U.S. patent application number 13/970705 was filed with the patent office on 2013-12-19 for method and system for adding liquidity to alternative investment transactions.
This patent application is currently assigned to JPMORGAN CHASE BANK, N.A.. The applicant listed for this patent is JPMORGAN CHASE BANK, N.A.. Invention is credited to Peter C. Freund.
Application Number | 20130339273 13/970705 |
Document ID | / |
Family ID | 23319429 |
Filed Date | 2013-12-19 |
United States Patent
Application |
20130339273 |
Kind Code |
A1 |
Freund; Peter C. |
December 19, 2013 |
METHOD AND SYSTEM FOR ADDING LIQUIDITY TO ALTERNATIVE INVESTMENT
TRANSACTIONS
Abstract
The invention provides a method and system for providing
liquidity to an alternative investment fund. The transaction system
includes a plurality of fund investors; an alternative investment
fund in which the fund investors commit to the investment of
"alternative investment funds," the alternative investment fund
managed by a fund manager; a structure operated in conjunction with
the alternative investment fund, the structure managed by a
structure manager; and a plurality of structure investors, the
structure investors investing structure funds into the structure.
The structure provides at least one fund investor with an option to
designate cash distributions of the alternative investment fund,
which are made available to the at least one fund investor, to the
structure. In the system the at least one fund investor obtains a
liquidation of alternative investment funds upon the designation of
the cash distributions of the alternative investment fund.
Inventors: |
Freund; Peter C.; (New York,
NY) |
|
Applicant: |
Name |
City |
State |
Country |
Type |
JPMORGAN CHASE BANK, N.A. |
New York |
NY |
US |
|
|
Assignee: |
JPMORGAN CHASE BANK, N.A.
New York
NY
|
Family ID: |
23319429 |
Appl. No.: |
13/970705 |
Filed: |
August 20, 2013 |
Related U.S. Patent Documents
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Application
Number |
Filing Date |
Patent Number |
|
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10315242 |
Dec 10, 2002 |
8560425 |
|
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13970705 |
|
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60337177 |
Dec 10, 2001 |
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Current U.S.
Class: |
705/36R |
Current CPC
Class: |
G06Q 40/00 20130101;
G06Q 40/04 20130101; G06Q 40/06 20130101 |
Class at
Publication: |
705/36.R |
International
Class: |
G06Q 40/06 20060101
G06Q040/06 |
Claims
1. A computer-implemented method for providing liquidity to an AI
fund, wherein the AI fund comprises equity interest in investments
selected from a group consisting of private equity funds, hedge
funds, leveraged buyout funds, venture capital funds, partnerships,
real estate investment trusts, real estate properties, and private
company stocks, the method comprising: receiving, from a first AI
fund investor, an assignment of a designated investment in the AI
fund; establishing at least two classes of trust equity interests
based on the assignment, the two classes of trust equity interests
providing distributions based on returns on the assigned investment
and including a senior equity interest and a junior equity
interest; determining the senior equity interest by calculating (1)
a preferred amount equity component to be paid in priority to the
junior equity interest and (2) a first portion of a non-preferred
equity component that is paid after satisfaction of the preferred
amount; calculating the junior equity interest comprising a second
portion of the non-preferred equity component that is paid after
satisfaction of the preferred amount; receiving title of the senior
equity interest and assigning the junior equity interest to the AI
fund or the AI fund investor; assigning the senior equity interest
to a trust participant other than the AI fund investor, thereby
providing for the AI fund investor to obtain a liquidation of the
designated investment while continuing to share in a potential
up-side return based on the junior equity interest; and
distributing the returns on the assigned investment to the trust
participant and the AI fund investor based on the senior equity
interest and the junior equity interest.
2. The computer-implemented system of claim 1, wherein the senior
equity interest includes the preferred amount and a portion of a
residual component of capital return following satisfaction of the
preferred amount.
3. The computer-implemented method of claim 1, further comprising:
calculating the preferred amount to be no greater than 30% of a
fair market value of the designated investment, thereby providing
for the senior equity interest holder to receive returns from the
designated investment in the AI fund up to that preferred amount
before returns are paid to the junior equity interest holder.
4. The computer-implemented method of claim 1, further comprising:
calculating the preferred amount to be 30% or less of a fair-market
value of the designated investment, thereby providing a senior
equity interest that has the characteristics of an investment
tirade debt.
5. The computer-implemented method of claim 1, further comprising:
distributing to the AI fund investor funds corresponding to no
greater than 30% of the fair-market value of the designated
investment in the AI fund, thereby providing the AI fund investor
no greater than 30% liquidity while maintaining a longer-term
upside interest in the performance of the AI fund through the
junior equity interest held by the AI fund investor.
6. The computer-implemented method of claim 1, further comprising:
paying out the non-preferred equity component to the trust equity
interests in subordinate priority to the preferred amount, the
senior equity interest receiving a first portion comprising 10% of
the non-preferred equity component and the junior interest
receiving a second portion comprising 90% of the non-preferred
equity component, thereby providing for the holder of the junior
equity interest and the holder of the senior equity interest to
share in the long-term upside of the designated investment.
7. The computer-implemented method of claim 1, further comprising:
establishing a plurality of equity trust interests comprising a
senior interest and a plurality of junior interests, the junior
interests being subordinate in priority to the senior interest,
each of the junior interests having established return components
that define the priorities as between said junior interests.
8. The computer-implemented method of claim 1, further comprising:
establishing a plurality of equity tranches corresponding to the
senior equity interest and a plurality of junior equity
interests.
9. The computer-implemented method of claim 8, wherein the
non-preferred equity component is shared among the senior equity
interest and multiple junior equity interests.
10. The computer-implemented method of claim 1, wherein the entity
that receives the senior equity interest is an individual
buyer.
11. The computer-implemented method of claim 1, wherein the entity
that receives the senior equity interest is a second fund.
12. The computer-implemented method of claim 1, wherein the entity
that receives the senior equity interest is a second trust.
13. The computer-implemented method of claim 1, wherein the AI fund
investor's interest is an ownership interest in the AI fund.
14. The computer-implemented method of claim 1, wherein the AI fund
investor's interest is a right to distributions from the investor's
ownership interest in the AI fund.
15. The computer-implemented method of claim 1, wherein the
compositions and respective priorities of the senior equity
interest and the junior equity interest are negotiated between the
AI fund investor and a buyer receiving the senior equity
interest.
16. The computer-implemented method of claim 1, wherein a plurality
of AI fund investors designate portions of their respective
interests in the AI fund for liquidation, the designations
resulting in issued classes of trust equity interests that differ
between at least some of the plurality of AI fund investors.
17. The computer-implemented method of claim 16, wherein the
plurality of AI fund investors can select the portion of their
respective interests to be liquidated, such that some investors
liquidate different-sized interests than others.
18. The computer-implemented method of claim 1, wherein the senior
equity interest has priority with regard to the junior equity
interest, but is subordinate in priority to another senior equity
interest.
19. The computer-implemented method of claim 1, wherein the senior
equity interest has a first portion of a non-preferred equity
component, the junior interest has a second portion of the
non-preferred equity component, and there is at least one
additional trust equity interest subordinate to the senior equity
interest that receives a third portion of the non-preferred equity
component.
20. A non-transitory computer readable medium comprising program
instructions for providing liquidity to an AI fund, wherein the AI
fund comprises equity interest in investments selected from a group
consisting of private equity funds, hedge funds, leveraged buyout
funds, venture capital funds, partnerships, real estate investment
trusts, real estate properties, and private company stocks, the
program instructions comprising code for causing at least one
computer processor to perform the following: receiving, from a
first AI fund investor, an assignment of a designated investment in
the AI fund; establishing at least two classes of trust equity
interests based on the assignment, the two classes of trust equity
interests providing distributions based on returns on the assigned
investment and including a senior equity interest and a junior
equity interest; determining the senior equity interest by
calculating (1) a preferred amount equity component to be paid in
priority to the junior equity interest and (2) a first portion of a
non-preferred equity component that is paid after satisfaction of
the preferred amount; calculating the junior equity interest
comprising a second portion of the non-preferred equity component
that is paid after satisfaction of the preferred amount; receiving
title of the senior equity interest and assigning the junior equity
interest to the AI fund or the AI fund investor; assigning the
senior equity interest to a trust participant other than the AI
fund investor, thereby providing for the AI fund investor to obtain
a liquidation of the designated investment while continuing to
share in a potential up-side return based on the junior equity
interest; and distributing the returns on the assigned investment
to the trust participant and the AI fund investor based on the
senior equity interest and the junior equity interest.
21. A computer-implemented system for providing liquidity to an AI
fund, wherein the AI fund comprises equity interest in investments
selected from a group consisting of private equity funds, hedge
funds, leveraged buyout funds, venture capital funds, partnerships,
real estate investment trusts, real estate properties, and private
company stocks, the system comprising at least one processor and at
least one storage medium adapted to perform the following:
receiving, from a first AI fund investor, an assignment of a
designated investment in the AI fund; establishing at least two
classes of trust equity interests based on the assignment, the two
classes of trust equity interests providing distributions based on
returns on the assigned investment and including a senior equity
interest and a junior equity interest; determining the senior
equity interest by calculating (1) a preferred amount equity
component to be paid in priority to the junior equity interest and
(2) a first portion of a non-preferred equity component that is
paid after satisfaction of the preferred amount; calculating the
junior equity interest comprising a second portion of the
non-preferred equity component that is paid after satisfaction of
the preferred amount; receiving title of the senior equity interest
and assigning the junior equity interest to the AI fund or the AI
fund investor; assigning the senior equity interest to a trust
participant other than the AI fund investor, thereby providing for
the AI fund investor to obtain a liquidation of the designated
investment while continuing to share in a potential up-side return
based on the junior equity interest; and distributing the returns
on the assigned investment to the trust participant and the AI fund
investor based on the senior equity interest and the junior equity
interest.
22. A computer-implemented method for obtaining liquidity to an AI
fund through the use of a synthetic preferred stock arrangement,
wherein the AI fund owns common equity in a private company, the
method comprising: transferring, by at least one computer, the
common equity in the private company from the AI fund to a trust;
causing the trust to split the common equity into two or more
equity tranches including: (a) a synthetic preferred stock having a
preference, a cumulative preferred dividend, and a specified
participation in cash flows after the preference and its accrued
dividends have been paid, and (b) a residual interest; selling the
synthetic preferred stock to investors; retaining the residual
interest in the AI fund or by limited partners of the AI fund; and
distributing cash flows from the common equity based on the two or
more equity tranches.
23. The computer-implemented method of claim 22, further
comprising: paying the preference portion of the cash flows to the
investors of the synthetic preferred stock; and splitting a
remainder portion of the cash flows among the investors and the AI
fund or the limited partners of the AI fund.
Description
CROSS REFERENCE TO RELATED APPLICATION
[0001] The present application is a continuation of and claims
priority to U.S. patent application Ser. No. 10/315,242, entitled
"Method And System For Adding Liquidity To Alternative Investment
Transactions," filed Dec. 10, 2002, which claimed priority to U.S.
Provisional Application No. 60/337,177, filed Dec. 10, 2001. Both
these prior applications are incorporated herein by reference in
their entireties.
BACKGROUND OF THE INVENTION
[0002] The invention relates generally to improving liquidity for
equity interests that cannot be efficiently monetized, by dividing
up the cash flows from the equity interests and efficiently
distributing them among different classes of investors.
[0003] Interests in private, Alternative Investment Funds
("AIFunds") can be highly illiquid. As used herein, Alternative
Investment Funds ("AIFunds") include, but are not limited to,
equity interests in private equity funds; hedge funds; leveraged
buyout funds; venture capital funds; partnerships; real estate
investment trusts; as well as positions in illiquid assets such as
real estate, or stock in private companies, for example.
