A Private equity fund’s (PE Fund, or the Fund) term sheet (a Term Sheet) provides a summary of terms of the Fund. The terms are typically in short form,
Term Sheet Drafting for a Private Equity Fund
A Private equity fund’s (PE Fund, or the Fund) term sheet (a Term Sheet) provides a summary of terms of the Fund. The terms are typically in short form, and will be spelled out in greater detail in the Fund’s Limited Partnership Agreement and Private Placement Memorandum (PPM). The Term Sheet is often also part of the PPM and serves as an introduction to the more detailed PPM. A stand-alone Term Sheet is primarily a marketing document, and is not legally binding. At times, a Term Sheet may be delivered to prospective investors that meet the Fund’s suitability standards, prior to the potential investor receiving the PPM and other Fund documents. In other instances, or where the terms of a Fund are still being considered by the sponsor, the preliminary Term Sheet will not be presented as a standalone document to prospective investors. In these circumstances, the Term Sheet may only be seen in a business-to-business exchange or only by Fund counsel or other service providers. The Term Sheet is not an offer to sell Interests in the Fund; such an offer may only be made with a complete set of offering documents (i.e., the PPM, subscription agreement, management agreement and other legal documents) send to qualified prospective investors. In certain instances, delivery of a standalone Term Sheet to prospective investors, especially without regulatory disclaimers and other disclosures, may run afoul of U.S. and certain foreign securities regulations. It is crucial, therefore, that counsel to the Fund and fund sponsor (Sponsor) keep a close eye on circulation of any Term Sheet, no matter how preliminary.
The Term Sheet should contain a summary of most of the terms that are described in further detail in the PPM and partnership agreement (Partnership Agreement), but will typically not be a thorough discussion of certain categories and sub-categories disclosed to investors in the Fund’s offering documents. When a Term Sheet is included in the introduction to the PPM, it can be seen as more of an outline of what will be discussed in detail in the remainder of the PPM, the Partnership Agreement, and other relevant offering documents. Note that the following terms are not an exhaustive list. Many Term Sheets will reference either the Partnership Agreement or a particular section of the PPM when discussing specific topics that require further clarification (e.g., ERISA, Tax Considerations, and Risk Factors). Certain PE Funds will include more or fewer of the terms discussed herein, and some terms listed below may not be relevant to all PE Funds. Attorneys should discuss which if any terms their clients wish to exclude from the Term sheet, and which terms they wish to highlight through prominent inclusion.
Most Term Sheets will begin with the Fund’s full legal name, including the legal form and state (or country) of organization (e.g., Delaware limited partnership).
The Term Sheet should include the legal name of the general partner (General Partner), including its legal form and state of organization. It may also include the name(s) of the Principal(s) and a short statement of the role of the General Partner.
If the Fund has an investment manager (Investment Manager), the Term Sheet should list its legal name, its legal form and its state of organization. It may also include a short statement of the duties to be performed by the Investment Manager, such as managing the day-to-day operation of the Fund.
This section may include, for each Investor, the minimum capital commitment (Capital Commitment) required by the Fund. This section may also state that the General Partner has the discretion to accept different Capital Commitment minimums and maximums from Investors. It may also include a cap on the aggregate Capital Commitments and the target size of the Fund.
General Partner Commitment
This section should note that the General Partner intends to commit capital to the Fund to demonstrate the alignment of its interest with that of the investors. The amount of this commitment, typically from 1%–2% of aggregate Capital Commitments, should also be noted, as well as what if any portion of this commitment will be made in cash (as opposed to a deemed commitment made via offsets to the management fee (Management Fee)). Funds may also wish to highlight the fact that other investment professionals of the Investment Manager will also invest personal capital in the Fund, if applicable.
Depending on the exception from regulation as an investment company on which the Fund plans to rely, a summary of investor qualifications should be included. For example, if the Fund relies on Section 3(c)(7), the Term Sheet would generally disclose that eligible Investors must be either “qualified purchasers” as defined in the Investment Company Act of 1940 (the “40 Act”), or non-U.S. Persons as defined in Regulation S of the Securities Act of 1933 (the “33 Act”). If the term sheet is presented as part of the larger PPM, referencing the relevant section in the PPM may be preferable to spelling out investor qualifications in the summary.
The Term Sheet should identify the initial closing date (Closing Date) of the Fund, even if the date is “as soon as practicable”. In addition, the Fund’s use of subsequent closings subsequent closings should also be disclosed. If there is an outside date or timeframe in which a final closing final closing must occur (e.g., no more than 18 months from the initial Closing Date), that date should be included.
This section should describe the Commitment Period, which will typically begin at the first Closing Date and end anywhere from 4–6 years from that initial date. Any capital calls permitted after the end of the Commitment Period should also be listed. These capital calls will typically include calls for funds necessary to cover expenses and liabilities of the Fund, calls to complete investments by the Fund in transactions that were in process as of the end of the Commitment Period, and calls to pay for follow-on investments in existing portfolio companies (Portfolio Companies). Any caps on the amount of follow-on investments or restrictions on their timing may also be mentioned under this heading.
