The newly enacted Limited Partnership Law is different from traditional partnership provisions under the Civil Code in that a partnership is granted a juristic person status, and that partners consist of general partners and limited partners based on their attributes and legal liabilities and in consideration of the types of capital contribution, operational responsibilities and willingness to assume risks. This system will indubitably provide new options to pure investors and proactive operators so that they can collaborate in their commercial activities and bring new vitality and opportunities to business organizations in Taiwan. This essay seeks, as a preliminary attempt, to explore the application possibilities of the new law and analyze the reform and advantages made possible by this law.
I. Motion picture industry:
After the Limited Partnership Law was adopted, the type of business that best fits the initial imagination of the competent authority is definitely the motion picture domain in the cultural and innovation sectors, since the competent authority has used motion pictures as illustrative examples to explain the specific applications of the Limited Partnership Law to the public during several interviews. One of the characteristics of the motion picture business is its project-based operation. To wit, the investors that can be attracted and the team that can be introduced of a particular movie are significantly different, and most are dissolved after a certain number of years without pursuing sustainability. Secondly, motion picture production is quite professional, since not only huge monetary capital but also intangible intellectual and experience capital are required. However, movie directors equipped with innovative ideas and professionalism need to have the right to completely dictate the shooting of movies even though they oftentimes do not have the financial capital required for the undertaking. For investors, their initial investment objectives are likely to be limited to profitability over time and do not wish to assume unforeseeable risks. Furthermore, investors who do not have professional and artistic capabilities are not expected to have too much room for intervention.
According to the above-mentioned characteristics, the newly amended Limited Partnership Law can properly meet the actual needs of the motion picture enterprises and provide an appropriate institutional framework for relevant people. For starter, the differences between general partners and limited partners lie in the roles of professionals such as directors and of investors in the process of movie production. As a general partners, a movie director could use intangible asset such as fame and experience as his invested capital, and enjoy the absolute right to control the whole project while assume the risk as well, and financial investors, who really put the financial resource in the project, enjoy the right to limit liability and foreseeable risk. In addition, the room of free agreement in a limited partnership is very wide for arrangements such as the duration of existence and the reasons of dissolution. This meets the cyclical feature of the “project investment model” of a motion picture enterprise. Since the completion of shooting is followed immediately by dissolution and settlement and distribution of earnings and will not cause any issue vis-a-via the shooting of another movie, the legal relationships are straightforward and clear.
II. Private equity funds (venture capital funds):
With respect to the definition and nature of a private equity fund, a private equity fund is different from a venture capital fund in a narrow sense (a private equity fund targets for acquisition or reorganization an enterprise that has entered a stable phase over its long-term growth cycle, whereas a venture capital fund targets, by definition, a start-up and seeks to exit when the start-up becomes listed or is acquired for a high price.) In a broad sense, however, a private equity fund can also be interpreted as follows: “An equity or equivalent equity not traded in an open market can be referred to as a private equity or private interest. To wit, for funds not raised from an open market or from non-specific individuals, if the funds are primarily used for investment in enterprise equity and relevant objects, they can be referred to as private equity funds.” For the sake of brevity, the term “private equity funds” are hereinafter collectively referred to as investment funds applicable to limited partnerships and will not be separately indicated as venture capital funds.
Currently, operators in Taiwan mostly choose “companies limited by shares” as the organizational structure for a private equity fund due to the failure of the Limited Partnership Law to be adopted and implemented for many years and because of other historical factors. A private equity fund is generally operated in the following manner. A venture capitalist sets up a venture capital limited company, which entrusts the management of the venture capital fund to a fund management company under most circumstances. Venture capitalist in some case would enter into an agreement with the aforementioned company to stipulate the rights and obligations and matters relating to the operation of the fund. In view of the practice in the US, private funds are mostly operated in the format of limited partnership. In comparison, when the format of a company limited by shares is used as the only option, this has given rise to issues such as “a lack of reasonable exit mechanism,” “a lack of operational flexibility and incentive mechanisms,” “too many mandatory requirements under the Company Law” and “tax regime arrangements.” As a result, this has long been a reform target urged by many members of the society.
Today, since we have had a legal regime for limited partnership, practices, conventions and experiences in other countries are quite useful references in exploring how the partnership agreement should be formulated and how the organizational structure of a private equity fund should be arranged and planned when the operation of a private equity fund based on the organizational structure of a limited partnership is researched. Relevant practical information is hereby summarized and briefly discussed below for reference.
(1) Primary participants:
1. Main partners/general partners: They are usually the promotors or owners of private equity funds, enjoy operating and controlling rights, take control of the operation of private equity funds and charge carried interest when the fund investment is cashed. In practice, to separate the risks of the owner’s own assets, a new limited liability company is often set up to serve as a general partner.
2. Limited partner: This refers to a fund investor who only enjoys profit distribution pursuant to the limited partnership agreement. In addition, as long as the investor does not participate in the business execution of the fund, a limited partner only assumes limited liabilities for the liabilities incurred by the fund. When a limited partner contributes capital by stage, the limited partnership will notify the limited partner to perform his capital contribution obligation only when it needs funds to invest or pay expenses.
3. Investment manager: This is assigned by main partners and is responsible for the operation and management of the daily affairs of the fund. In practice, however, there are also funds promoted and dominated by investment managers while general partners are merely newly established entities set by investment managers to promote private equity funds. The advantage lies in the effective separation of the unlimited liability risks assumed by the main partners.
4. Investment committee: This is assigned by the promotors and has the authority and responsibility to choose relevant investment objects, structure, and settlement of the fund.
(2) Structural planning procedure:
Since the placement procedure for a private equity fund is constrained in the sense that it shall not be publicly offered and requires significant financial strength of investors, placement is conducted in targeted and individual manners roughly pursuant to the following procedure. First, potential investors should be sought and after it is confirmed that they meet the qualification requirements (the requirement here is not limited to the standard set by individual funds for their target customers and should focus more on the compliance of law under financial control of various governments), relevant investment documents are provided so that both parties will sign relevant documents after the negotiation is successfully concluded. In addition, contractual terms are amended by a side letter under individual circumstances (this is the case mostly because the fund management team is willing to offer more favorable subscription terms due to differences in the financial strength and resources of individual investors, and sometimes confidentiality is required to prevent other subscribers from sensing the unfairness.)
(3) Common provisions of a limited partnership agreement for a private equity fund
¥ Term: The term of a private equity fund is typically around 6 to 10 years and may be extended, depending on the circumstances. The preliminary stage focuses on the selection and investment of investment objects, while the latter stage focuses on improving the health of the company.
¥ Committed capital: Typically, the size of the total investment capital of a private equity fund is usually agreed upon, and the main partners have the right to decide if they will accept circumstances where the agreed-upon size is exceeded or is not reached.
¥ Minimum commitment: The targets for raising private equity funds are primarily institutional investors and high net worth individuals. Therefore, a minimum commitment is set.
¥ Committed call: When a limited partnership agreement is executed, the investors are not required to provide investment funding and will not start to make their investment payment until the limited partnership issues a notice after an investment object is identified.
¥ Default by limited partners: If a limited partner fails to make the investment payment by the due date, the limited partner is subject to overdue interest and a default penalty and its relevant shareholding interest will be subject to compulsory sale.
¥ Key person event: The selling point of a private equity fund often lies in the reputation of its key managers. Therefore, if key managers leave or do not concentrate on the operation of the fund, this will cause the fund to suspend its investment or lead to other similar results.
Ð Management fee: Its calculation is based on a certain percentage of the total committed capital or the actual investment amount.
Ð Carried interest: A certain performance compensation is calculated based on the total profit in excess of the agreed-upon investment return.
¥ Clawback: Since carried interest is calculated based on a single investment object, not on the entire investment portfolio, when part of the investment is successful, the main partners can obtain carried interest. However, if other investments subsequently fail, unfairness may occur. Therefore, this clause is put in place so that in the event of any above-mentioned circumstance, the previous carried interest received by main partners will be clawed back to compensate the losses of limited partners.
The Limited Liability Law signifies a new business type derived from the intention of the government to encourage cultural and innovative sectors. It is a breakthrough as compared with the traditional partnership where all partners are constrained by the requirement to assume unlimited liabilities. In comparison with the organization of a company, a limited partnership is more agile and flexible due to its characteristics of contractual autonomy under the Civil Code. Although how the Limited Partnership Law will be actually operated still requires continued attention, still expectation remains high regarding how it will bring about changes and stimulations to the business activities in Taiwan.