[0004] Investors expect that higher returns will compensate them
for this illiquidity. For example, many general partners (GPs)
raise capital from limited partners (LPs) for their AIFunds. The GP
uses his expertise to invest the funds, seeking a high return. Each
fund will typically be invested in a portfolio of interests. Much
of the economic value GPs contribute for AIFunds is connected with
their willingness to make illiquid investments. Such investments
are only possible because LPs have committed their funds for
extended periods. GPs usually earn a management fee, and a carry,
i.e., a portion of the profit earned on invested funds.
[0005] LP investors are typically institutional investors and
wealthy individuals. LPs generally expect returns from AIFunds of
as much as twenty percent per year. However, actual returns from
AIFunds are highly variable. Cash flow will generally be
distributed after a realization event, such as the sale of a
company or an initial public offering (IPO). LP distributions can
be made over a long period of time and the timing is
unpredictable.
[0006] Today, there are an enormous number of LPs that would like
to reduce their exposure to AIFunds. However, none of their options
are attractive. The buy-side of the market for participations in
AIFunds is developing, but at this point, there is still a
substantial imbalance with much greater sell side pressure.
Historically, the market for participations was quite thin, with
brokers attempting to match buyers and sellers for particular
positions. Today, the chief buyers for the Primary Fund
participations are the new funds raised to purchase secondary
market participations ("Secondary Funds"). Such funds offer
diversification across many different funds, industry groups and
vintage years. Billions of dollars have been raised for Secondary
Funds, but bids for Primary Fund participations are still quite
low. To understand why, it is useful to think through the process.
There is substantial inefficiency at every step.
[0007] First, the market for AIFund participations is small and
inefficient. An excellent measure of market efficiency is bid/asked
spreads. Characteristic of small, illiquid markets with little
transparency, bid/asked spreads in the AIFunds market are very
wide.
[0008] Second, selling pressure has overwhelmed investor demand for
AIFund participations. The general drop in equity prices has hurt
all investors. However, technology has been particularly hard hit,
and those seeking high returns in technology are the same investors
who purchased participations in AIFunds. Having entered with great
optimism, expecting high returns, these investors now are
confronted with very heavy losses from technology, a much higher
percentage of `alternative investments` than is prudent, and much
constrained liquidity. The order imbalance for AIFund
participations is manifest in various ways. Most AIFund GPs mark
their positions to market, but bids for purchasing those positions
are usually at a substantial discount to the GP Net Asset Values
("NAVs"). The discounts systematically exceed by a wide margin any
unwarranted optimism of fund managers. A buyer pricing an AIFund
participation starts with a bottoms-up analysis of direct
investments to determine future cash flows. Obviously, projecting
cash flows is a very subjective process that is likely to be
influenced towards excessive caution by the large sell-side
overhang. New AIFunds have a typical expected return of high teens
to 20%. One of the most active current purchasers of AIFund
participations acknowledges that its prices for participations are
computed to yield investors in its Secondary Fund 25% returns,
after fees. This Secondary Fund manager freely admits that even
when it agrees that the GP has fairly priced AIFund participations,
it consistently bids substantially less than GP valuations.
[0009] An additional inefficiency is that much of the new liquidity
for AIFund participations is illusory. At any given time, there is
a limited pool of money available to purchase alternative
investments. Though Secondary Funds are being sold, very few new
investors are being drawn into the AIFunds market. Instead, the
ownership is simply being shifted from weak hands to stronger
hands. Secondary Funds have not changed the risk characteristics of
AIFund investments in a way that will bring in new investors. That
is, "strong hands" might be characterized as an individual or
entity that can maintain the illiquid investment of an AIFund for
substantial return in the future, i.e., possible years in the
future. In contrast. "weak hands" might be characterized as an
individual or entity that was overly optimistic in investing in an
AIFund, and needs liquidity before his investment is returned from
the AIFund. This can be true even though the weak hands know that
long term profits would be substantial, i.e. if they were not
forced out by their immediate short term liquidity needs.
[0010] To explain further, prior to the fall in markets of the
recent past, it can be assumed that `strong hands` held an optimal
amount of AIFund investments. With the unexpected fall in equity
markets, their ownership of AIFunds was pushed towards a
sub-optimally large percentage. Notwithstanding, the `strong hands`
held their positions because the risk-adjusted cost of selling was
too high, i.e., their expected return of the marked down positions
compensated for the incremental risk.
[0011] Secondary Funds are sold almost exclusively on the basis of
price. The same `strong hands` are now buying into the new
Secondary Funds because the expected returns are high enough to
compensate them for a larger then normal concentration in AIFunds.
Expected returns must overcome their risk of excessive
concentration. Despite relative inelasticity of demand, if the
price gets cheap enough, buyers will be attracted.
[0012] A further inefficiency of Secondary Funds is that AIFunds
offer little transparency into the value of participations. Each
fund has numerous individual investments, for which only the GP has
full information. In addition, only the GP can control the timing
of liquidity events. In the absence of control or information,
buyers of AIFund participations must build in a large risk premium
for their uncertainty.
[0013] Yet an additional inefficiency is that new Secondary Funds
impose a second layer of fees. Secondary Fund GPs must compete with
normal AIFunds for investors. The assets of primary AIFunds and
Secondary funds are very similar, and Secondary Fund GPs must be
compensated. As a result, bids for AIFund participations fully
discount Secondary Fund fees, i.e. sellers of AIFund participations
are likely to bear the full cost of GP fees for the Secondary
Funds.
[0014] A further difficulty is that investors are reluctant to take
losses. Recognizing losses is difficult for all investors.
Crystallizing the realization of losses is a discipline that is
hard even for seasoned traders. Institutional holders are very much
affected by the accounting consequences of selling participations
at a loss. The consequence is that investors postpone recognition
of losses as long as possible. When investors have no choice but to
lighten up their investments in AIFund participations, frequently
they must raise cash quickly.
[0015] Furthermore, recently proposed arrangements have very
limited value. Currently, there are a number of arrangements to
mitigate the immediate accounting consequences of getting liquidity
for AIFund positions. Usually, the result is that losses are spread
over a period of years instead of being taken all at once. However,
the true economic cost is not diminished.
[0016] An additional difficulty arises because GPs are reluctant to
approve transfer of LP ownership interests. GPs must usually
approve all transfers of ownership for participations. GP's have
several disincentives to approve such transfers. One disincentive
is that transfers of LP interests directly compete for investors
with future sales by the same fund managers. If a AIFund approves a
transfer, that AIFund loses the opportunity to sell a future fund
to an investor that likes a specific fund manager.
[0017] A further disincentive is that many funds would like to keep
performance information closely held among their existing
investors. Transfer of participations distributes more widely that
information. This is particularly sensitive now, because it is the
performance of their least successful funds that will likely become
better known. A yet further disincentive for a GP to approve such
transfers is that many funds like to foster the notion that their
LPs form a tight, exclusive group. GP's want investors to believe
there is scarcity value to their funds and that it is a privilege
to be able to invest with them. Remarketing of participations
reduces that exclusivity a lot.
[0018] A further difficulty arises because the new Secondary Funds
have very specific investment criteria. The new Secondary Funds
must distinguish themselves from AIFunds. One means is to focus on
the excess returns available because of the market imbalance.
However, another big selling point is the fact that Secondary Funds
are largely invested, and return of capital is expected much
quicker than for primary AIFunds. Typical Secondary Funds seek on
average to buy participations that are at least 70%.COPYRGT.
funded. With the run up of the markets, the amount of capital
invested in AIFunds rose exponentially in recent times. In
addition, many of the funds raised since 1999 are viewed as suspect
by investors, fearful that GPs bought positions at inflated values.
AIFunds raised since 1999 far exceed the size sold earlier. Many of
the recent funds are less than 50% committed. Thus, a substantial
percentage of Primary Fund participations do not fit the criteria
for purchase by Secondary Funds.
[0019] Finally, the origination and distribution costs for
Secondary Funds are high. Raising funds is always costly, and
despite the selling pressure, it is expensive to acquire assets for
Secondary Funds. Buyers of secondary participations must: i)
carefully evaluate each of the underlying positions and project
their cash flow, with little direct information; ii) overcome the
reluctance of investors to recognize losses, and their sticker
shock at the bid; iii) obtain the GP's approval to transfer of
participation ownership; and iv) attract new investors into a
distressed sector of the market.
[0020] As a result of these known difficulties and inefficiencies,
various solutions have been proposed for addressing the liquidity
problem. To date, the market has offered just a few mechanisms to
provide AIFund investors with liquidity: i) at great cost, brokers
match buyers and sellers for individual participations; ii) more
recently, Secondary Fund GPs buy AIFund participations for their
funds; iii) occasionally, buyers have offered arrangements that
either mitigate the accounting impact of losses, permit
participation sellers to retain and shape some residual risk
position; and iv) a very few leveraged transactions were placed
that included one debt tranche supported by an insurance wrap, with
the remaining portion constituting leveraged equity in AIFund
participations. The latter transactions have not been successful
recently for lack of buyers of the leveraged equity piece.
[0021] Recently, a new arrangement, the principal protected note,
has been brought to market. The appeal of this product is chiefly
regulatory arbitrage. Through an economically inefficient ruse,
investors are able to pretend that potentially high yielding AIFund
investments are high quality debt instruments. A recent example is
a $500MM 15-year note incorporating an insurance wrap (essentially,
50% downside protection of the portfolio value) that will permit
domestic insurance companies to carry their investment based on the
regulatory capital of a AAA note. Investors receive exactly the
return of the AIFund cash flows, less the premium paid to the
insurance company.
[0022] Unless new investors are brought to the AIFund participation
market, the sell-side pressure will grow even greater. There will
be increasing competition for the few `strong hands` buyers left
standing. To compensate for increasing concentration risk, with
each new purchase, remaining buyers will raise their investment
hurdle rate. Price has been and will continue to be the only means
of attracting investors.
[0023] AIFunds have been discussed above and liquidity problems
associated with those AIFunds. Problems are also present, in known
techniques, with AIFunds in the corporate context. To explain, in
accordance with further aspects of the Background of the Invention,
corporations typically have a corporate capital structure that
permits different types of loans, such as loans secured with
assets, unsecured loans, subordinated loans, etc. From an equity
perspective, there can be common and preferred stocks. The rights
and entitlements of each class of equity can be quite variable
regarding such issues as voting, conversion, control and
preference. Creation of new preferred stock requires issuer
participation, and is complicated because the approval of all
securities subordinated by the new issue must usually be
sought.
[0024] Further, the underlying asset for CDOs, CLOs and CMOs
(collatorized debt obligations, collatorized loan obligations and
collatorized mortgage obligations), for example, may typically be a
portfolio of various debt instruments. The priority/tranche
technology was developed to finance these portfolios more
efficiently, i.e., wherein the underlying assets are debt. Instead
of selling the generic, bundled exposure of the debt portfolio,
different classes of investors, each with different risk reward
and/or investment outlooks are offered interests tailored to their
particular preferences. The aggregate cash flow arising from the
portfolio of debt in the securitized issue is distributed based on
a "waterfall" of priorities. Each separate cash flow "tranche" has
a given priority of claims regarding repayment, e.g. the senior
most tranche might have a rating of AAA, while the junior most
might have the risk characteristics of junk bonds or equity.
However, various shortcomings exist with known techniques in the
situation when a general partner of an Alternative Investment Fund
desires liquidity, but cannot borrow against stock pursuant to
Alternative Investment Fund powers.
[0025] In view of the deficiencies in the solutions described
above, a method and system is needed for efficiently introducing
liquidity into AIFund investments.