Term of the Fund
The Term of the Fund (e.g., 10 years following the initial closing date (Initial Closing Date)) should be disclosed. In addition, most Funds will provide for extensions to the Term in the discretion of the General Manager (sometimes requiring the consent of the Fund’s advisory board or a majority in interest of the investors). The number and length of any permitted extension(s) should be disclosed as well as any provision for early termination of the Fund’s Term.
This section should list general investment restrictions such as the percentage of aggregate capital commitments the Fund may invest in any single Portfolio Investment (also called “portfolio concentration”). Most Funds will have a number of investment restrictions, ranging from geographic restrictions to restrictions on the size and type of businesses in which the Fund can invest (e.g., oil and gas investments or gun manufacturers). Depending on the length of the Fund’s list of restrictions, listing only primary restrictions in the Term Sheet may be preferable.
Many Funds will use bridge financing (Bridge Financing) to facilitate certain Portfolio Investments. Disclosure typically will provide a limit on the amount of aggregate outstanding Bridge Financings allowable at any time (usually presented as a percentage of aggregate commitments). This section may also provide how proceeds from repayment of Bridge Financings will be distributed to the Investors and whether such proceeds will be considered a part of an investor’s unfunded commitments available for recall to fund future investments and Fund expenses. Reference should be made to the PPM or Partnership Agreement Bridge Financing disclosure.
Most Funds will allow some form of recycling (Recycling), which enables the Fund to retain or recall proceeds from the disposition of Portfolio Investments to reinvest in new portfolio investments or to pay the Management Fees or expenses. Recycling may be limited by time (e.g., allowing Recycling only during the Commitment Period), by amount (e.g., limiting the total amount invested by the Fund to 120% of Commitments), and by the types of proceeds that can be Recycled (e.g., proceeds of investments realized within twelve months of being made). Recycling provisions can be complex, and reference should therefore be made to the PPM or Partnership Agreement Recycling provisions disclosure.
The Distributions section of a Term Sheet is often relatively complex compared to the other items in the summary of terms. This section generally includes the distribution waterfall (Distribution Waterfall) provisions (including carried interest), distributions in kind, and amounts and timing of distributions (Distributions). It is common to list the Distribution Waterfall in its entirety in the Term Sheet. Distributions of short-term interest, the handling of marketable and illiquid securities and other complexities may or may not be included. Reference should always be made to the Distribution provisions in the Partnership Agreement and/or the PPM.
General Partner Clawback
A Fund’s clawback (Clawback) provisions may also be complex and include such ancillary documents as a guarantee or an escrow agreement. A summary of the Clawback provision’s main features, including when the Clawback is calculated and amounts recalled and distributed, its relation to the Distribution Waterfall carried interest provisions (including any escrowing of carried interest amounts), and other general terms is appropriate. Reference should be made to the Partnership Agreement’s Clawback provisions and the guarantee and escrow requirements, if relevant.
The Term Sheet should briefly discuss the extent of the Fund’s ability to recall amounts previously distributed to investors. Typically, this section will discuss the reasons for any such investor giveback, such as if the Fund incurs liabilities following distributions made to the Investors.
This section should provide a thorough discussion of the Management Fee as described in the Partnership Agreement or Management Agreement, including the fee percentage and how it is calculated. Management fee offsets, fee waivers, and any step-downs or changes in calculations of the fee during the Fund’s term should be discussed. Reference should be made to both the Management Agreement (if applicable) and the Partnership Agreement.
Organizational expenses, operating expenses and general partner expenses should be summarized in this section. A lengthy discussion is not necessarily appropriate, but an indication of which expenses are borne by the Fund and the Investment Manager or General Partner is warranted. Reference can be made to the Management Agreement and to the Partnership Agreement as applicable for further discussion of Fund and organizational expenses.
If the Fund intends to borrow, make guarantees of portfolio company indebtedness, or use leverage in its portfolio, a brief summary of its borrowing practices should be noted in this section. This section should also include applicable limitations on the aggregate amounts of borrowings and guarantees outstanding at any one time (calculated as a percentage of the Fund’s aggregate Capital Commitments).
If the Fund will allow Investors to participate in co-investments, (Co-investments) a brief discussion of the Fund’s Co-Investment policy should be included. As Co-Investments have been the subject of recent regulatory scrutiny, the sponsor’s co-investment policy should be made available to investors, whether as part of the Investment Manager’s form ADV (Form ADV) or as a standalone policy.
Successor Funds and Parallel Funds
This section should summarize the restrictions on the General Partner launching a successor fund (Successor Fund). Typically, a Successor Fund may be launched at the end of the current Fund’s Commitment Period, or when the current Fund has at least a defined percentage of Capital Commitments invested or reserved for investments and expenses.
Many General Partners will establish a Form ADV that will be created for non-U.S. or U.S. tax-exempt investors. This section will typically disclose that such fund may differ in form but will seek to invest proportionately in all transactions on substantially the same terms and conditions as the initial Fund. This section may also require that any such Parallel Funds be formed on or before final closing of the main Fund.
Alternative Investment Vehicles
For legal, tax, regulatory, or other reasons, the Investment Manager may form one or more alternative investment entities to make, restructure or otherwise hold investments outside of the Fund. A summary disclosing the Investment Manager’s right to form such alternative investment vehicles (AIVs) should be included. Reference to the relevant sections of the PPM and Partnership Agreement containing the specifics of such regulatory or other situations and the details of managing the AIV should be noted.
Key Person Event
Because of the importance of key person (Key Person) provisions, especially from a marketing standpoint, a more detailed summary is appropriate for the Term Sheet. Key Persons should be listed and the circumstances in which their action or inaction may trigger a key person event (Key Person Event) should be noted. The summary should also note the length of any permitted cure period for the Key Person Event, and the consequences for failure to remedy the Key Person Event within the cure period. Reference should be made to the Key Person provisions in the Partnership Agreement.
Funds often choose not to include default (Default) provisions or remedies in the Summary of Terms. To the extent Default is mentioned, it is often sufficient simply to say that the fund will have “customary” default remedies, and to reference the Default provisions in the Partnership Agreement. Listing the Default triggers and potential penalties for defaulting investors is not necessary. The Partnership Agreement will include customary default provisions to address situations in which a Limited Partner fails to fund any portion of its Commitment when called by the General Partner or to otherwise make a payment when due.
Most Funds will have a limited partner advisory board (Board) made up of representatives of significant Fund investors. The anticipated size of the Board and member responsibilities may be summarized in this section. For specifics such as removal or incapacitation of a Board member and replacing such members, reference should be made to the relevant provisions in the Partnership Agreement.
A PE Fund will have detailed investor reporting requirements in its Partnership Agreement. A brief summary of quarterly and annual Reporting to investors should be noted along with reference to the Reporting section in the Partnership Agreement.
A statement saying that the Fund or the General Partner may enter into side letters or other similar agreements with certain Investors is sufficient for this section. Side letters are addressed more fully in the Partnership Agreement.
If relevant, this section may include specific information relating to unrelated business taxable income (UBTI) and effectively connected income (ECI). Briefly discussing the relevant Internal Revenue Code sections and summarizing UBTI and ECI is appropriate if the Fund has (or plans to admit) U.S. tax-exempt or non-U.S. investors. Reference to the relevant sections in the Partnership Agreement should be noted for further details.
An acknowledgement that the General Partner intends to conduct the operations of the Fund so that the assets of the Fund will not be considered plan assets of any plan investor under ERISA is relevant to this section. Additional content may be added where the Fund already qualifies, or intends to qualify, as a Venture Capital Operating Company (VCOC). Since ERISA matters can be very detailed, reference should be made to the specific ERISA disclosure in the PPM and provisions in the Partnership Agreement.
Transfers and Withdrawals
Briefly note that, generally, an Investor may not sell, assign, or transfer any interest in the Fund without the prior written consent of the General Partner, nor may an investor typically withdraw any amount from the Fund. More complete disclosure of regulatory withdrawals will appear in the Partnership Agreement.
Indemnification and Exculpation
Note that there are typically indemnification and exculpation provisions in the Partnership Agreement, management agreement and subscription agreements. For the Term Sheet, however, this provision should include only the Indemnification and Exculpation provision in the Partnership Agreement, as it applies to the indemnifications provided by the Fund to the General Partner, the principals and the Board. Care should be taken to be sure that the disclosure in the Term Sheet matches the Partnership Agreement, as this is a provision that is referenced when things have gone awry.
This section should simply note that an investment in the Fund involves significant risks and there can be no assurance that the Fund’s investment objectives will be achieved. The Term Sheet should typically only briefly mention general risk language since attempting to list every risk disclosed in the PPM would be cumbersome. Note that some of the most important disclosure considerations in the PPM are the certain risks associated with investing in the Fund. The risk disclosure in the PPM is often thorough, ranging from credit and portfolio risk to economic and political risk. Fund risks will generally be specific to the Fund’s investments and investment objectives. Risk provisions typically attempt to encompass every conceivable risk the Fund may encounter, in order to help shield the Fund from potential lawsuits from investors if there were losses on their investment.
Fund Counsel / Auditors / Placement Agent
Each service provider should be listed separately by name only. Note that listing the Fund’s counsel in the Term Sheet and the PPM is beneficial to attorneys reviewing Fund documents on behalf of potential investors. Knowing what law firm represents the Fund (and most likely drafted the Fund documents) provides a reviewing attorney some insight into what provisions may or may not be easily negotiated.
For more information on private equity funds, including a summary of the offering process, distinctions between private equity and hedge funds, and regulatory considerations, see the following practice notes and forms:
• Introduction to Private Investment Funds
• Key Differences between Hedge Funds and Private Equity Funds Comparison Chart
• Private Equity Fund Life Cycle
• Drafting and Reviewing the Key Documentation for a Private Equity Fund and Its Offering
• Term Sheet for a Private Equity Fund
• U.S. Regulatory Framework for the Offering of Private Equity Fund Securities
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