Employee co-investment can be an effective tool for private credit fund managers and so it is worth givingthe terms some careful consideration.
Typically, there will be some form of employee co-investment in a private credit fund. Some managers, particularly larger managers with a significant international footprint, will have structured programs, whilst others manage the process more informally.
Key reasons to implement (or widen) co-investment from a manager's employees include:
- Its value as a reward to employees (thereby enhancing employee retention and providing a competitive edge in recruiting).
- Fostering a sense of community within the business by democratizing investment opportunities.
- Demonstrating alignment and shared ownership with external fund investors.
Broadly, employee co-investment may be structured in three forms: (1) as a direct investment into the main fund; (2) as a separate employee co-investment fund (an "employee fund"); or (3) as a phantom program (effectively bonus or profit-sharing programs linked to fund performance). Setting up an employee fund is often the most appropriate structure, especially where larger numbers of employees are concerned.
Initial Decisions
There are a number of strategic decisions to be made when structuring an employee fund:
Will the vehicle be investing in only one or multiple strategies? The simplest option is where exposure is only required on a fund-by-fund basis for a small number of underlying funds, in which case a manager may decide to form separate near-identical employee funds to invest in each underlying fund. For a larger-scale project, an alternative is to have an overarching co-investment vehicle with separate classes or sub-funds, each of which co-invests with a specific fund. Such classes/sub-funds are quick and easy to replicate the next time an opportunity arises. Alternatively, if broad exposure to the manager's business is required, a single vehicle could invest across the spectrum of deals that the manager invests in (or a subset thereof).
Will the employee fund invest as a feeder fund into the main fund, or will it co-invest alongside the main fund? The answer to this question will be influenced by the existing main fund structure, including whether it is set up for feeders or parallel investment, and other regulatory matters.
How widely will the employee fund be offered? Local regulations will influence who can invest, but managers may also set their own seniority and compensation thresholds for eligibility. Managers must also decide if personal investment vehicles, non-employees (such as retirees and consultants) and family members may participate.
Structure of employee fund. The location and legal form of the employee vehicle are likely to be driven by a number of factors. These include the location of the eligible employees and the relative number of these populations, the jurisdictions of the underlying funds and the nature of the investments of the underlying funds.
Will the employee fund be leveraged? Managers will need to consider whether leverage will be applied to employees' investments. Some programs offer different leverage options. Although leverage is attractive it increases structural complexity.
Economic terms. Managers will also need to consider whether fee or carried interest waivers will be offered on employee investments, and whether employees will bear the costs of establishing and operating the co-investment program (or whether the manager will bear these costs).
Offering the Employee Fund
Regulatory Matters
It is important to understand the regulatory position regarding offering employee funds in each jurisdiction in which participating employees reside. While some jurisdictions, such as the U.S., UK and Europe, have regulatory regimes for employee participation, many jurisdictions do not. This means that the offering needs to be brought within general securities offering regimes or tolerated exemptions to these regimes.
Tax
Managers must decide how much to understand each jurisdiction's tax position, and whether to offer different vehicles to optimize tax outcomes for different employees.
Operational Matters
Employee funds raise somewhat unique operational matters. For example, managers will need to consider how to deal with an evolving employee population, managing drawdowns and what happens if an employee is in default. Managers will also need to determine how to comply with AML, compliance, tax and reporting obligations.
If you would like to learn futher information on this topic, read our previous OnPoint, Getting a Slice of the Action: Employee Co-Investment in Private Funds.
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.