SUMMARY OF THE INVENTION
[0026] In accordance with one embodiment, the invention provides a
method and system for providing liquidity to an AIFund. The
transaction system may include a plurality of fund investors; an
Alternative Investment Fund in which the fund investors commit to
the investment of "Alternative Investment Funds," the Alternative
Investment Fund managed by a fund manager; a structure operated in
conjunction with the Alternative Investment Fund, the structure
managed by a structure manager; and a plurality of structure
investors, the structure investors investing structure funds into
the structure. The structure provides at least one fund investor
with an option to designate cash distributions of the Alternative
Investment Fund, which are made available to the at least one fund
investor, to the structure. In the system the at least one fund
investor obtains a liquidation of Alternative Investment Funds upon
the designation of the cash distributions of the Alternative
Investment Fund.
[0027] In one aspect, the invention provides a method for providing
liquidity to an alternative investment fund, the method comprising:
providing a set of contractual obligations to enforce an agreement
that improves the liquidity position of an entity; and effecting
the flow of value, based on the contractual obligations, by
assuring that certain value flowing, arising from an alternative
investment interest controlled by the entity, will be diverted to
the benefit of a liquidity provider.
[0028] In a further aspect, the invention provides a transaction
system for providing liquidity to an alternative investment fund,
the transaction system comprising: a plurality of fund investors;
an alternative investment fund in which the fund investors commit
to the investment of alternative investment funds, the alternative
investment fund managed by a fund manager; a structure operated in
conjunction with the alternative investment fund; a plurality of
structure investors, the structure investors investing structure
funds into the structure; and the structure providing at least one
fund investor with an option to designate cash distributions of the
alternative investment fund, which are made available to the at
least one fund investor, to the structure; wherein the at least one
fund investor obtains a liquidation of alternative investment funds
upon the designation of the cash distributions of the alternative
investment fund; and wherein the structure pools the designation of
cash distributions of the alternative investment fund, which are
made available to the at least one fund investor, with interests in
cash flows from other alternative investment funds.
BRIEF DESCRIPTION OF THE DRAWINGS
[0029] The present invention can be more fully understood by
reading the following detailed description together with the
accompanying drawings, in which like reference indicators are used
to designate like elements, and in which:
[0030] FIG. 1 is a block diagram of a transaction system showing
aspects of a Structure in accordance with one embodiment of the
invention;
[0031] FIG. 2 is a flowchart showing a transaction process in
accordance with one embodiment of the invention;
[0032] FIG. 3 is a flowchart showing further details of the
"General Partner of Structure forms Structure" step of FIG. 2, in
accordance with one embodiment of the invention;
[0033] FIG. 4 is a flowchart showing further details of the
"Structure's GP performs various formation tasks" step of FIG. 3,
in accordance with one embodiment of the invention;
[0034] FIG. 5 is a flowchart showing further details of the "Fund
GP and Structure GP solicit for investments" step of FIG. 2, in
accordance with one embodiment of the invention;
[0035] FIG. 6 is a flowchart showing further details of the
"Investor may consider provisions of Structure, in determining
whether to participate in primary fund, step of FIG. 2, in
accordance with one embodiment of the invention;
[0036] FIG. 7 is a flowchart showing further details of the
"Investor A" proceeds to utilize Structure" step of FIG. 2, in
accordance with one embodiment of the invention;
[0037] FIG. 8 is a flowchart showing further details of the
"Structure Participant considers and effects investment in
Structure" step of FIG. 2, in accordance with one embodiment of the
invention;
[0038] FIG. 9 is a flowchart showing further details of the
"Structure operates" step of FIG. 2, in accordance with one
embodiment of the invention;
[0039] FIG. 10 is a flowchart showing further details of the
"Structure goes through formative tasks" step of FIG. 9, in
accordance with one embodiment of the invention;
[0040] FIG. 11 is a diagram showing a Structure in accordance with
a further embodiment of the invention;
[0041] FIG. 12 is a diagram showing further aspects of the
"participants" of FIG. 11 in accordance with one embodiment of the
invention;
[0042] FIG. 13 is a diagram showing further aspects of the "assets"
of FIG. 11 in accordance with one embodiment of the invention;
[0043] FIG. 14 is a diagram showing further aspects of the
"contracts" of FIG. 11 in accordance with one embodiment of the
invention;
[0044] FIG. 15 is a diagram showing further aspects of the
"transactions" of FIG. 11 in accordance with one embodiment of the
invention;
[0045] FIG. 16 is a diagram showing further aspects of the
"liquidity facility" of FIG. 11 in accordance with one embodiment
of the invention;
[0046] FIG. 17 is a diagram showing further aspects of the
"additional Structure provisions" of FIG. 11 in accordance with one
embodiment of the invention;
[0047] FIG. 18 is a block diagram showing aspects of "synthetic
preferred stock" in accordance with one embodiment of the
invention;
[0048] FIG. 19 is a flowchart showing a process of using "synthetic
preferred stock" in accordance with one embodiment of the
invention; and
[0049] FIG. 20 is a flowchart showing further details of the
process of FIG. 19 in accordance with one embodiment of the
invention.
DETAILED DESCRIPTION OF THE INVENTION
[0050] Hereinafter, aspects of a transaction system in accordance
with various embodiments of the invention will be described. As
used herein, any term in the singular may be interpreted to be in
the plural, and alternatively, any term in the plural may be
interpreted to be in the singular. The systems and methods of the
invention are directed to the above stated problems, as well as
other problems, that are present in conventional techniques.
[0051] The invention relates generally to improving liquidity for
equity interests that cannot be efficiently monetized and/or
maximizing the value when liquidating, i.e., selling out, such
positions, by dividing up the cash flows from the illiquid equity
interests and efficiently distributing them among different classes
of investors. In addition, the invention takes advantage of the
efficiencies provided by aligning the interests of the liquidity
provider with the interests of the entity in control of the
underlying assets, whether such entity is the beneficial owner or
not. The systems and methods of the invention also provide for how
to assure that non-participating beneficial owners of underlying
assets are not prejudiced by the alignment of interests between the
participating beneficial owners and the entity in control of the
underlying assets. The systems and methods of the invention are
very flexible and will support a myriad of provisions that can
optimize the economic interests among all the parties involved.
[0052] In addition, the invention relates to a system and method to
improve the efficiency of such arrangements. An aspect that makes
such transactions particularly difficult is that very little
information about the underlying assets is publicly available. For
AIFunds managed by professionals on behalf of beneficial owners,
rarely do investors have much information about the individual
AIFund investments. Liquidity providers can substantially reduce
their risk and expense by engaging with and gaining the support of
general partners of the underlying funds, or principals that manage
or control the illiquid assets, to facilitate directly or
indirectly the transactions.
[0053] In addition, the invention relates to a system and method to
facilitate the most economic financing for the liquidity provider.
The liquidity provider may assemble a large and diverse pool of
such illiquid interests, and seek insurance and/or a rating in
order to finance that position in the most economic fashion.
[0054] In addition the invention relates to a system and method to
permit tax-exempt investors to obtain liquidity without incurring
debt. The systems and methods of the invention provide various
other advantages not provided by conventional techniques.
[0055] As set forth herein, the systems and methods of the
invention are described in the context of an Alternative Investment
Fund (AI Fund). To further describe the nature of an Alternative
Investment Fund, many investments offer essentially immediate
liquidity. Stocks, bonds, commodities, currencies, futures and
options can be bought and sold at any time. One can also borrow
against such assets quite easily through brokers. Many asset
managers offer similar liquidity, mutual funds can generally be
redeemed each day. However, there is a class of investment
opportunity that requires a great deal more patience. While day
traders can churn their holdings, sometimes several times in a
single day; some market dislocations can take months or even years
to unfold. Further, investments broadly accessible to many
investors rarely yield high returns. Trading in illiquid
instruments or making investment bets with long time horizons
demands investors willing to commit money for lengthy periods of
time. In such circumstances, investors must trust managers a great
deal: bid/asked spreads are high; market values are at best
indicative, until there is a realization event; information about
investments is frequently not publicly available; and, complexity
often prevents all but principals from understanding the investment
bets. Few investors can make such long-term commitments, and thus
more attractive returns are available to investors willing to
accept some degree of illiquidity. Illiquidity is characteristic of
many equity investments, including: private equity, LBOs, venture
capital, and hedge funds, real estate investment trusts, and simple
investments in private companies. Broadly, AIFunds are by
definition illiquid investments. Further, "illiquid investments"
means that an investor cannot obtain the liquidity that the
investor needs in a timely basis.
[0056] Two examples of how the invention might be employed will
illustrate the value of the invention. In accordance with one
embodiment of the invention, the invention provides liquidity to
holders of participations in AIFunds. In accordance with a further
embodiment described below, the invention provides liquidity to
holders of equity positions in private companies, using what may be
characterized as "Synthetic Preferred Stock."
[0057] In accordance with the purposes of the invention as embodied
and broadly described herein, there is provided a method and system
for introducing liquidity into the market for AIFund
participations.
[0058] The proposed transaction (the "Structure"), in accordance
with one embodiment of the invention, fundamentally alters the
characteristics of AIFund participations to attract new and more
efficient investors to the market, in accordance with one
embodiment of the invention. That is, the invention will be herein
described in terms of a "Structure." As used herein, "Structure"
means a transaction, that might utilize a trust, a set of
contractual obligations and/or some other understanding to enforce
an agreement that improves the liquidity position of an entity, by
assuring that certain value flowing, for example cash flow, arising
from equity or other AIFund interests controlled by such entity
will be diverted to the benefit of a Liquidity provider.
[0059] The Structure can access debt investors to fund a portion of
the capital required to purchase the AIFund cash flows. Separately,
or in combination with debt, the Structure can take advantage of
the insurance market as well. Illustratively, there are two main
features in accordance with aspects of the invention. A portion of
the AIFund ownership can be left with current investors (avoiding
the difficult sale in the current market of leveraged AIFund
equity) while offering investors substantial liquidity.
Alternatively, at some point in the future, it might be that all
tranches in the trust could be sold to third parties, leaving the
original owner of the participation with no residual interest.
Further, in the method of the invention, AIFund GPs are given a
novel role that is highly efficient. To date, the only active
involvement by AIFund GPs in providing liquidity to LPs has been
agreement to the assignment of participations. The Structure of the
invention leverages each GP's: (i) ability to minimize financing
cost of a senior undivided equity interest, by providing
proprietary historical return data from their respective fund
groups; (ii) intimate understanding of their AIFund investments,
risks and liquidity options; and, (iii) longstanding, preexisting,
trusted relationships with their respective LPs, to originate
senior equity interests, for example.
[0060] FIG. 1 is a block diagram showing a transaction system 2 in
accordance with one embodiment of the invention. The transaction
system 2 revolves around the Structure, i.e., the transaction of
the invention. As shown in FIG. 1, the transaction system 2
includes one or more primary funds (10, 12, 14), a General Partner
20 of the primary fund, and various investors (30, 32) of the
primary fund. Further, the transaction system 2 includes a General
Partner 50 of the Structure and various Structure participants (60,
62). Each of the components of the transaction system 2 play a role
in the Structure, i.e., play a role in the transaction provided by
the Structure.
[0061] It should be appreciated that one or any number of primary
funds might be involved. The primary funds (10, 12, 14) interact
within the Structure 40. For purposes of illustration, FIG. 1
refers to a primary fund 10 and its interaction within the
Structure 40. The primary fund 10 could be in the form of a private
equity fund, for example. However, the systems and methods of the
invention may work with any type of AIFund.
[0062] FIG. 1 also shows that the transaction system 2 may include
a trust 95, or alternatively a set of contractual provisions, for
example. Further aspects of this controlling mechanism are
described below. Hereinafter, further details of the primary fund
10 will be described. However, it is to be appreciated that the
primary fund 12 and the primary fund 14 interact with the Structure
40 in a similar manner.
[0063] As shown in FIG. 1, the primary fund 10 is managed by a Fund
General Partner 20 of the particular primary fund. Further, FIG. 1
illustratively shows two limited partners of the primary fund 10,
including primary fund participant 30 and primary fund participant
32. However, there may well be, and typically are, numerous other
limited partners.
