CFM Fund Structuring & Legal Frameworks 5 — Questions and Answers
Question 1: The 'preferred return' (hurdle rate) in a private equity fund is best defined as:
- The minimum annual return LPs must earn before the GP receives any carried interest (Correct answer)
- The rate at which the fund borrows from its credit facility
- The maximum management fee expressed as an annual percentage
- The target IRR disclosed in the fund's marketing materials
Correct answer: The minimum annual return LPs must earn before the GP receives any carried interest
The preferred return is the minimum compounded annual return LPs must receive before the GP begins participating in profits via carried interest.
Question 2: Which of the following most accurately describes a 'co-investment' opportunity in private equity?
- An LP's right to withdraw capital during the fund's investment period
- An offer by the GP for select LPs to invest directly alongside the fund in a specific deal, often with reduced fees (Correct answer)
- The GP's obligation to reinvest realized gains into new portfolio companies
- A secondary market transaction in which one LP sells its interest to another
Correct answer: An offer by the GP for select LPs to invest directly alongside the fund in a specific deal, often with reduced fees
Co-investments allow favored LPs to invest directly in individual deals at lower or no fee, increasing their exposure to specific opportunities.
Question 3: Under the Dodd-Frank Act, which category of investment adviser was newly required to register with the SEC that was previously exempt?
- Venture capital fund advisers
- Advisers to mid-sized hedge funds with AUM between $100M and $150M
- Advisers to private funds with at least $150 million in AUM (Correct answer)
- Commodity pool operators with fewer than 15 clients
Correct answer: Advisers to private funds with at least $150 million in AUM
Dodd-Frank eliminated the 'private adviser' exemption and required advisers to private funds with $150M+ AUM to register with the SEC.
Question 4: What is a 'key man' clause in a limited partnership agreement?
- A provision requiring the GP to hire a minimum number of investment professionals
- A clause that suspends or terminates the fund's investment period if specified key individuals leave the GP (Correct answer)
- A requirement that LPs approve all portfolio company board members
- A lock-up provision preventing key employees from joining competitors
Correct answer: A clause that suspends or terminates the fund's investment period if specified key individuals leave the GP
A key man clause protects LPs by halting new investments if critical individuals identified as essential to the fund depart.
Question 5: A fund structured as a 'series LLC' provides which distinct advantage?
- It eliminates the need for a general partner
- It allows segregation of assets and liabilities into separate series within a single legal entity (Correct answer)
- It automatically registers each series with the SEC as a separate fund
- It converts carried interest into ordinary income for tax purposes
Correct answer: It allows segregation of assets and liabilities into separate series within a single legal entity
A series LLC enables multiple segregated investment pools with independent assets and liabilities under one umbrella entity, reducing formation costs.
Question 6: In fund governance, what is the primary function of a Limited Partner Advisory Committee (LPAC)?
- To make day-to-day investment decisions on behalf of the fund
- To review and approve conflict-of-interest situations and provide oversight of the GP's conduct (Correct answer)
- To negotiate management fee terms on behalf of all LPs
- To conduct annual audits of the fund's financial statements
Correct answer: To review and approve conflict-of-interest situations and provide oversight of the GP's conduct
The LPAC reviews conflicts of interest, approves waivers, and provides governance oversight without controlling investment decisions.
Question 7: The 'recycling' provision in a private equity fund agreement allows the GP to:
- Transfer portfolio companies between different funds managed by the same GP
- Reinvest realized proceeds from early exits back into new investments during the investment period (Correct answer)
- Roll over management fees into the next fund's capital commitment
- Re-allocate carried interest from one vintage fund to another
Correct answer: Reinvest realized proceeds from early exits back into new investments during the investment period
Recycling lets the GP redeploy capital returned from early realizations so the committed capital is fully put to work rather than distributed immediately.
CFM Fund Structuring & Legal Frameworks 5
The 'preferred return' (hurdle rate) in a private equity fund is best defined as: