LegalTalk Alert

Establishing a new Venture Capital orPrivate Equity Fund
Updated: 27 April 2015
Author: Steven Maarbani

How can selecting the right fund structure help new fund managers gain a competitive
advantage?
When establishing a new Venture Capital or Private Equity fund, a compelling value proposition is essential.
In the first of a series of three articles for new fund managers, designed to provide an overview of the fundestablishment process, this article outlines popular fund structure options and explains how choosing theright fund structure can help new fund managers build a compelling value proposition and ensure a more
successful capital raising campaign.
Fund structure options
There is no standard Venture Capital or Private Equity fund structure, although the internationally preferred
structure is the limited partnership. In Australia, options for fund structure include bespoke unit trusts, Early
Stage Venture Capital Limited Partnerships (ESVCLPs), Venture Capital Limited Partnerships (VCLPs) andManaged Investment Trusts (MITs).1
The most appropriate fund structure for a new Venture Capital or Private Equity fund will depend upon anumber of factors, including: the size of the fund the investment strategy
 the sector, industry and stage of development of target portfolio entities
 the tax resident status and level of sophistication of the target investor group 2Unit trusts and MITs
A unit trust structure can provide considerable flexibility and allow for bespoke fund structure design.
Funds structured as unit trusts are either managed by the trustee or have the investment management
functions outsourced to a (often related) special purpose investment management entity.
Investors in a unit trust obtain units and have rights and obligations governed by the unit trust deed.

1 This article does not deal with Listed Investment Companies.
2 The laws which govern fund structures in Australia are complex. It is beyond the scope of this article to comprehensively detail all material aspects of therelevant laws

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Generic unit trusts are not subject to restrictions on the class of asset in which the fund may make aninvestment, restrictions on the quantum of such investments, any rules regarding compulsory diversificationof the investment portfolio or the total fund size.
As a general rule, a unit trust is a tax flow-through vehicle, which means that income, profits, gains andlosses of the trust flow-through to the unit holders who are then taxed according to their respective tax
status.
Some of the key legislated tax concessions that are available to investors and the fund manager of a Venture
Capital or Private Equity fund, structured as an ESVCLP or a VCLP, are not available in respect of a unit
trust. Further, the ATO has released rulings indicating it will treat income from the disposal of assets byPrivate Equity funds on revenue account. However, if the trust qualifies as a MIT, it can elect to treat
qualifying assets on capital account. MITs also have the benefit of a reduced level of withholding tax.
VCLP
The VCLP, which was introduced to encourage foreign investment in Australian venture capital, provides an
exemption from income tax on profits (capital and revenue) from the disposal of eligible investments bycertain foreign partners of the VCLP3, and treats the carried interest of the fund manager on capital account.
The VCLP structure provides no such tax advantages for Australian resident investors, who would need torely on case law principles to determine the status of any gains or profits realised.
Funds structured as VCLPs are either managed by the general partner of the limited partnership, or have theinvestment management functions outsourced to a (often related) special purpose investment managemententity.
Investors in a VCLP obtain limited partnership interests and have rights and obligations governed by thelimited partnership deed.
Unlike standard incorporated limited partnerships, the VCLP is a tax flow-through vehicle allowing
distributions to be taxed in the hands of the investors. The ability to claim losses will depend on an individual
investor's circumstances. One of the restrictions of VCLPs is that they must only invest in eligible venture
capital investments, which broadly excludes investing in entities whose predominant activities include
property development or land ownership, banking, providing capital to others, leasing, factoring,securitisation, insurance, construction or the acquisition of infrastructure facilities and making passive
investments.
VCLPs must have a minimum fund size of AUD$10 million. There is no restriction on the maximum fund sizeof a VCLP. VCLPs are generally used for mid-market Private Equity funds that are likely to target foreign
investors.
ESVCLPs
With an ESVCLP, income and capital gains derived from, or from the disposal of, eligible venture capital
investments are exempt from tax in Australia in the hands of both domestic and foreign investors.
The tax-free treatment is a significant legislative incentive which helps mitigate the risk of early stage venture
capital opportunities, and has the potential to considerably increase a fund’s internal rate of return and assist
it to attract a wider pool of investors. As with VCLPs, losses do not flow through to the limited partners.
Funds structured as ESVCLPs are either managed by the general partner of the limited partnership, or havethe investment management functions outsourced to a (often related) special purpose investment
management entity.

3 As a result of the introduction of Division 855 of the ITAA97, which exempts non-residents from Australian income tax in relation to capital gains from thesale of investee companies in defined circumstances, this benefit is now largely redundant for non-resident limited partners of VCLPs.

As with VCLPs, one of the restrictions of ESVCLPs is that they must only invest in eligible venture capital
investments. Also, an ESVCLP must have an approved investment plan which demonstrates a focus on earlystage venture capital.
Whilst the legislation does not define early stage, the starting point is that the gross assets of an investee atthe time an ESVCLP makes its first investment in it must not exceed AUD$50 million. This relatively highthreshold could include expansion stage investments.
The fund must be structured as a limited partnership and have committed capital of at least AUD$10 million
and not more than AUD$100 million. ESVCLPs are generally used for funds that are targeting Australianresident investors and that have an investment strategy that is focused on early stage high-growth
opportunities.
Conclusion
The choice of fund structure has important implications for investors and fund managers alike, including: taxation treatment of investor distributions and the carried interest of the fund manager
 Australian Financial Services Licensing obligations
 levels and complexity of regulatory compliance, and the extent of restrictions on the fund’s investment strategy and size.
Together, these implications can impact revenue outcomes, internal rates of return and the composition of afund’s ultimate investment portfolio. An astute decision on fund structure can help fund managers to
improve their competitive advantage and assist to ensure a more successful capital raising campaign.
Let’s talkFor a deeper discussion of how these issues might affect your business, please contact:

Kel Fitzalan
Partner, Sydney+61 (2) 8266 1600
kel.fitzalan@au.pwc.com

Steven Maarbani
Partner, Sydney+61 (2) 8266 6834
steven.maarbani@au.pwc.com© 2015 PricewaterhouseCoopers. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers a partnership formed inAustralia, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. Thispublication is a general summary. It is not legal or tax advice. Readers should not act on the basis of this publication before obtaining professional
advice. PricewaterhouseCoopers is not licensed to provide financial product advice under the Corporations Act 2001 Cth). Taxation is only one of
the matters that you need to consider when making a decision on a financial product. You should consider taking advice from the holder of anAustralian Financial Services License before making a decision on a financial product.
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