[0064] FIG. 1 also shows that the Structure 40 is associated with a
General Partner 50 of the Structure 40. The General Partner 50
manages the Structure. In accordance with one aspect of the
invention, the General Partner 50 of the Structure actively works
with the General Partner 20 of the primary fund to effect operation
of the Structure 40. That is, the General Partner 50 of the
Structure and the General Partner 20 of the primary fund work
together to maximize the benefit that the Structure 40 can provide
to the primary fund 10 and its LPs.
[0065] The transaction system 2 of FIG. 1 also includes
representative Structure participants (60, 62 and 64). There may of
course be, and typically are, numerous other Structure
participants. The Structure participant 60, as well as the primary
fund participant 30, might be an individual, an institution, or
some other entity, for example.
[0066] The transaction system 2 of FIG. 1 also includes a rating
agency 70. In accordance with one embodiment of the invention, the
Structure 40 may rely on rating agency evaluations from rating
agencies 70 to attract financing. Aspects of the rating agency 70
and its interaction with the Structure 40 are described below.
Further, the transaction system 2 might include an insurance
company 80, which might be used to provide an insurance wrap
against the assets of the Structure 40, as described below.
[0067] As shown in FIG. 1, the transaction system 2 further
includes a tranche splitting mechanism 90. The tranche splitting
mechanism 90 is responsible for splitting the cash flows of equity
interests, which flow from the primary fund 10, within the
transaction provided by the Structure. To explain further, the
person, for example, such as the General Partner 50 of the
Structure, cannot typically be trusted to have both beneficial
interests in the assets of the Structure, and to split out the cash
flows in the appropriate fashion. Such an arrangement would go
against trust concerns. As a result, the tranche splitting
mechanism 90 provides a mechanism by which the General Partner 50
of the Structure, for example, does not split out the cash flows.
Accordingly, trust concerns are satisfied. The tranche splitting
mechanism 90 might be an unbiased person or some type of unbiased
arrangement, for example.
[0068] As a practical note, as shown in FIG. 1, the various
individuals, the various funds and the Structure might be connected
over a suitable network using suitable processing systems. For
example, the Internet might be utilized. However, it is appreciated
that the various components of the transaction system 2 of FIG. 1
do not have to communicate over a network. Rather, other forms of
communication might be utilized.
[0069] The Structure 40 of the invention fundamentally alters the
characteristics of primary fund participations to attract new and
more efficient investors to the market. The Structure 40 can access
debt and reinsurance markets (using ratings and/or insurance wraps)
to fund purchase of Primary Fund cash flows. At least two main
differences distinguish the Structure 40 from previous solutions.
Firstly, a portion of the Primary Fund ownership is left with
current investors (avoiding the difficult sale of leveraged AIFund
equity) while offering LPs 30 substantial liquidity; and secondly,
Primary Fund GPs 20 are given a novel role that is highly
efficient. To date, the only active involvement of Primary Fund GPs
has been to approve transfer of participation ownership interests.
The Structure 40 leverages the longstanding, preexisting, trusted
relationship Primary Fund GPs 20 have with their respective LPs
30.
[0070] Partnership with GPs 20 offers many benefits, including: i)
GPs 20 are the most direct and efficient means to connect with LPs
30; ii) each GP 20 has all available information about its fund
investments, and thus is in the best position to manage their risk;
iii) the GP 20 must approve any transfer of LP participation
ownership interests; and, iv) the GP 20 is in the best position to
enforce assignment of certain cash flows from their LPs 30 to the
Structure 40. It should be appreciated that the "partnership"
between a GP 20 and the Structure GP 50, as described herein, is an
affiliation or working relationship, rather than a "legal"
relationship.
[0071] Instead of simply re-offering some form of participation in
AIFunds, the Structure 40 can be funded using debt instruments,
thus accessing new sources of funds. Restructuring the instrument
permits the market for AIFund risk to be broadened substantially.
Over the last decade, the sophistication related to structured
finance has improved immensely. The underlying assets for CMOs,
CLOs, CDOs, and receivable financing structures all produce cash
flows. The rating services, investors and reinsurers have developed
a lot of expertise in analyzing the relative riskiness of different
tranches of those cash flows.
[0072] The Structure's GP 50 will purchase and pool interests in
the first cash flows from Primary Fund participations. The
reinsurance and debt markets are extremely deep and efficient. The
Structure 40 takes advantage of broad and deep markets to improve
the efficiency of the secondary market for Primary Fund
participations. By restructuring the investment, buyers of
commodity risk products can be brought in on the basis of a very
narrow bid/asked spread. Instead of relying on the narrow group of
strong hands investors in AIFunds, the Structure 40 facilitates
access to the reinsurance and debt markets. The successful
Structure 40 will reduce the selling pressure on Primary Fund
participations.
[0073] In accordance with one embodiment of the invention, the
Structure 40 may incorporate several features: i) a pool of
participations may be purchased with diversity of type, industry,
geography and vintage year; ii) only a fractional amount of any
individual investor's participation in an ArFund may be purchased,
usually less than 30% of its FMV; iii) at present such purchases
may be of the first cash flows returned from the underlying Primary
Fund participations; iv) the Structure's GP 50 may fund from the
outset, and could provide a guarantee for any unfunded LP
commitments to the AIFund; and vi) capital returned before all
commitments are funded may first be used to offset Structure
investments. The Structure GP 50 may purchase an insurance wrap
against its assets, in accordance with one embodiment of the
invention. Together with Structure equity, the wrap might support a
credit rating permitting the Structure GP 50 to fund most of the
Structure 40 with debt instruments such as commercial paper rated
A1/P1. The benefits of the Structure 40 are evident when compared
to the current liquidity alternatives for LPs 30 in AIFunds.
[0074] Surprising to many is the fact that the first cash flows
from an equity portfolio may have the same risk as a high-grade
debt instrument, while the bottom tranche of a portfolio of debt
might have the risk characteristics of equity. By leveraging this
understanding, a whole new class of investors can be drawn to
provide liquidity for the AIFunds market.
[0075] The market for AIFunds is tiny by comparison to the
reinsurance and debt markets. Broadening the appeal for a slice of
the AIFunds market will help to address the huge order imbalance in
a way that relies less on pure price to attract investment.
[0076] With a 30% loan-to-fair market value (FMV) ratio, proper
diversity and quality, the first tranche cash flows from Primary
Fund investments can attain the risk characteristics of investment
grade debt. However, because fixed income buyers are not adept at
analyzing cash flows from AIFunds investments, the Structure 40
will likely rely on evaluations from rating agencies 70 to attract
investors, in accordance with one embodiment of the invention. Such
ratings will depend either on a previously negotiated structured
vehicle, or an insurance wrap policy.
[0077] Further, by including Primary Fund GPs 20 as partners in the
Structure 40, maximum transparency into the valuation of underlying
AIFunds investments is achieved. By properly aligning the interests
of the Primary Market GPs, Structure investors 60 will be assured
that all information pertinent to proper risk management will be
available. The Structure 40 will recognize contributions by Primary
Market GPs 20, but in a manner that will assure the OP has strong
incentive to minimize risks, and maximize returns to investors in
the Structure 40, e.g. profits due to Primary Fund GPs 20 might be
subject to a hold back against first loss exposure associated with
each GP's 20 own fund(s).
[0078] The Structure 40 should also reduce the second layer of GP
fees. By partnering with Primary Fund GPs: less expertise is
required to manage the risks of the Structure 40, than to manage
the risks for a Secondary Fund, as described above; the cost of
acquiring participation interests will be reduced substantially;
and, the Structure 40 will not have to seek permission from the
Primary Fund GPs 20 to transfer the participation.
[0079] The Structure 40 liquidity does not require LP investors 30
to realize losses currently. From an investor's perspective, the
Structure 40 appears to be a financing of the LP investor's 30
Primary Fund investment on favorable terms. Investors need not
crystallize any loss on their participations. In fact, if the
participations ultimately produce the originally expected returns,
the investor will usually realize that return.
[0080] How is such magic achieved? The fact is that the Primary
Fund investors increase their risk exposure by giving up the lower
risk, first cash flows from their participations. However, by
leveraging the efficiency of the debt and reinsurance markets, the
investor can minimize the incremental risk, while retaining the
possibility that he can obtain his original expected return.
[0081] Weak hands always seem to be forced to liquidate their
positions at the absolute worst time. The transaction afforded by
the Structure 40 provides investors with the opportunity to gain
30% liquidity, for example, against the current value of their
Primary Fund investments, while efficiently retaining the upside in
his investment. Many believe the equity market is currently near
its nadir. The Structure 40 will provide Primary Fund investors
additional liquidity to hold on longer, offering additional time to
allow the market to improve.
[0082] The Structure 40 avoids GP 20 concerns over transfer of
participation ownership interests. The Structure will not: i)
cannibalize the market for future AIFunds; ii) substantially expand
distribution of proprietary information; and iii) dilute the
exclusivity of the GP's brand image. Distribution costs are
minimized by enlisting the assistance of Primary Market GPs.
[0083] In further explanation of the invention, FIG. 2 is a
high-level flowchart showing the process in accordance with one
embodiment of the invention. As shown in FIG. 2, the process starts
in step 100 and passes to step 200. In step 200, the Fund General
Partner (20) forms the
primary fund. After step 200, the process passes to step 300. In
step 300, the Structure General Partner (50) forms the Structure
40. Then, the process passes to step 400.
[0084] In step 400, the Fund GP and Structure GP solicit for
investments. It should of course be appreciated that the particular
timing of the events shown in FIG. 2 might vary substantially. For
example, a particular primary fund 10 might be formed years in
advance of the Structure 40, which works with the particular
primary fund 10. As a result, the General Partner 20 of the primary
fund 10 could of course solicit investments in the primary fund 10
years in advance of the Structure General Partner 50 soliciting for
investments in the Structure 40. However, in accordance with this
illustrative embodiment of the invention, the primary fund 10 is
formed concurrently or after the Structure 40. As a result, an
investor 30 interested in the primary fund 10 may be more attracted
to the primary fund 10, i.e., as a result of the enhanced liquidity
that the Structure 40 provides.
[0085] After step 400 of FIG. 2, the process passes to step 500. In
step 500, the Investor (30, 32) considers the provisions of the
primary fund 10. Then in step 510, the investor (30, 32) decides to
invest in the primary fund, and as a result, becomes what may be
characterized as a "primary participant". The investor (30, 32) may
typically be a limited partner dealing with the general partner 20
of the primary fund 10.
[0086] After step 510, the process passes to step 520 in which the
investor 30, for example,
effects an investment in the primary fund 10. This investment may
be in the form of monies transferred to the primary fund 10 and/or
a commitment by the investor 30 to the General Partner 20 of the
primary fund.
[0087] As shown in FIG. 2, in step 530, time passes by and the
primary fund participant 30, i.e., the investor 30, seeks liquidity
from its interest in the primary fund 10. As a result, in step 600,
the primary fund participant 30 may consider the provisions of the
Structure as a mechanism to achieve liquidity. Then, in step 700 of
FIG. 2, the investor 30 indeed proceeds to utilize the Structure.
After step 700, the process passes to step 800.
[0088] In step 800, a potential "Structure participant" 60
considers investment in the Structure 40. It is noted that there is
not a direct relationship between step 700 and step 800 in that the
Structure 40 may involve numerous other contributions from primary
funds, i.e., in addition to the contribution to the Structure 40 by
the primary participant 30. Further, in step 800, the Structure
participant 60 decides to effect an investment in the
Structure.
[0089] After step 800 as shown in FIG. 2, the process passes to
step 900. In step 900, the Structure 40 operates. Further details
of step 900, as well as other steps of the process of FIG. 2, are
described below. After step 900, the process passes to step 970. In
step 970, the process ends.
