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Co-sponsorship of a Private Equity Fund’s General Partner in the UAE: A Growing Trend
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h.storrar@tamimi.com 
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As sovereign wealth funds, family offices, and domestic and international financial investors in the UAE (and the wider MENA region) look for more direct and innovative ways to deploy their capital, we are seeing a growing trend for direct participation in an investment fund’s general partner (GP). This trend is particularly prominent in the Abu Dhabi Global Market (ADGM).
Traditionally, such investors have taken the opportunity to co-invest alongside a private equity fund’s main fund (rather than simply investing in that fund). However, there is increasing appetite for revenue derived from management fees and carried interest — to which a GP has exposure — rather than simple equity exposure pursuant to a co-investment or a direct fund investment. The two investment structures are not mutually exclusive, with GP interests and co-investments existing simultaneously across single or multiple fund structures.
For context, a GP of an investment fund is responsible for the active management of the fund, from raising capital from limited partner (LP) investors to asset selection, developing assets acquired by the fund, and ultimately disposing of those assets in order to generate a return.
The GP may itself be financially regulated or, more commonly, the investment management activities may be undertaken by a separate regulated entity. In the ADGM, the applicable regulator is the Financial Services Regulatory Authority (FSRA). A category 3C licence is the most relevant for a private-equity fund manager’s regulatory requirements.
Notwithstanding where the regulatory framework sits, the GP will most likely take the form of a private company limited by shares. The ADGM’s companies regulations are closely modelled on UK companies legislation and will therefore be familiar to international investors accustomed to common-law corporate governance frameworks. This provides significant comfort when it comes to establishing governance and ownership interests, and particularly for joint venture purposes, comfort regarding ultimate liquidity.
From our recent experience, we are seeing investors taking minority positions (less than 50%) in the GP and taking responsibility for initial funding and start-up capital, principally to fund GP and fund establishment costs. The majority shareholder brings the relevant sectoral asset management experience. Currently, there is much emphasis in the UAE market on the commercial and residential real-estate and logistics sectors for regional private equity funds, with some growing interest in medical technology.
It is critically important that the joint venture partners establish their roles from the outset. Generally, and not unexpectedly, the financial investor will take a far more passive role, with the asset manager taking primary responsibility for day-to-day operations. There are a number of protections the investor will seek to cater for in their governance and ownership rights in the joint venture, including typical joint venture provisions and those more peculiar to this kind of arrangement. Key themes include the following.
Negative control
The asset manager will invariably control the board of the GP and, accordingly, the investor will seek agreement on certain matters the asset manager cannot undertake without its consent. Over and above typical reserved matters found in a corporate joint venture, changes to fund documentation — particularly the limited partnership agreement (LPA) — and the creation, variation, or termination of any related party arrangements are fundamental, as these could ultimately have a direct effect on revenue streams.
Lock-in and tag rights
With many international asset managers taking an interest in the region, there is a heightened risk of an early sale by the asset manager JV partner to an incoming international manager (with a corresponding drag exercise). An incoming asset manager would typically seek to acquire the relevant FSRA licence rather than establishing from scratch, which may mean a shorter period in terms of regulatory processes. Accordingly, an investor would typically wish to ensure there is a prohibition on disposals of shares within a specified period post-establishment and a right to tag its holding into any sale following such a period.
It is worth noting that the investor’s rights in this instance are similarly aligned with the rights of the investors in the fund, where a change of control in the fund manager is often only permitted with limited partnership advisory committee approval. However, the investor should not rely on the exercise of such fund-level protections, as its strategic and economic interests in the GP are distinct from the LP investors’ interests in the fund, and the exercise of those rights is outside the investor’s control.
Non-circumvention
Typically, the investor will be entering the joint venture to achieve a wider strategic goal in connection with the particular sector in which the fund invests, and will wish to ensure its financial success in that sector is aligned with the fund manager’s. Accordingly, the investor will likely seek protections addressing matters such as exclusivity and priority on new opportunities, co-investment rights in related strategies, and restrictions on the asset manager pursuing competing opportunities without investor consent.
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Whilst traditionally those investors have taken the opportunity to co-invest alongside a private equity fund's main fund (rather than simply investing in that fund), we are seeing an increasing appetite for revenue derived from management fees and carried interest.
Good leaver/bad leaver
Key persons employed by the asset manager will typically be restricted from leaving under the LPA, but it is also important that any such departures are catered for under the joint venture arrangements. In particular, rights to employee share options should be addressed, with appropriate provisions for those options to fall away or be curtailed in bad leaver scenarios. The investor should also seek negative control over changes to any share option scheme.
Share classes
In some cases, it may be necessary for the investor to seek a separate and preferential class of share. For example, this may involve giving recourse to a 1x return on capital and a certain percentage return (hurdle), prior to any participation from the fund manager, particularly in cases where significant initial capital outlay may have been provided by the investor. However, shares ranking pari passu tend to be more common, with a simple pro-rata right to participate in returns and distributions of the GP between the shareholders (with preferential return prior to the GP’s carry to be found within the fund itself in favour of the LPs).
It should also be noted that many joint venture GPs in the region begin life as a simple unregulated private-sponsorship arrangement, where two or more parties have raised private capital for the purposes of making investments but have not been undertaking any form of regulated activity.
A related trend we are observing is that, as investment size grows and more capital is required, it becomes necessary for the original sponsors to undertake regulated activities (i.e. raising capital in the market). This necessitates the establishment of a formal fund structure (and the transfer of seed assets into such structure), with a corresponding requirement to re-document the joint venture and shareholder arrangements to suit the GP/LP model.
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