Happy Friday, Funds Family!

Today we’ll walk through the six main phases of a closed-end fund’s life cycle:

1. Pre-Closing Fundraising 👶 

2. Initial Closing Date

3. Initial Capital Call

4. Final Closing Date

5. Investment Period Ends

6. Fund Term Ends 🪦 

Please note that this article applies to closed-end funds with a defined life. Open-end, or “evergreen” funds have a perpetual life and will be the subject of a future article.

Closed-end funds are common for real estate, private equity, and venture capital. Open-end funds are typical for hedge funds. Credit funds can go either way.

Now, let’s dive in 🏊️ 

(Here’s a link to the full-size image below)

1. Pre-Closing Fundraising

Each investment fund begins as a sparkle in the eye of an aspiring fund manager (GP).

But before you can run an investment fund…you must form legal entities and raise the money from investors (LPs)!

This video describes our process for forming investment funds, but we’ll summarize the steps below.

• Research fund terms and structure. Before finding a lawyer, I would suggest researching what you want your fund to look like. Especially if your lawyer bills by the hour, it’s better to arrive with a fully-baked idea, including the terms of your fund. Your lawyer will help you refine your offering.

• Draft a preliminary pitch deck. Create a small slide deck outlining your offering and show it to your friends and family. See if anyone is interested! If nobody bites, go back to the drawing board until you craft a compelling offer with an ironclad thesis.

• Find a lawyer and draft a comprehensive summary of terms. Next, you’ll want to find a lawyer. They will help you draft a full summary of terms detailing your offering. At this point, you will also want to refine and finalize your marketing deck.

• Draft long-form fund documents. Once you have traction with investors, your lawyer should draft your primary fund documents, including the LPA (or LLC Agreement), Subscription Documents, and (if applicable) PPM. You’ll send these to investors.

• Lawyer stuff. While investors review your documents, your lawyer will do all sorts of things such as forming legal entities, preparing for securities filings, and drafting ancillary documents.

• Open bank accounts. At this point, you should open a bank account for each entity in your fund structure. You need somewhere for investors to send the money!

• Negotiate. Some investors may negotiate. You can handle negotiations by (i) changing the terms for everyone by revising the LPA or (ii) changing the terms for specific investors by drafting a side letter agreement with them (which does not affect other investors).

• Collect Investor Subscription Documents. When investors are ready to commit, they will send you signed subscription documents. ⚠️ Do not countersign these documents until you want to hold the initial closing! The date you countersign the first investor’s subscription documents is technically the initial closing date. Sometimes GPs countersign the sub docs immediately, not realizing they accidentally held the initial closing.

2. Initial Closing Date

The Initial Closing Date is a big deal for an investment fund. It’s the day when you admit the first LPs. 🙌 

As mentioned above, the initial closing date happens when you countersign the first LP’s subscription documents.

In addition to countersigning subscription documents, a few other things should happen:

• Signing Party 🥳. You will sign the fund’s LPA, as well as ancillary documents like closing resolutions, management agreements, and side letters.

• Form D. Within 15 days of the initial closing date, your lawyer should file a Form D with the SEC. Please see this article on the Securities Act for a discussion on Form D and its purpose. You can also pre-file your Form D before the initial closing date, which is what we do for most clients.

• Blue Sky Filings. Within 15 days of the initial closing date, your lawyer should make “blue sky” filings with each state where you have at least one investor. You can make these filings here.

• Advisers Act Filings. Depending on your asset class, home state, and assets under management, you may need to make an additional filing within 60 days of closing your fund. We discuss these requirements in these articles on the Advisers Act and State Investment Advisers Laws.

💸 Where does the money go on the initial closing date?

Nowhere!

This is often misunderstood, but an investment fund’s initial closing date is merely the date when LPs agree to be legally bound to send money to the fund when called (asked for) by the GP.

It’s a legal date more than anything else. 📜 

On many initial closing dates, no money moves.

3. Initial Capital Call

Show me the money! 💵 

Once the fund holds an initial closing, you can officially call capital 📞 from LPs.

Calling capital involves the GP sending a notice to LPs asking for money. The capital call notice typically says (i) how much money the LP needs to send and (ii) a deadline for sending the money. ⏰ In many fund LPAs, LPs have 5-10 business days to send money after the GP issues the capital call notice.