[0090] FIG. 3 is a flowchart showing further details of the
"General Partner of Structure (50) forms Structure (40)" step 300
of FIG. 2, in accordance with one embodiment of the invention.
[0091] As shown in FIG. 3, the sub-process passes from step 300 to
step 310. In step 310, the General partner (GP) 50 of the Structure
obtains the agreement of the fund GP to his collaboration in
offering the Structure, and drafts the various provisions of the
Structure. These provisions are illustratively shown in FIG. 3.
However, it should of course be appreciated that various other
provisions or considerations might be involved in the formation of
the Structure. Further, it should be noted that the Structure GP
might in fact play the role of the Fund GP, as described herein.
Further, the Fund GP might in fact play the role of the Structure
GP.
[0092] In further explanation of the Structure provisions, for
example, the Structure provisions might include that: (1) The
Structure's GP purchases and may pool interests in the cash flows
from primary fund participations to form the Structure; (2) The
interests in the pool may be homogeneous, from a single primary
fund or can be Participations having diversity of type, industry,
geography and vintage year; (3) The Structure GP may buy one or
more tranches of the cash flows returned from the underlying
primary fund participations; (4) the Structure's GP (50) may fund
from the outset, pay over time, and/or provide a guarantee for any
unfunded AIFund LP commitments; and (5) the Structure GP may seek
to securitize Structure assets, either homogeneous or a diversified
pool. The Structure equity, with or without an insurance wrap, may
support a credit rating permitting the GP cheaply to fund a portion
of the Structure with debt instruments such as commercial paper
rated A1/P1.
[0093] After step 310 of FIG. 3, the process passes to step 320. In
step 320, the Structure's GP (50) performs various formation tasks.
Further details of step 320 are described below with reference to
FIG. 4.
[0094] After step 320 of FIG. 3, the process passes to step 330. In
step 330, the process returns to step 400 of FIG. 2.
[0095] FIG. 4 is a flowchart showing further details of the
"Structure's GP (50) performs various formation tasks" step of FIG.
3, in accordance with one embodiment of the invention.
[0096] The process of FIG. 4 starts in step 320, and passes to step
322. In step 322, the GP (50) of the Structure selects the primary
funds (10, 12, 14, etc.) that may contribute to the Structure. The
expertise and experience of the fund General Partner 20, the actual
investments made, as well as any of a wide variety of other
criteria, may be used in the selection of the particular primary
funds that are chosen for the Structure. Then in step 324, the
Structure GP together with input from the respective Primary Fund
GPs, analyzes the risk associated with the cash flows of the chosen
primary funds that contribute to the Structure. However, as noted
above, the General Partner 50 of the Structure does not perform the
splitting of the cash flows into the different tranches. After step
324, the process passes to step 325. In step 325, based on the risk
assessment at the time of investment, the Structure GP determines,
for this simple embodiment, the appropriate combination of "advance
rate" (preference amount) and "senior undivided equity interest"
dividend rate for each new Structure investment, in accordance with
one embodiment of the invention.
[0097] Then in step 326, The GP of the Structure may or may not
purchase an insurance wrap against the assets of the Structure
based on the risk assessment, and whether he decides to securitize
a portion of the Structure's funding requirements. Then in step
328, if the GP of the Structure decides to do a securitization, the
GP of the Structure submits the Structure information to a rating
agency 70 for evaluation. The rating agency 70 performs the
evaluation.
[0098] After step 328 of FIG. 4, the process passes to step 329. In
step 329, the process returns to step 330 of FIG. 3.
[0099] FIG. 5 is a flowchart illustratively showing further details
of the "Fund GP (20) and Structure GP (50) solicit for investments"
step 400 of FIG. 2, in accordance with one embodiment of the
invention.
[0100] The process of FIG. 5 starts in step 400 and passes to step
410. In step 410, the General partner (20) contacts individuals and
institutions for example, based in long term contacts, for example,
to solicit participation in the primary fund. This solicitation by
the General Partner 20 of the primary fund may promote the
particular primary fund by using the enhanced liquidity afforded
(to the primary fund) by the Structure 40. After step 410, the
process passes to step 420.
[0101] In step 420, the Structure GP (50) contacts individuals and
institutions, based on long term contacts, and/or publicly
advertises, so as to solicit participation in the Structure. As
described above, the nature of investment by a Structure
participant 60 is substantially different than an investment by a
primary fund participant 30. Accordingly, it is appreciated that
the appropriate techniques by which the General Partner 20 of the
primary fund and the General Partner 50 of the Structure solicit
investment may well be different. After step 420, the process
passes to step 430.
[0102] In step 430, the Fund GP (20) and Structure GP (50) may
together promote the particular primary fund (for which that fund
GP is responsible) and promote the Structure. After step 430 of
FIG. 5, the process passes to step 440. As reflected in the
progression of step 430 to 440, any of a number of further steps
may be taken to solicit investment. In step 440 of FIG. 5, the
process returns to step 500 of FIG. 2.
[0103] FIG. 6 is a flowchart showing further details of the
"Investor (30, 32) may consider provisions of the Structure, in
determining whether to participate in the primary fund (10)," step
600 of FIG. 2, in accordance with one embodiment of the
invention.
[0104] The process of FIG. 6 starts in step 600 and passes to step
610. In step 610, Investor (30, 32) may find attractive the option
to utilize the Structure, currently or in the future. Then, in step
620, it is noted that participation in the Structure will permit
the investor to obtain substantial liquidity, while retaining a
percentage of the potential economic upside of his investment. Then
in step 625, the investor may request that the fund GP support the
Structure so that the Investor can obtain liquidity by
participation.
[0105] Further, in step 630, if the fund GP (20) has already agreed
to support the Structure (40, the investor 30 will not have to seek
the approval of the Fund General Partner 20 to participate in the
Structure, as it will have been previously agreed to. Then, in step
640, the investor considers that so long as the future return on
primary fund assets exceeds the returns paid to the Structure, the
investor will receive primary fund returns higher than he would
have received without the Structure
[0106] After step 640 of FIG. 6, the process passes to step 650. In
step 650, the process returns to step 700 of FIG. 2.
[0107] FIG. 7 is a flowchart showing further details of the
"Investor A 30 proceeds to utilize Structure" step 700 of FIG. 2,
in accordance with one embodiment of the invention. Note that FIG.
7 contrasts "Investor A" 30 of FIG. 1 (who illustratively uses the
Structure as described herein) with "Investor B" 32, who does not
use the Structure. It should further be noted that Investor B, and
the interests of Investor B in the primary fund 10, are essentially
unaffected by Investor A's use of the Structure.
[0108] As shown in FIG. 7, the process starts in step 700 and
passes to step 710. In step 710, Investor A has determined that he
needs to liquidate a portion of his interests in the primary fund.
Then, in step 720, Investor A 30 works with the Fund GP 20, who is
assisting the Structure OP 50. After step 720 of FIG. 7, the
process passes to step 730.
[0109] In step 730, Investor A (30) assigns his primary fund
participation to the Structure/Trust, while retaining full
beneficial interest, and instructs the Structure trustee to create
two interests, the "senior equity interest" and the "residual
equity interest." That is, in this example, the tranche splitting
mechanism 90, as described above, is the Structure trustee. Then,
in step 735, the Investor A instructs the trust to transfer title
to the senior equity interest to the Structure, after Investor A
receives payment from the Structure.
[0110] After step 735 of FIG. 7, the process passes to step 740. As
reflected in the progression of step 730 to 740, any number of
further steps may be taken to effect Investor A's utilization of
the Structure. In step 740, the process returns to step 800 of FIG.
2.
[0111] FIG. 8 is a flowchart showing further details of the
"Structure Participant (60) considers and effects investment in the
Structure" step 800 of FIG. 2, in accordance with one embodiment of
the invention.
[0112] As shown in FIG. 8, the sub-process starts in step 800 and
passes to step 810. In step 810, the Structure participant 60
considers that assigned cash flow from an equity portfolio may
possess the same risk as a high-grade debt instrument. Then, in
step 815, Structure Participant (60) notes that he will accept
uncertain future cash flow, with limited liquidity, in expectation
that he will earn above market risk-adjusted returns. Further, in
step 820, the Structure participant 60 (in this embodiment)
considers that the Structure GP (50) may invest in one or more
tranches of the Structure assets.
[0113] After step 820, the process passes to step 830. In step 830,
the Structure participant 60 considers that if the Structure GP
(50) seeks to securitize Structure assets, he will likely obtain
ratings from one or more of the ratings agencies. This rating
agency information may be used and considered by the Structure
participant 60.
[0114] After step 830 of FIG. 8, the process passes to step 840. As
reflected in the progression of step 830 to 840, any number of
further steps may be taken in relation to the Structure
participant's 60 investment in the Structure. In step 840 of FIG.
8, the process returns to step 900 of FIG. 2.
[0115] FIG. 9 is a flowchart showing details of the "Structure
operates" step 900 of FIG. 2, in accordance with one embodiment of
the invention. As shown in FIG. 9, the process starts in step 900
and passes to step 910.
[0116] In step 910, the primary fund 10 returns capital based on
ownership of participations, to non-participating LPs and the
Structure. Then, the process passes to step 920. In step 920, the
Structure first pays accrued dividends to the "senior equity
interest". Then, in step 930, the Structure pays the preference
amount to the "senior equity interest". Then, the process passes to
step 940.
[0117] In step 940, the Structure distributes any additional cash
flows, 90%/10% to the "residual equity interest" and "senior equity
interest," respectively, for example. After step 940 of FIG. 9, the
process passes to step 950. In step 950, the Structure goes through
further formative tasks. Details of FIG. 9 are described below with
reference to FIG. 10. After step 950, the process passes to step
960. In step 960, the process returns to step 970 of FIG. 2.
[0118] FIG. 10 is a flowchart showing further details of the
"Structure goes through further formative tasks" of FIG. 9. To
explain, it is appreciated that the Structure may typically be in a
formative state. That is, a Structure may routinely acquire further
equity interests from Alternative Investment Funds and/or seek
securization, etc. for example. FIG. 10 is reflective of this
realization.
[0119] Accordingly, the process of FIG. 10 starts in step 950 and
passes to step 952. In step 952, the GP (50) of the Structure
selects the primary funds (10, 12, 14, etc.) that contribute to the
Structure. Then in step 953, the Structure GP together with input
from the respective Primary Fund GPs, analyzes the risk associated
with the cash flows of the chosen primary funds that contribute to
the Structure. In step 954, based on the risk assessment at the
time of investment, the Structure GP determines the appropriate
combination of "advance rate" and "senior undivided equity
interest" dividend rate for each new Structure investment, in
accordance with one embodiment of the invention.
[0120] Then in step 955 the GP of the Structure may or may not
purchase an insurance wrap against the assets of the Structure
based on the risk assessment, and whether he decides to securitize
a portion of the Structure's funding requirements. Then in step
956, if the GP of the Structure decides to do a securitization, the
GP of the Structure submits the Structure information to a rating
agency 70 for evaluation. The rating agency 70 performs the
evaluation.
[0121] After step 956 of FIG. 10, the process passes to step 957.
In step 957, the process returns to step 960 of FIG. 9.
[0122] As should be apparent, the steps of FIG. 10 may well
correspond to the steps of FIG. 4 above, i.e., wherein the General
Partner 50 of the Structure performs the formation tasks. Further,
other ongoing formative type steps may be performed that are not
identified in FIG. 10, as should be apparent to one of ordinary
skill. In accordance with further aspects of the invention, a large
percentage of investors in AIFunds are tax-exempt entities, such as
pension funds. Under US tax law, tax-exempt entities are not
permitted to borrow against their investments, and debt is
forbidden. However, tax-exempt entities can liquefy, or maximize
the value of their AIFund investments using embodiments of the
invention, because the transaction will not involve any debt. The
tax-exempt investor will sell equity interests cash flow tranches)
to obtain all or part of the value of their original equity
investment.
