For those involved in the establishment and management of limited partnership funds, the basic legal principles and restrictions have changed very little since they were first created by the Limited Partnerships Act 1907.
There have of course been important changes to the taxation and accounting treatment of investment funds, which are the main adopters of limited partnerships, including the recent removal of base cost shifting and relatively recent changes to the accounting requirements which caused existing funds to consider their structure and reporting.
The changes proposed by the draft Legislative Reform (Limited Partnerships) Order 2015 are different however. They reflect a more comprehensive and joined up review of how the law applying to investment fund limited partnerships could be updated and clarified to reflect market practice and ensure that the UK continues to be an attractive jurisdiction for such funds, with rules which meet the needs of modern private equity investment.
The proposed changes are centred round the creation of “private fund limited partnerships”. These will be specifically designated as such when they are registered, with a solicitor certifying that a fund meets the legislative requirements in order to benefit from the relevant provisions. Such a fund must be a “collective investment scheme” but one which is not open to retail investors.
This new structure and designation will be available not just to the main fund which serves as the collective investment scheme, but also carried interest vehicles, feeder funds, co-investment vehicles etc. While the timetable for implementation remains to be confirmed, and the consultation only comes to an end on 5th October, it is important that those managing existing funds assess the merits of this new designation as once the proposed legislation comes into force, they will have twelve months in which to apply to qualify for the new status.
The draft legislation includes a number of improvements but the main ones of interest to fund raisers and fund managers are likely to be:-
- The publication of a “white list” of permitted activities. This is intended to remove some longstanding uncertainty regarding what activities could expose limited partners to unlimited liability if they were seen to start to edge into some kind of management role. Some of the activities included on the white list include
(i) acting as a director, member, officer or agent of a general partner;
(ii) appointing someone to represent a limited partner on a committee;
(iii) enforcing rights under the partnership agreement;
(iv) taking decisions regarding the types of investment made, changes in the nature of the partnership, acquisitions and disposals of partnership business, the appointment of partners and the dissolution or winding up of the partnership.
While some of these approved activities are consistent with general market practice, others may push the boundaries, including taking part in a decision about whether to allow the incurring, extension or discharge of debt by the partnership or
the creation, extension or discharge of any other obligation owed by the partnership. The key consideration is that the activity should relate to the internal running of the fund and should not extend to any ability on the part of a limited partner to bind or act on behalf of the limited partnership fund.
- The removal of the requirement for investors to have a capital contribution. The commercial value in maintaining capital contributions is very minimal and provided investors receive the tax treatment that they require, arguably it serves no real purpose. Indeed it can lead to complexity in drafting and accounting that many would prefer to avoid. To take account of this, it is proposed that capital contributions will no longer be required for private fund limited partnerships although there will remain an option to retain such a mechanism. This may be important for ensuring that investors in certain jurisdictions continue to get the desired tax treatment.
- There will no longer be a need to publish transfers between limited partners in The Gazette or lodge a notice if a general partner becomes a limited partner.
- On registration of a new private fund limited partnership there will be increased privacy, with the capital contributions, the nature of the fund and the term of the fund no longer being required to be published.
The draft legislation does not go as far as to grant English limited partnerships separate legal personality. Scottish limited partnerships have always had such separate legal identity, which allows them to enter into contracts in their own name, an advantage that has attracted many funds to register in Scotland. Such a capacity is not yet available to English partnerships as there are broader legal implications arising from such a change although the BVCA continues to lobby Government on this issue.
These changes are undoubtedly to be welcomed and on the face of it you would assume that almost every new venture capital fund would take advantage of the changes, once they come into effect. As is always the case with limited partnerships however, taxation will have a key role to play. If fundraisers find that they need to maintain a capital contribution mechanism in order to attract investment from a range of foreign investors, there would be little advantage in dispensing with it for other classes of investors and so this perceived relaxation may be undermined by the overriding tax considerations.
While it will also be possible for existing funds to apply for the new designation (within the first twelve months) the technical work involved in restructuring the capital contribution provisions and the existing fund accounts may mean that there is little real incentive to apply, even with some of the other benefits referred to above.
These practical considerations should not detract from the positive contribution that the legislation should make and whether a fund formally adopts the new designation or not, the publication of the white list is certainly to be welcomed and common sense dictates that it will be very instructive in the interpretation of the existing legislation in its application to all limited partnership VC funds.