Monday, November 2, 2009

What Fund Offering Terms Should Omani Institutional Investors Negotiate? Part 1:
Private Equity

Private equity funds are broadly accepted as an established asset class among institutional, sovereign and other sophisticated investors. As a general matter, the performance of private equity funds does not closely correlate with that of the public equity markets, thereby providing an excellent risk diversification tool for investors seeking to make a passive, long-term commitment of their capital. In this article, we briefly examine certain key terms that Omani institutional investors (e.g., sovereign wealth funds, pension and other government funds, private financial institutions, and banks) should consider negotiating for in relation to their capital commitment to private equity funds.

  • MFN Clause: The most-favoured-nation clause guarantees the institutional investor treatment no less favourable than that accorded, in the past or future, to any other investor in the fund. Any preferential treatment must be disclosed to the institutional investor, with the option to elect to receive such treatment itself.

  • Fees: Generally, management fees should be determined in relation to a fund’s aggregate capital commitments during the investment period and in relation to its declining invested balance thereafter. The carried interest, moreover, should only be paid if a hurdle rate is achieved (generally either 8% or 12% return, depending on the fund’s investment strategy), calculated on a “funds-as-a-whole” basis and subject to a guaranteed clawback. Further, no placement, organizational or other fees should be chargeable unless otherwise agreed with the institutional investor and disclosed on an item-by-item basis. The calculation of all fees and carried interest distributions should be confirmed by an independent audit to provide transparency to the institutional investor, and all fees should be commercially reasonable and in line with market rates.

  • Excusal Rights: Under the Executive Regulations and Instructions issued by the Ministry of Finance of Oman, certain institutional investors (such as sovereign wealth funds) may be statutorily forbidden from investing and/or maintaining more than a set percentage of their aggregate assets in investments outside of Oman. In such case, the institutional investor should require the fund to provide it with prior notice of any prospective investment to allow time to consider the permissibility of the investment and to elect not to participate.

  • In-kind Distributions: An institutional investor should ensure that all distributions of fund assets are made in cash, unless it specifically agrees to in-kind distributions, in which case it should request the right to establish a liquidating trust to receive the in-kind distribution.

  • Transferability: An institutional investor should request a carve-out to the fund’s transfer restrictions to permit affiliated-party transfers (for example, where the institutional investor is undergoing a reorganization) without requiring the fund’s consent.

  • Allocations of Carried Interest/Change of Control Disclosure: The fund manager should disclose the allocation of carried interest amongst its personnel and any changes to such allocations. Further, any changes of control of the fund manager should be disclosed to the institutional investor and trigger a suspension on commitment drawdowns.

  • Privileges and Immunities: Certain institutional investors may, under Omani law, benefit from immunity from certain domestic and international laws which would otherwise be applicable to them. No provision of any fund document should prejudice such immunity unless deliberately waived by the institutional investor.

  • Alternative Investment Vehicle: Where the fund elects to establish an alternative investment vehicle to pursue a particular investment opportunity, the institutional investor should have the right to “opt out” of the vehicle upon sufficient prior notice.

  • Forum Selection: Omani courts should have exclusive jurisdiction in respect of any legal action brought against an institutional investor relating to its investment in the fund.
Investing in private equity entails a long-term capital commitment by the investor (up to 12 years), coupled with little or no influence on the decision- making process of a fund. It is, therefore, crucial for Omani institutional investors to negotiate the inclusion of terms, such as the above, in a side letter agreement with the fund manager before investing to ensure high levels of transparency and oversight of the fund manager’s decision-making process, and the alignment of the fund’s investment strategy with the investor’s portfolio diversification and regulatory requirements.