Many GPs issue the first capital call notice on or around the initial closing date.

The first capital call is often used to fund the following:

• The first quarter’s management fees

• Fund expenses (legal, accounting, reimbursements for setup costs)

• Investments in the pipeline

🏗️ Warehoused Investments

In some cases, the GP may have plopped some investments into the fund before the initial closing date. This sometimes happens when the GP finds a great deal but the fund isn’t ready yet.

The GP might (i) buy this deal themselves and sell it to the fund after the initial closing date or (ii) lend money to the fund before the initial closing date to enable the fund to buy the investment.

In either case, the first capital call might include funds to repay the GP for the warehoused investment. ♻️ 

⚠️If you’re a GP with a warehoused investment, you should disclose the warehoused investment in your fund documents. LPs should understand the material facts, such as the price you paid and the price the fund will pay (which are often the same price). As these transactions involve conflicts of interest, you want to disclose, disclose, disclose!

📊 Pro Rata Capital Contributions

In most closed-end funds, capital is called pro rata, which means each investor contributes the same percentage of their capital commitment at each capital call.

For example, at the first capital call, the GP might call 20% of each LP’s commitments.

Some funds have mechanics to allow non-pro-rata capital contributions, but these can get complicated quickly. Most funds are pro rata.

4. Final Closing Date

Most investment funds don’t raise their full target fund size at the initial closing.

For example, an investment fund may have a $100 million target fund size but only close on $30 million of commitments at the initial closing. Then, they raise the remaining $70 million over the next year or two. 💰️ 

Most closed-end funds have a cutoff date for when fundraising must stop. A typical fundraising period lasts 12 months from the initial closing date, with an optional 6-month extension at the GP’s discretion. ✅ This cutoff can typically be further extended if the LPs agree.

Until the final closing date, GPs often invest and fundraise simultaneously. While this is a lot of work, it enables the fund to show potential LPs a track record of actual investments 📈 , which may help them raise more money.

5. Investment Period Ends

Closed-end funds typically have an investment period during which the fund can make new investments. The investment period is usually ~half the fund’s life (e.g., 5 years in a standard 10-year fund).

While the fund can’t make new investments, it can usually still call capital for various purposes, including money to:

• Pay fund expenses

• Complete deals that were in process when the investment period ended

• Fund follow-on investments or improvement on existing investments

• Exercise existing options to purchase an investment

• Undertake 1031 exchanges

• Make new investments specifically approved by the LPs

Management fee step-down 📉 

The management fee earned by the GP typically decreases after the investment period ends. There are two main ways this can happen.

“Venture Capital Style”

In venture capital funds, the management fee percentage usually decreases ⬇️ (for example, from 2% to 1.5%) upon the termination of the investment period.

However, the management fee base typically stays the same ➡️ (usually committed capital, which means the total fund size).

“Private Equity Style”

In many other funds (such as private equity and real estate), the management fee percentage is constant (perhaps 2% for the fund’s life). ➡️

However, the management fee base steps down ⬇️ from (i) aggregate commitments to (ii) invested capital. As the fund sells assets, the management fee decreases.

6. Fund Term Ends

All good things must come to an end. 👋 

Eventually, the fund’s term ends, at which point the fund begins to liquidate and sell off any remaining investments.

A closed-end fund often lasts ~10 years, with the option for the GP to extend for 1-2 years and an option for the LPs to extend for an additional year.

♻️ Continuation Funds

In some cases, the GP (and potentially some LPs) might not want to sell the assets. The assets are great!

In this case, the GP may form a continuation fund to purchase some of the best assets from the terminating fund. In many cases, LPs can elect to tag along and keep the party going. 🥳 

In some cases, new outside LPs will be brought into the new continuation fund as well.

👀 When can you start Fund 2?

This is contractually negotiated, but GPs can usually start Fund 2 (or any successor fund) once Fund 1’s investment period is over.

Until then, the Fund 1 LPs want to ensure the GP pays attention to Fund 1 and not diverting investment opportunities to other funds.

Thanks for reading, everyone.

Have a great weekend! 🙌 

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.