[0123] In accordance with one aspect of the invention, as described
above, the primary fund participant 30 sells an interest to the
General Partner 50 of the Structure, for example. However, in
accordance with one embodiment of the invention, the Structure may
be arranged so that, under certain circumstances at the option of
the primary fund participant 30, this
interest might be repurchased by the primary fund participant 30 at
a previously agreed price. This might be the situation when the
liquidity needs of the primary fund participant 30 change, i.e.,
such that the primary fund participant 30 does not need the
liquidity.
[0124] FIG. 11 is a diagram showing such further aspects of the
invention in accordance with one embodiment. In particular, FIG.
11-FIG. 17 show the terms of an illustrative term sheet in
accordance with one embodiment of the invention. The various terms
of the term sheet form what may be characterized as a Structure
1100. The Structure 1100 includes Participants 1200, Assets 1300,
Contracts 1400, various Transactions 1500, a Liquid Facility 1600,
as well as various additional Structure Provisions 1700.
[0125] In overview of the Structure 1100, in order to monetize a
portion of an existing investment in a primary fund, an LP Investor
contributes its limited partnership interest (an "LP Interest") to
a special purpose trust created for that specific primary fund
("Fund XYZ LP Trust", or the "LP Trust"), for example. The LP Trust
issues two types of trust certificates to the LP Investor: a Senior
Undivided Equity Interest ("SUEI") and a Residual Undivided Equity
Interest ("RUEI"). The LP Investor sells the SUEI to the SUEI
Equity Trust, and retains the RUEI. Further, the SUEI Equity Trust
raises money to purchase the SUEIs through the issuance of Trust
Certificates and Senior Secured Notes.
[0126] In further explanation, the Participants 1200 of the
Structure of FIG. 11 are described in further detail in FIG. 12.
The Participants include an LP Investor who may be an eligible
institutional and/or individual investors, approved by an Eligible
Sponsor, for example. Further, the Eligible Sponsors may be
specific top private equity fund sponsors, which are determined
when developing a particular deal. Note that items in "( )" in
FIGS. 12-17 indicate items to be determined and/or items that would
be negotiated in a particular deal.
[0127] As shown in FIG. 12, the Eligible Sponsor will be paid an
annual fee of a particular percentage of the outstanding Senior
Undivided Equity Interest (SUEI) balances, plus receive a
percentage of the Residual Equity Distribution allocated to the
SUEI, as compensation for marketing and providing other reporting
services for the transaction. Such services might include, for
example, LP Investor identification, valuation of LP Interests,
permission for assignment of LP Interest to the LP Trust, and
standard periodic reporting on market value and condition of the
Private Equity Fund.
[0128] A further Participant as shown in FIG. 12 is the Trustee.
The Trustee might be a suitable bank, for example. Another
Participant is the Marketing and Servicing Agent. The Marketing and
Servicing Agent role might be fulfilled by the Eligible Sponsors,
for example. A further Participant is the Origination Agent. This
role might be fulfilled by a specialty arm of a bank, for
example.
[0129] A yet further Participant is an Investment Enhancer. The
Investment Enhancer might be an insurance company or financial
services company acceptable to the Credit Enhancer and the Rating
Agencies. Further, the Credit Enhancer may be a monoline insurance
company rated Alternative Investment Fund, for example. A further
Participant may be a Structuring and
Placement Agent, which might also be an entity that is part of or
associated with a bank, for example.
[0130] Various assets are associated with the Structure. The Assets
1300 are described in further detail in FIG. 13. One Asset of the
Structure is the Senior Undivided Equity Interest ("SUEI"). Each
SUET represents a senior ownership interest in the assets of the LP
Trust. That is, the SUEI represents an ownership interest in the
first cash distributions available to the LP Trust, as holders of
the related LP Interests, up to the SUEI Preferred Capital Amount.
In addition, the SUEI receives a Cumulative Preferred Distribution
amount, plus 10%, for example, of the Residual Equity
Distributions, in accordance with one embodiment of the
invention.
[0131] As noted in FIG. 13, taxes and voting rights may be
allocated on a pro rata basis, between the SUEI and the Residual
Undivided Equity Interest ("RUEI"), described below, based on the
initial SUEI Preferred Capital Amount and the Market Value of the
LP Interest.
[0132] It should further be noted that the workings of the
Structure depend on the SUIE being considered equity. Accordingly,
it is appreciated that the terms of the particular deal, i.e., the
terms of the Structure, may need to be amended to be sure the SUEI
is indeed considered Equity.
[0133] A further asset of the Structure is the Residual Undivided
Equity Interest ("RUEI"), in accordance with this embodiment of the
invention. Each RUEI represents a subordinated ownership interest
in the assets of the LP Trust. That is, the RUEI represents an
ownership interest in 90%, for example, of the Residual Equity
Distributions available to the LP Trust.
[0134] Hereinafter, further assets associated with the SUEI and the
RUEI will be described. A particular piece of the SUEI is the SUEI
Preferred Capital Amount. This is the face amount of the SUET as
determined on an individual private equity fund basis. A further
piece of the SUET is the Preferred Cumulative Distribution. The
value of the Preferred Cumulative Distribution might be 15% as a
percentage of the current outstanding capital of the SUEI
(Preferred Capital Amount, plus Preferred Cumulative Distribution
amounts not yet received, compounded semi-annually), for example.
Accordingly, the Total Preferred SUEI Distribution is the SUEI
Preferred Capital Amount, plus the Preferred Cumulative
Distribution.
[0135] The Residual Equity Distributions make up the RUEI. The
Residual Equity Distributions equal all amounts distributed by LP
Trust after the Total Preferred SUEI Distributions are made, in
accordance with this example of the invention.
[0136] Further assets associated with the Structure are the Limited
Partner (LP) Trust Assets. These assets include LP Interests
contributed by the LP Investor and approved by the Eligible
Sponsor. It is further noted that, in accordance with one
embodiment of the invention, a separate LP Trust is created for
each private equity fund.
[0137] Yet further assets associated with the Structure are the
SUEI Trust Assets. The SUET Trust Assets are the Senior Undivided
Equity Interests ("SUEIs") in the LP Trusts, all dividends and
payments of capital on the SUEI, the Support Contracts, and all
payments received on the Support Contracts, for example.
[0138] In accordance with one embodiment of the invention, the
Contracts 1400 associated with the Structure are described in FIG.
14, and may be characterized as Support Contracts. A Support
Contract is a contract between an Investment Enhancer and the SUEI
Equity Trust. The contract obligates the Investment Enhancer to
fund an amount on the Final Payment Date sufficient to retire all
outstanding Senior Secured Notes. If the Investment Enhancer makes
a payment on the Final Payment Date, the Investment Enhancer will
take title to all SUEI Equity Trust Assets. The Investment Enhancer
will be paid a per annum fee, for providing such support.
[0139] The face amount of the Support Contract may be determined
based on the expected initial Senior Secured Notes that will be
financed. It is anticipated that the face amount of the Support
Contract might be equal to 30-40% of the current valuation of the
limited partnership investment, depending on the Eligible Fund.
Further, it is noted that the legal form of the Support Contract
should be acceptable to the Credit Enhancer and the rating
agencies, and is anticipated to be in the form of a "Put" or
"floor" equity derivative, for example.
[0140] One aspect of the Support Contracts is the Support Contract
Exercise Rights. The Support Contract Exercise Rights provide that
if all of the Senior Secured Notes have not been paid on the Final
Payment Date, the Trust Certificate Holders will have the option
(i) to allow the Support Contract to lapse, and retain the assets
in the SUEI Equity Trust, or (ii) put the SUEI Equity Trust assets
to the Credit Enhancer, in accordance with one embodiment of the
invention. Further, if the Trust Certificate holders put the SUEI
Equity Trust Assets to the Credit Enhancer, the Credit Enhancer
will have the option: (i) to allow the Support Contract to lapse,
and retain the assets in the SUET Equity Trust, or (ii) to exercise
the Support Contract, receive payment, and put the assets in the
SUEI Equity Trust to the Investment Enhancer, in accordance with
one embodiment of the invention.
[0141] Further, various Transactions 1500 associated with the
Structure are described in further detail in FIG. 15. One
transaction is the sale of SUEI. In the sale SUEI, the LP Investors
offer to sell, and the SUEI Trust agrees to purchase, for a price
equal to the SUEI Preferred Capital Amount. To pay for the SUEIs,
the SUEI Trust issues Senior Secured Notes and Trust Certificates.
Accordingly, for example, the securities offered might be Senior
Secured Notes in the value of $1 billion, for example, and Trust
Certificates in the amount of $100 million, for example. Senior
Secured Notes represent a right to receive payments of interest at
the applicable yield on the Senior Secured Notes and principal on
or before the Final Payment Date. The Senior Secured Notes are
insured by the Credit Enhancer, in accordance with this embodiment
of the invention. Further, the Yield on the Senior Secured Notes
might be a Floating rate Libor, plus a particular percentage with a
cap, as desired.
[0142] Trust Certificates represent a fractional undivided
beneficial interest in the SUEI Trust Assets and represent the
right to receive all payments made to the SUEI Trust, after
retirement of all Senior Secured Notes. It is further noted, with
reference to Principle Payments of Senior Secured Notes, that
Senior Secured Notes will amortize immediately based on cash
distributions available to the LP Trust, after payment of certain
fees, interest on the Senior Secured Notes, and reimbursement of
the cash collateral account or Liquidity Facility, if required, in
accordance with one embodiment of the invention.
[0143] Further, the Final Payment Date might be 5 years from
closing date, for example.
[0144] With regard to the Allocations of Distributions,
Distributions received on the SUEI, payments received on any
Support Contracts and investment earnings will be distributed in a
particular priority. For example, the order of priority might be as
follows:
[0145] 1. Trustee Fees;
[0146] 2. Servicing Fees;
[0147] 3. Support Contract Fees;
[0148] 4. Interest due on Senior Secured Notes;
[0149] 5. Origination and Marketing Fees;
[0150] 6. Reimbursement of the Cash Collateral Account or Liquidity
Facility;
[0151] 7. Principal on Senior Secured Notes;
[0152] 8. To the Trust Certificates (after the Senior Secured Notes
have been paid in full).
If distributions received in the current period are insufficient to
cover 1-5 above, amounts as necessary may be taken out of a
Liquidity Facility, as described below. If funds are insufficient,
or the principal amount of the Senior Notes are not paid in full by
the Final Payment Date, the Credit Enhancer will make any payments
necessary, after all amounts on deposit in the trust have been
used, in accordance with one embodiment of the invention.
[0153] In accordance with this embodiment of the invention, the
Structure may include a Liquidity Facility 1600 as shown in FIG.
16. That is, in accordance with one embodiment of the invention, a
Liquidity Facility will be established at Closing by the Trust
Certificate holders equal to 25% of the amount of the Support
Contract, for example, to cover temporary shortfalls in interest on
the Senior Trust Notes, and other expenses. The balance available
from the Liquidity Facility may be maintained such that the Support
Contract plus the Liquidity Facility always exceeds 112%, for
example, of the outstanding Senior Secured Notes. Further, the Form
and provider of the Liquidity Facility will be acceptable to the
Credit Enhancer and the rating Agencies.
[0154] As shown in FIG. 17, various additional Structure Provisions
1700 may be utilized. In particular, Representation and Warranties,
Indemnification and Events of Default provisions may be provided.
That is, Senior Secured Note holders, Trust Certificate holders,
Servicer, and each Sponsor will make customary representations,
warranties and indemnifications.
[0155] Further, various Legal Opinions may be involved in the
Structure. For example, a tax opinion will be received approving:
(i) equity treatment of the SUEI; and (ii) the `true sale`
treatment of the transaction between the LP Investor and the SUEI
Equity Trust.
[0156] Other standard opinions as necessary will also be provided.
