Private Fund Structuring “101”
Insights Nicole Kalajian · February 21, 2023
This memorandum describes the typical entity structures used when launching a new private fund. Although various factors influence the choice of entity structures used for a private fund, this memorandum will discuss the most basic considerations – namely preferences of the fund’s investors and the manager. It should be noted at the outset that different structures will involve different costs and complexities. Thus, it is important to take time and care when initially selecting the fund’s entity structures. The following discussion is provided as a source of information only and is not intended to be comprehensive or constitute legal advice. We recommend that you consult competent legal and other advisers in connection with starting any private fund.
I. Introduction to Basic Entity Private Fund Structures
Private funds can take on four possible forms under U.S. federal income tax laws: (1) onshore entities classified as corporations (rarely used), (2) onshore entities classified as partnerships (the most common), (3) offshore entities classified as corporations (the most common offshore structure) and (4) offshore entities classified as partnerships (less common as a choice of investment vehicle for offshore structuring).
Managers rarely organize their funds as onshore entities classified as C-corporations for U.S. federal income tax purposes. This is because C-corporations are subject to an entity- level tax and are not eligible for favorable tax rates on long-term capital gains or qualified dividend income. In addition, domestic and foreign shareholders of C-corporations generally are subject to a second level of income tax on dividends arising from the C-corporation. Similarly, although S-corporations provide for only one level of tax, the significant ownership restrictions that apply to S-corporations make them a poor vehicle for private funds.
II. Investor Classifications and Preferences
Determining the fund’s target investor group is a threshold question in entity structuring decisions. Fund investors fall into one of three classes: (1) U.S. taxable investors, (2) U.S. tax-exempt investors (such as government or corporate pension plans, HR-10 plans, individual retirement accounts, charities or private university endowment funds), and (3) non-U.S. investors. U.S. taxable investors are best served by onshore funds that are classified as partnerships, while U.S. tax-exempt and non-U.S. investors prefer to invest in offshore funds classified as corporations. The reasons for these investor preferences are set out in further detail below.
Nicole Kalajian is a Chicago-based attorney who focuses her practice on investment management. This summary is provided for informational purposes only and is not intended to constitute legal advice nor does it create an attorney-client relationship with Rimon, P.C. or its affiliates. Prior results referred to in these materials do not guarantee or suggest a similar result in other matters.
Nicole Kalajian focuses her practice on investment management. Ms. Kalajian represents securities and commodities professionals in a variety of regulatory, compliance and corporate matters. She has extensive experience advising private fund clients, including hedge funds, commodity pools, cryptocurrency funds, fund of funds, socially responsible investment vehicles, venture capital funds, private equity funds and real estate funds. Ms. Kalajian also provides legal and structuring guidance concerning master-feeder structures, domestic and foreign funds, international offerings, separately managed accounts, and robo-adviser platforms. Read more here.