How To Avoid A Fund Blow Up

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Its 2.4 miles from Hampstead Village to Golder’s Green in London.

A 12 minute drive thru narrow, winding roads during non-peak hours.

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We did it in 6!

At 2am in the morning.

To the ear splitting music of “Under the Bridge” by the Red Hot Chili Peppers

I had just finished my shift.

As a server in a posh French restaurant.

And a colleague gave me a ride home in his white Beemer

I was 18 years old and taking in Life.

BIG GULPS at a time!

Truth is I still remember that drive every time the Chili Peppers come on the radio.

It was exhilarating.


And colossally stupid.

Of course age teaches you a few things (hopefully).

We (try) learn some tricks to help smooth out the highs and the lows that comes our way.

You’ve got to go through it to get it

The point being that an investor, as in life, has to go through the cycles a few times before getting comfortable with the Drive.

Thus it is with Private Investing.

Simply going through the Administrative cycle of an investment can show you the pitfalls you may experience if you’re not careful to do your work upfront:

But let me help you

I have tried to list the various ‘pieces of paper’ you will encounter during the LIFE CYCLE of a PVT.  Investment.  In many instances these are part of a recurring annual cycle but they can be clues, bread crumbs on what can trip you up and make all hell break loose. So here we go:

Life cycle of private investments

  1. 1099 – A US Tax document indicating how much you received as an arm’s length contactor / supplier. A copy of the 1099 goes to the IRS.
    It is unusual to receive if you are a passive LP investor. However it is applicable if you receive a referral fee or do consulting work for a fund.
  2. 1042-S Foreign person US Source income withholding – reported to the IRS. Your country may have a double tax agreement with the USA and hence you can offset taxes paid in the US against domestic taxes. Check with your Accountant.
    S. offshore funds issue PFIC statements to US investors. It’s similar to a K-1 (see below)
  3. Audited financial statements – IMPORTANT review audited financial statements as part of your initial due diligence. These are not always available but if they are make note of the Auditors opinion. Numerous service providers and regulators rely on the auditors opinion for the investment to remain in good standing.
  4. Capital Call – this is a notice instructing investors that a portion of their committed allocation will be ‘called’ into the fund. The investor must be prepared to wire in the money. Failure to do so can have BAD consequences and ultimately a draconian loss of the funds you have already invested.
  5. Capital Distribution – Money coming your way! Either a sale of an investment occurred or a portion of the Earnings after Tax is being distributed as a dividend or income. Some funds allow you to automatically reinvest distributions – but it may still be taxable to you.
  6. Capital Statement – your capital account balance aka. Net Asset Value or NAV. Depending on the nature of the fund this may be issued by the funds accountant (administrator) monthly or quarterly or even less frequent.
  7. Contact Info – self-explanatory but obviously your address and domicile will have tax implications … consult an accountant or lawyer.
  8. Contact Notes – keep notes of all meetings! Its good practice to be able to have a continuous conversation with a manager over time. Also you never know when you have to fact check or refresh your memory when emotions are running hot.
  9. Daily Reports – more applicable for trading and liquid orientated funds. Usually produced by the custodian. Will show daily P&L. Best to have it feed automatically into you portfolio reporting and/or risk management software.
  10. Daily Positions – great transparency if you can get it ... what to do with it? Best to feed into a risky management system
  11. Disclosure – generally disclaimers that all you are reading may in fact not be valid and may certainly not be repeated or should be relied upon for the future. But sometimes they offer good indications of disclosed conflicts of interest which are noteworthy for future “arm’s length” transactions.
  12. Due Diligence Questionnaire (also known as a DDQ) – A concise summary of the firm, strategy and compliance regimen. A must have to request upfront BEFORE you make an investment. A part of your initial review. The Alternative Investment Management Association (AIMA) publish excellent templates.
  13. D – government issued
  14. Investment Confirmation – usually from a third party administrator evidencing an investment has been made, amount, date, share class. Could also be evidenced by a proof of funds wire from a custodian.
  15. Interim Financials.. management accounts usually unaudited.
  16. Investment Document - generic
  17. K1s – depending on complexity of fund the k-1s may be issued prior to April 15th tax deadline (simpler to value funds) or after April 15th (which requires a tax extension for taxable clients … and usually irritates high net worth clients)
  18. Legal document – generic can includes the LPA – Limited Partnership Agreement. Document that governs the interaction between limited partners, operating partners and the fund. LPs have limited liability—they are only liable on debts incurred by the firm to the extent of their registered investment and have restricted management authority. The GPs pay the LPs a return on their investment, the nature and extent of which is usually defined in the partnership agreement.
  19. Marketing Document – monthly tear sheet / risk report
  20. NAV Package – monthly or quarterly, reports the net asset value of your account, taking into account most recent mark-to-market gains and losses usually realized and unrealized. Preferably issued by a 3rd party administrator (think Madoff)
  21. Offering Memorandum – the bible! Governing laws of the offering. Iists risks involved, terms, fees etc. mostly boiler plate but needs to be read carefully for any hidden terms/restrictions.
  22. Operating Agreement – document governing the operations of the fund, will govern how the manager must operate the fund for the benefit of the limited partners. Usually restates Fees, liquidity etc.
  23. Performance Update – usually produced by manager – quick update on performance with brief commentary. Usually delivered via email for expediency.
  24. Privacy Policy – usually boiler plate but without it your details can be shared with whomever without your permission.
  25. Presentation – Some investors place large emphasis on the pitch book, the time it takes to prepare and the details. Some glance at it, preferring to go through in detail with the manager. Regardless I think it says a lot about a manager who has an up to date, good looking pitch book. And remember it’s a marketing piece so don’t expect to find any hidden secrets here.
  26. Quarterly Report – read what the manager is saying, how are things progressing, also a good time to tell investors about changes in the team, back-office, and service providers. Is the thesis developing as originally laid out by the manager?
  27. Subscription Agreement—this is prima faciea evidence of your admission into the fund/ entity. Indicated the $ committed. Important fund administrator keeps a signed copy
  28. Tax Document
  29. Tax Estimate
  30. Video

A lot of focus is placed on initial due diligence ... which is justified because its your last chance to take a relatively unbiased view of the investment. Once your funds are tied up (and illiquid) emotions WILL run hot.

But ongoing monitoring is just as important to make sure the manager is making good on his/her original premise and this stream of documents can provide the evidence you are looking for…

It would be useful if an unbiased trusted source can be used to maintain a record of all these documents … which is what Blockchain is purported to do. So we would expect to see private fund issuance moving into the ICO space if it hasn’t done so already. And performance “promises” can be written into Smart Contracts

That’s a good idea Greg!

Thank you for reading my post. I regularly write about private market opportunities and trends. If you would like to read my regular posts feel free to also connect on LinkedIn, Twitter or via Atlanta Capital Group Investment Management.

Greg Silberman is the Chief Investment Officer of Atlanta Capital Group Investment Management [ACGIM]. Atlanta Capital Group Investment Management specializes in creating custom private market solutions for RIA/Family Office clients.

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