For example, a GAAP Accounting Treatment opinion may be obtained.
It is anticipated that for GAAP accounting purposes the LP Trust
will be considered a QSPE, and the sale of the SUEI will be
considered a sale under FAS140.
[0157] Further, a Tax Status opinion may be obtained. With respect
to the tax treatment, it is anticipated that for Federal Tax
Purposes the SUEI will be considered equity; the sale of the SUEI
will not be considered a financing; the Senior Secured Notes will
be treated a debt of the SUEI Equity Trust; and the Trust
Certificates will be treated as equity of the SUFI Equity
Trust.
[0158] Further, a rating opinion may be obtained. It is expected
that the Senior Secured Notes will be rated A1-P1 or its
equivalent, by at least two of the nationally recognized rating
agencies.
[0159] Further, suitable provisions in the Structure may address
Fees and Expenses. In accordance with one embodiment of the
invention, all Upfront Legal, Accounting, Structuring Agent,
Placement Agent, and other Issuance Fees and Expenses will be paid
by the LP Investors, Certificate Holders and the Sponsors, as
agreed to upfront. Further, all Trustee Fees, Origination Fees,
Marketing Fees, Servicing Fees, Support Contract Fees, Credit
Enhancement Fees, and any other miscellaneous fees and expenses
will be paid out of the SUET Trust Assets.
[0160] Accordingly, a wide variety of provisions are described
above in accordance with one embodiment of the Structure of the
invention. It is appreciated that such provisions may be varied as
desired. Further, additional provisions may well be added depending
on the particulars of a specific deal.
[0161] Hereinafter, further aspects of the invention will be
disclosed. As described in the "Background of the Invention," it is
appreciated that corporations typically have a corporate capital
structure that permits different types of loans, such as loans
secured with assets, unsecured loans, subordinated loans, etc., for
example. From an equity perspective, there can be common and
preferred stocks. The rights and entitlements of each class of
equity can be quite variable regarding such issues as voting,
conversion, control and preference. Creation of new preferred stock
requires issuer participation, and is complicated because the
approval of all securities subordinated by the new issue must
usually be sought.
[0162] As is also described above, the underlying asset for CDOs,
CLOs and CMOs (collatorized debt obligations, collatorized loan
obligations and collatorized mortgage obligations), for example,
may typically be a portfolio of various debt instruments. The
priority/tranche technology was developed to finance these
portfolios more efficiently, i.e., wherein the underlying assets
are debt. Instead of selling the generic, bundled exposure of the
debt portfolio, different classes of investors, each with different
risk reward and/or investment outlooks are offered interests
tailored to their particular preferences. The aggregate cash flow
arising from the portfolio of debt in the securitized issue is
distributed based on a "waterfall" of priorities. Each separate
cash flow "tranche" has a given priority of claims regarding
repayment, e.g. the senior most tranche might have a rating of AAA,
while the junior most might have the risk characteristics of junk
bonds or equity. However, various shortcomings exist with known
techniques in the situation when a general partner of an
Alternative Investment Fund desires liquidity, but cannot borrow
against stock pursuant to Alternative Investment Fund powers.
[0163] In accordance with a further embodiment of the invention,
what may be characterized as Synthetic Preferred Stock ("SPS")
applies the priority/tranche concepts of the invention to
individual companies. The value of the SPS invention is that the
efficiencies of priority/tranche technology can be applied to
portfolios of existing equity positions (in a single company, or
multiple companies), whether held, directly or indirectly, by one
owner or many. The proposed cash flow prioritization for a
portfolio of stock requires only the approval of those who control
the equity interest in one or more individual companies. It does
not require any action by, or approval of, the issuer or any of its
investors. The value of this new approach, in accordance with one
embodiment of the invention, chiefly relates to negotiated
transactions between the current holder of equity securities, and
investors interested in taking either a senior or junior position
with regard to the stock. It is proposed that the Synthetic
Preferred Stock would not require the filing of a prospectus
(unless securities are expected to be redistributed), or any other
involvement with the SEC.
[0164] It is appreciated that investors come in all shapes and
sizes. There are numerous circumstances where SPS might improve
economic efficiency. So long as investors have different strategies
or perceptions of risk, optimizing the distribution of risks and
benefits into the hands of those who most value the individual
attributes will improve capital market efficiency.
[0165] Hereinafter, the general application of SPS will be
described. As an example, SPS may provide incremental efficiency
for the Private Equity/Venture Capital Funds ("PE/VC") market, for
example_General Partners ("GPs") for PE/VC funds are good at
picking companies that have potential to rapidly grow in value, and
then helping the companies to realize that potential. Expected
PE/VC returns require fund investments to rise very quickly in
value, and for GPs to exit as soon as the rapid rise in value
begins to decline. PE/VC GPs are less interested and less capable
of managing more stable companies that have reached their
potential. However, sometimes liquidation of a successful PE/VC
investment must be delayed because of market conditions. Such
companies may cease to provide the expected PE/VC returns.
Retention of such investments within PE/VC funds disadvantages both
Limited Partners ("LPs") and GPs. LPs would prefer to redeploy
their assets in investments expected to grow at high rates. GP
performance economics are reduced by retention of such lower return
investments.
[0166] The invention proposes that there may be value in
establishing a new level of investment management intermediary.
PE/VC GPs cease to add value when an investment begins to provide
stable returns. At that stage, it may make sense to place such
investments in the hands of investors that can provide less costly
financing and who are more adept at realizing value in later stage,
more stable companies. Synthetic Preferred Stock, in accordance
with one embodiment of the invention, might permit investors with a
lower risk appetite than PE/VC investors to offer LPs some
immediate liquidity, while also assuring that ultimate liquidation
of the investment is managed in the best manner possible.
[0167] In the simplest example of Synthetic Preferred Stock, in
accordance with one embodiment of the invention, imagine the owner
of common equity in a private company seeks liquidity, but cannot
borrow against the stock. The owner-could contribute the stock to a
trust. The trust could establish two classes of equity: one class
of SPS, with a preference, a cumulative preferred dividend and
perhaps some upside participation; and the residual to the junior
class. The liquidity provider could then buy the synthetic
preferred stock from the owner.
[0168] The Synthetic Preferred Stock may initially appear
economically the same as such things as swaps or options on the
equity. However, Synthetic Preferred Stock can be much richer and
provide a great deal more flexibility than even complex options.
Though there can be many complexities connected with options/swaps
on stocks, ultimately there is a crisp realization An example is
perhaps the best means to illustrate this difference.
[0169] In accordance with one embodiment of the invention, the
Synthetic Preferred Stock may be used to liquefy an equity position
held by a Private Equity Fund. Suppose the dominant position
remaining in a Private Equity Fund ("PEF") is majority ownership of
the common stock of a private company ("ABC"). The PEF GP would
like to provide liquidity to its investors and distribute the
interests in order to terminate the fund. However, market
conditions prevent the GP from achieving a satisfactory price for
ABC, and the LPs do not want the GP to distribute illiquid shares
in a private company. By use of Synthetic Preferred Stock, the GP
can distribute a large portion of the value of the ABC holding
currently in cash, while retaining control/management of the
liquidation of the residual interest.
[0170] The use of SPS permits a very flexible arrangement capable
of serving the interests of all parties. The GP would like to exit
ABC as soon as possible. ABC's value will grow in a normal, steady
manner, but at returns far below expected returns for LBO funds.
The GP's value-added has run its course, and their ongoing
involvement will produce little incremental benefit. The GP would
like to distribute all the remaining assets of PEF and close the
fund because retention of ABC will continue to bring down PEF
returns.
[0171] Further, LPs in the PEF would like their investment to be
returned. The remaining assets in the PEF no longer produce LBO
returns and the LPs would like to redeploy their alternative
investment assets into higher yielding investments. The SPS can
permit the GP to distribute a substantial immediate cash payment to
LPs. The GP can then retain the residual interest, or subject to
certain conditions, dividend out the residual interest to the
LPs.
[0172] Further, the buyer of the SPS can be more patient than the
PEF, because their expected returns are lower, but the holders of
the SPS are not necessarily long-term equity investors. Further,
the holders of the SPS need to establish protections to permit them
to take action if the value of ABC's common equity declines, or the
trust is not be liquidated within some reasonable time period.
[0173] In accordance with one embodiment of the invention, most GPs
of AIFunds are prohibited from incurring debt within their
respective funds. For example, such GPs could not borrow against an
equity holding in a private company. However, AIFund GPs can
liquefy some investments using the systems and methods of the
invention, by selling equity interests. To explain, FIG. 18 is a
block diagram showing further aspects of the SPS with reference to
a transaction system 2000. FIG. 18 is described below with
reference to the flowcharts of FIGS. 19 and 20. The transaction
system 2000 includes an Alternative Investment Fund (AI Fund) 2100,
which is managed by a General Partner 2110. The General partner,
either alone or working with a liquidity provider, effects the
creation of a Trust 2200. As described below, the General Partner
transfers title to the stock (2100) from the AI Fund to the Trust.
The Trust then sets up two different classes of equity, as
described below.
[0174] FIG. 19 is a flowchart showing a process in accordance with
one embodiment of the invention relating to the SPS. As shown in
FIG. 19, the process starts in step 2300 and passes to step 2310.
In step 2310, the AIFund owns common equity in a private company.
Further, the AIFund GP desires liquidity, but cannot, pursuant to
AIFund powers, borrow against stock.
[0175] As a result, in accordance with one embodiment of the
invention, in step 2320, the Fund GP transfers title to common
equity from the AIFund to a trust. However, the AIFund retains
beneficial ownership. Then, in step 2330, the GP negotiates an
agreement with an Investor to sell a senior interest in trust
assets, that provides for appropriate incentives to liquidate the
trust assets in a reasonable period of time while balancing the
different interests of all parties. Then, in step 2340, the AIFund
GP instructs the Trust to split equity interest into two, or more,
equity tranches.
[0176] The process then passes to step 2345. In step 2345, the
trust sets up two new classes of equity. A first class is the SPS,
which has a preference, a cumulative preferred dividend, and a
small participation in cash flows after the preference and its
accrued dividends have been paid; and a second class, the residual.
Then the process passes to step 2350.
[0177] In step 2350, the AIFund GP sells the SPS to an Investor
2210 and receives the money. Then, in step 2360, the AIFund OP
instructs the Trust to transfer title to the SPS to Investors, and
the AIFund GP dividends out the proceeds to LPs. Further, the
residual interest can either be retained in the AIFund or
distributed to AIFund LPs. Then, in step 2370, as cash flow from
Trust assets becomes available, it is distributed according to the
trust documents
[0178] After step 2370, in step 2380, following complete
liquidation of Trust assets, the Trust is dissolved. The process
then passes to step 2370, and the process is terminated.
[0179] FIG. 20 is a flowchart showing in further detail the "as
cash flow from Trust assets becomes available, it is distributed
according to the trust documents" step 2370 of FIG. 19. The process
of FIG. 20 starts in step 2370 and passes to step 2372. In step
2372, accrued dividends to the SPS are paid to the Investor
2210.
[0180] Then, in step 2374, the preference amount of the SPS is
repaid to the Investor. Then in step 2376, residual amounts are
split among the Investor and the AIFund pursuant to the SPS
agreement.
[0181] After step 2376, the process passes to step 2378. In step
2378, the process returns to step 2380 of FIG. 19, and proceeds as
described above.
[0182] The systems and methods of the invention have been described
above in accordance with various embodiments. Illustratively, the
systems and methods of the invention have been described in the
context of an ordinary limited partnership structure, with general
partners, limited partners and participations. However, it is
appreciated that there may well be other legal structures, other
than limited partnerships, for which the systems and methods of the
invention may be applied.
