thereafter will not be open to additional subscriptions. Commitments to fund investments will generally only be drawn down as needed within a stated time period, and upon the disposal of an asset, the proceeds will be returned to investors, with a "waterfall" allocation being made between limited partners and the general partner. As the fund does not need to provide for periodic subscriptions and redemptions, there is no need to strike a regular net asset value (which may be more difficult for illiquid assets) for the purpose of fixing subscription and redemption prices.

For all their attractions, it should be noted that set-up costs may present a perceived disadvantage of using a GP/LP structure. Firstly, two entities (the General Partner and Limited Partnership) need to be established and maintained. In addition, because of its contractual nature, investors will often expect more involvement in negotiating the terms of a fund's Limited Partnership agreement and related private placement memorandum. Individual investors may also demand better terms in the form of a side letter.

2. Corporate Structures – Segregated Portfolio Companies ("SPC")

Whilst traditional Companies can be used for closed-ended funds, traditionally they tend not to be as popular as the GP/LP structure. Historically, Limited Partnerships have received a more favourable tax treatment (especially in the U.S.), and therefore investors and managers became more familiar with the GP/LP structure.

However, Cayman SPC structures are becoming increasingly popular as they allow specific investments to be separated into different segregated portfolios, which can be ring-fenced from other segregated portfolios containing other investments. As the investments are not co-mingled, an investor can choose which investment to participate in, rather than being required to participate in all investments.

As the segregated portfolios are separate from each other, each can hold an investment and then be terminated once the investment has been realised, with the proceeds returned to investors. This provides much more flexibility for managers as the fund can continue until the final segregated portfolio is terminated without having to be wound up.

Establishment costs for SPCs are generally less than for a GP/LP structure, as there is more limited scope for negotiation with a corporate structure in which all shares of a class have the same rights. In addition, new segregated portfolios can easily be added for new investments. This is more cost effective than having to set up a completely new fund.

Conversely, for the reasons mentioned above, a corporate structure may be less suitable for closed-ended funds. For example, as shares are being issued, how does one deal with the concept of commitments and drawdowns? On a drawdown, should shares be issued partially paid, or fully paid with the investor having a contractual obligation to fund the balance of its unpaid commitment? Another issue may be how to deal with the allocation of expenses amongst investors that are shareholders – it is far easier to deal with the allocation of expenses for a Limited Partnership that maintains partnership accounts. Whilst not insurmountable, issues such as these need to be considered as they do not fit as easily into a corporate structure as a GP/LP structure.

We are Here to Help

Tailored professional advice should be sought in respect of individual circumstances. Please reach out to your usual Conyers contact or one of the individuals listed below with any questions regarding structuring a Cayman Islands closed-ended fund.

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.