[0183] Further, it is appreciated that in the various embodiments
described above, the invention is discussed in terms of the role
that various persons or entities play. That is, with respect to
FIG. 1, the General Partner 20 of the private equity fund plays a
role, the General Partner 50 of the Structure plays a role, and the
primary fund participant 30 plays a role. However, the respective
roles played by two or more persons or entities as described above
may in further embodiments be played by one person or entity.
Alternatively, the particular role played by one person or entity
as described above may in further embodiments be played by two or
more persons or entities. Further, it is appreciated that a
particular role played by one person or entity, as described above,
may in other embodiments be played fully by a different person or
entity. Accordingly, within the bounds of the invention, there are
a wide variety of actions that a particular person or entity may
take in effecting the transaction. For example, a primary fund
participant 30, such as a strong hands primary fund participant 30,
might also act in the role of a Structure participant 60.
[0184] In addition, it is appreciated that the risks among
different AIFunds may be diversified, as desired. That is, a
Structure participant 60 may choose participations, in the
Structure 40, having varying risks. This may be important to
obtaining the cheapest "wrap" and/or highest rating service shadow
rating. It should further be noted that both the AI Fund and the
Structure as described herein deal with equity interests. However,
it should be appreciated that an investor may well fund that equity
interest with debt.
[0185] In summary, the invention includes a system and method for
efficiently providing liquidity to LP investors in AIFunds. The
proposed transaction (the "Structure"), in accordance with one
embodiment of the invention, fundamentally alters the
characteristics of AIFund participations to attract new and more
efficient investors to the market. Taking elements of the now
unsaleable leveraged deals, the Structure also accesses debt
markets, using insurance wraps for example, to fund purchase of
AIFund cash flows.
[0186] As described above, FIG. 1 is a block diagram illustrating
one implementation of a liquidity Structure in connection with a
primary fund. The various participants such as limited partners
(30,32) and general partner 20 of the Alternative Investment Fund
10 may communicate over any suitable network 4, as shown in FIG. 1.
The participants may communicate using computers comprising any
known type of computer and may operate using any one of a variety
of operating programs such as the Microsoft Windows.TM. 98
programs. For example, the participant computers preferably include
a controller, a user interface, a network interface, and a memory.
The controller may be connected to the memory via a bus. The memory
may comprise a RAM, a ROM, and other types of storage devices such
as a CDROM or other optical storage.
[0187] The network 4, as shown in FIG. 1, can be formed as an
intranet, a PAN (Personal Area Network), a LAN (Local Area
Network), a WAN (Wide Area Network), a MAN (Metropolitan Area
Network) or other type of network. The network 4 may alternatively
use wireless technology to connect computers together. The user
devices operated by the limited partners 30, the general partners
20 and the liquidity Structure 40 may also communicate with the
Internet via an Internet service provider. The network 4 may
operate using any network-enabled code, such as Hyper Text Markup
Language (HTML), Dynamic HTML, Extensible Markup Language (XML),
Extensible style sheet and Specification Language (DSSSL),
Java.TM., etc.
[0188] Information pertaining to the primary fund 10, for example,
may be stored in a database, which may, include or interface to,
for example, the Oracle.TM. relational database sold commercially
by Oracle Corp. Other databases, such as Informix.TM., DB2
(Database 2), Sybase or other data storage or query formats,
platforms or resources such as OLAP (On Line Analytical
Processing), SQL (Standard Query Language), a storage area network
(SAN), Microsoft Access.TM. or others may also be used,
incorporated or accessed in the invention.
[0189] In further general explanation of the technology that may be
used to implement the method and system of the invention, as
described above, FIGS. 1, 11 and 18 show embodiments of the system
of the invention. Further, FIGS. 2-9, 19 and 20 illustratively show
various steps of one embodiment of the method of the invention.
[0190] The systems that are used by the various entities of the
invention, or portions of such systems, may be in the form of a
"processing machine," such as a general purpose computer, for
example. As used herein, the term "processing machine" is to be
understood to include at least one processor that uses at least one
memory. The at least one memory stores a set of instructions. The
instructions may be either permanently or temporarily stored in the
memory or memories of the processing machine. The processor
executes the instructions that are stored in the memory or memories
in order to process data. The set of instructions may include
various instructions that perform a particular task or tasks, such
as those tasks described above in the flowcharts. Such a set of
instructions for performing a particular task may be characterized
as a program, software program, or simply software.
[0191] As noted above, the processing machine executes the
instructions that are stored in the memory or memories to process
data. This processing of data may be in response to commands by a
user or users of the processing machine, in response to previous
processing, in response to a request by another processing machine
and/or any other input, for example.
[0192] As noted above, the processing machine used to implement the
invention may be a general purpose computer. However, the
processing machine described above may also utilize any of a wide
variety of other technologies including a special purpose computer,
a computer system including a microcomputer, mini-computer or
mainframe for example, a programmed microprocessor, a
micro-controller, a peripheral integrated circuit element, a CSIC
(Customer Specific Integrated Circuit) or ASIC (Application
Specific Integrated Circuit) or other integrated circuit, a logic
circuit, a digital signal processor, a programmable logic device
such as a FPGA, PLD, PLA or PAL, or any other device or arrangement
of devices that is capable of implementing the steps of the process
of the invention.
[0193] It is appreciated that in order to practice the method of
the invention as described above, it is not necessary that the
processors and/or the memories of the processing machine be
physically located in the same geographical place. That is, each of
the processors and the memories used in the invention may be
located in geographically distinct locations and connected so as to
communicate in any suitable manner. Additionally, it is appreciated
that each of the processor and/or the memory may be composed of
different physical pieces of equipment. Accordingly, it is not
necessary that the processor be one single piece of equipment in
one location and that the memory be another single piece of
equipment in another location. That is, it is contemplated that the
processor may be two pieces of equipment in two different physical
locations. The two distinct pieces of equipment may be connected in
any suitable manner. Additionally, the memory may include two or
more portions of memory in two or more physical locations.
[0194] To explain further, processing as described above is
performed by various components and various memories. However, it
is appreciated that the processing performed by two distinct
components as described above may, in accordance with a further
embodiment of the invention, be performed by a single component.
Further, the processing performed by one distinct component as
described above may be performed by two distinct components. In a
similar manner, the memory storage performed by two distinct memory
portions as described above may, in accordance With a further
embodiment of the invention, be performed by a single memory
portion. Further, the memory storage performed by one distinct
memory portion as described above may be performed by two memory
portions.
[0195] Further, various technologies may be used to provide
communication between the various processors and/or memories, as
well as to allow the processors and/or the memories of the
invention to communicate with any other entity; i.e., so as to
obtain further instructions or to access and use remote memory
stores, for example. Such technologies used to provide such
communication might include a network, the Internet, Intranet,
Extranet, LAN, an Ethernet, or any client server system that
provides communication, for example. Such communications
technologies may use any suitable protocol such as TCP/IP, UDP, or
OSI, for example.
[0196] As described above, a set of instructions is used in the
processing of the invention. The set of instructions may be in the
form of a program or software. The software may be in the form of
system software or application software, for example. The software
might also be in the form of a collection of separate programs, a
program module within a larger program, or a portion of a program
module, for example The software used might also include modular
programming in the form of object oriented programming. The
software tells the processing machine what to do with the data
being processed.
[0197] Further, it is appreciated that the instructions or set of
instructions used in the implementation and operation of the
invention may be in a suitable form such that the processing
machine may read the instructions. For example, the instructions
that form a program may be in the form of a suitable programming
language, which is converted to machine language or object code to
allow the processor or processors to read the instructions. That
is, written lines of programming code or source code, in a
particular programming language, are converted to machine language
using a compiler, assembler or interpreter. The machine language is
binary coded machine instructions that are specific to a particular
type of processing machine, i.e., to a particular type of computer,
for example. The computer understands the machine language.
[0198] Any suitable programming language may be used in accordance
with the various embodiments of the invention. Illustratively, the
programming language used may include assembly language, Ada, APL,
Basic, C, C++, COBOL, dBase, Forth, Fortran, Java, Modula-2,
Pascal. Prolog, REXX, Visual Basic, and/or JavaScript, for example.
Further, it is not necessary that a single type of instructions or
single programming language be utilized in conjunction with the
operation of the system and method of the invention. Rather, any
number of different programming languages may be utilized as is
necessary or desirable.
[0199] Also, the instructions and/or data used in the practice of
the invention may utilize any compression or encryption technique
or algorithm, as may be desired. An encryption module might be used
to encrypt data. Further, files or other data may be decrypted
using a suitable decryption module, for example.
[0200] As described above, the invention may illustratively be
embodied in the form of a processing machine, including a computer
or computer system, for example, that includes at least one memory.
It is to be appreciated that the set of instructions, i.e., the
software for example, that enables the computer operating system to
perform the operations described above may be contained on any of a
wide variety of media or medium, as desired. Further, the data that
is processed by the set of instructions might also be contained on
any of a wide variety of media or medium. That is, the particular
medium, i.e., the memory in the processing machine, utilized to
hold the set of instructions and/or the data used in the invention
may take on any of a variety of physical forms or transmissions,
for example. Illustratively, the medium may be in the form of
paper, paper transparencies, a compact disk, a DVD, an integrated
circuit, a hard disk, a floppy disk, an optical disk, a magnetic
tape, a RAM, a ROM, a PROM, a EPROM, a wire, a cable, a fiber,
communications channel, a satellite transmissions or other remote
transmission, as well as any other medium or source of data that
may be read by the processors of the invention.
[0201] Further, the memory or memories used in the processing
machine that implements the invention may be in any of a wide
variety of forms to allow the memory to hold instructions, data, or
other information, as is desired. Thus, the memory might be in the
form of a database to hold data. The database might use any desired
arrangement of files such as a flat file arrangement or a
relational database arrangement, for example.
[0202] In the system and method of the invention, a variety of
"user interfaces" may be utilized to allow a user to interface with
the processing machine or machines that are used to implement the
invention. As used herein, a user interface includes any hardware,
software, or combination of hardware and software used by the
processing machine that allows a user to interact with the
processing machine. A user interface may be in the form of a
dialogue screen for example. A user interface may also include any
of a mouse, touch screen, keyboard, voice reader, voice recognizer,
dialogue screen, menu box, list, checkbox, toggle switch, a
pushbutton or any other device that allows a user to receive
information regarding the operation of the processing machine as it
processes a set of instructions and/or provide the processing
machine with information. Accordingly, the user interface is any
device that provides communication between a user and a processing
machine. The information provided by the user to the processing
machine through the user interface may be in the form of a command,
a selection of data, or some other input, for example.
[0203] As discussed above, a user interface is utilized by the
processing machine that performs a set of instructions such that
the processing machine processes data for a user. The user
interface is typically used by the processing machine for
interacting with a user either to convey information or receive
information from the user. However, it should be appreciated that
in accordance with some embodiments of the system and method of the
invention, it is not necessary that a human user actually interact
with a user interface used by the processing machine of the
invention. Rather, it is contemplated that the user interface of
the invention might interact, i.e., convey and receive information,
with another processing machine, rather than a human user.
Accordingly, the other processing machine might be characterized as
a user. Further, it is contemplated that a user interface utilized
in the system and method of the invention may interact partially
with another processing machine or processing machines, while also
interacting partially with a human user.
[0204] It will be readily understood by those persons skilled in
the art that the present invention is susceptible to broad utility
and application. Many embodiments and adaptations of the present
invention other than those herein described, as well as many
variations, modifications and equivalent arrangements, will be
apparent from or reasonably suggested by the present invention and
foregoing description thereof, without departing from the substance
or scope of the invention.
[0205] Accordingly, while the present invention has been described
here in detail in relation to its exemplary embodiments, it is to
be understood that this disclosure is only illustrative and
exemplary of the present invention and is made to provide an
enabling disclosure of the invention. Accordingly, the foregoing
disclosure is not intended to be construed or to limit the present
invention or otherwise to exclude any other such embodiments,
adaptations, variations, modifications or equivalent
arrangements.
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