An introduction to the terms and issues regarding the formation and structure of a private equity fund.

1. SUCCESSFUL FORMATION OF A PE FUND
IN 2009
C. Craig Lilly
600 Hansen Way
Palo Alto, California 94304-1043
650.843.3232

2. This presentation is intended only as a general discussion and should not be
regarded as legal advice. For more information, please contact Craig Lilly at
650.843.3232.

3. U.S. Fundraising Declines in 2008
Commitments to Venture Capital Funds
$83.8
$80
$60 $57.5
$50.7
$40
$30.0 $32.2
$26.9 $25.6 $24.7
$20 $17.5 $17.3
$12.5
$10.1
$0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: Dow Jones VentureSource

6. 2009 Fund Themes
• VC firms will be more specialized.
• Future investments will be smaller, healthier
and less leveraged.
• Increased dialogue with LPs will continue;
liquidity constraints will still be a concern.

7. 2009 Fund Themes
• Liquidity constraints will continue to be sources of
concern for fund sponsors. Alternatives to consider to
address LPs' allocation and liquidity concerns include:
(a) raising a co-investment fund to invest with the
existing fund, (b) obtaining a bridge or capital
commitment loan with a lender to defer capital calls,
(c) assisting LPs with transfers of fund interests, (d)
deferring or reducing capital calls, commitments or
fees, and (e) amending the fund's organizational to
allow deal-by-deal investments.
• The secondary market will see more opportunities.
• The current economic climate will create more
distressed debt and asset investment opportunities.

8. 2009 Fund Themes
• Reduced equity and asset prices will yield
greater fund opportunities and returns.
• Fund managers will need to address higher
taxes if the current proposed budget is
passed.
• Increased disclosure/ regulation is
forthcoming.
• Venture and private equity will stabilize and
be a part of the solution.

9. Fund Legal Structure - Basics
• Private equity funds (“Fund”) in the United States are
generally formed as Delaware limited partnership (with
a new limited liability company serving as the general
partner).
• Investors will contribute capital to the limited
partnership and receive partnership interests and a
capital account in the partnership in return.
• The gains and losses attributable to the Fund’s
performance are passed through to the investor’s
capital accounts on a pro rata basis.
• Fund Term is generally 10 to 12 years (note:
extensions).
• Commitment Term is generally 3 - 5 years (note:
extensions); generally, GP contributes 1% or less, and
LPs commit the remaining 99% plus.

10. Fund Structure
General Partner, LLC
(Delaware LLC) Limited Partners
1% Capital
20% Carried 99% Capital
Interest 80% of Profits
Fund Limited Partnership
Management Advisor
(Delaware)
(Delaware LLC)
~2% Management
Fee (Management
Portfolio Investment #1 Portfolio Investment #2
Services Agreement)

11. General Partner and Investment
Management Entities - Legal Structure
• A separate limited liability company generally serves
as the general partner (and as the investment
manager).
• Note there are liabilities under the securities laws for
which an individual can be held to be personally liable
irrespective of the legal form of the entity which serves
as the general partner.
• A limited liability company or limited partnership is
advantageous for tax and estate planning purposes.
• For tax and other reasons, managers frequently use
two separate entities at the management level:
– (a) serving as the general partner of the Fund, or
– (b) serving under contract as the investment manager of
the Fund

12. General Partner Compensation -
2 and 20 Generally Plus More
• Carried Interest: The general partner typically is
entitled to an incentive allocation generally equal to
20% of the net profits (depending on industry/ fund
type, some funds pay a preferred return prior to carried
interest).
• Management Fee: Generally, 2% of the capital
commitments to the Fund and paid quarterly in
advance (note: fee conversion techniques).
• Transaction Fees: Fee income from portfolio
companies including (a) investment banking fees, (b)
break-up fees, (c) monitoring fees, and (d) consulting
fees.
Note The type and amount of transaction fees vary per industry and
fund type.

13. Applicable Laws
• SECURITIES ACT OF 1933
– Securities of Funds are typically offered in private
placement transactions which rely on the private
placement “safe harbor” provisions of Rule 506 of
Regulation D (or the safe harbor for offerings
outside the United States contained in Regulation
S).
– Form D filings with SEC within 15 days of closing.
– States are still permitted to require “blue sky”
notice filings and collect filing fees (generally file
within 15 days of closing).

14. Applicable Laws
• THE INVESTMENT ADVISERS ACT OF
1940
– Most Fund managers or general partners choose
not to register under as an advisor as a result of an
exemption from registration because they have
fewer than 15 clients.
– This is because the Fund is generally deemed,
under certain circumstances, to be one client and
do not hold themselves out to the public as
investment advisors.

15. The Investment Company Act
- Two Applicable Exemptions
• 3(c)(1) Fund Exemption
– The reference to “3(c)(1)” is to an exclusion from
registration as an investment company pursuant to
Section 3(c)(1) of the Investment Company Act (the
purpose of this Act is to generally regulates mutual fund).
– A Fund will not have to register under the Investment
Company Act if its outstanding securities are not owned
by more than 100 persons.
• Counting to 100 is not as straightforward as it might
seem.
• Sometimes the rules force a fund to “look through” an
entity investor and count each of the underlying
beneficial owners of the entity based on certain
percentage tests which may increase the number of
investors which count against the 100 investor limit.

16. 3(c)(7) Fund Exemption
• The reference to “3(c)(7)” is to an exclusion from
registration as an investment company pursuant to
Section 3(c)(7) of the Investment Company Act.
• This exclusion is available for a Fund which limits its
limited partners to individual investors (“Qualified
Purchasers”) who own not less than $5,000,000 in
investments, and to entities which own not less than
$25,000,000 in investments, as defined by the SEC.
• An entity that has less than $25,000,000, but which is
beneficially owned by persons who are Qualified
Purchasers may also be considered a Qualified
Purchaser.
• A 3(c)(7) Fund is limited to under 500 investors.

17. Securities Act of 1934
• Funds with 500 investors and $10,000,000 in
equity must register.

18. ERISA
• If 25% or more of in a Fund are held by
“benefit plan investors”, the Fund is subject to
undesirable ERISA constraints unless it
qualifies as a “venture capital operating
company” or as a “real estate operating
company”.

19. Fund Documentation
• Private Placement Memorandum.
• Limited Partnership Agreement.
• Subscription Agreement - Investor Suitability
Questionnaire.
• Secondary Documents:
– Asset/ Investment Management Agreement
– Side Letters
– GP Operating Agreement
– Third Party Administrator/Back Office Agreements

20. Accredited Investors
• $1 million in net worth or $200k single in last
2 years ($300k if married in last 2 years).
• Generally, only accredited investors are
offered LP interests and admitted as a LP.
The traditional wisdom is that accredited
investors are less likely to sue than non-
accredited investors and juries are less
sympathetic to accredited investors than they
are to nonaccredited investors.

21. Summary - Launching a
Private Equity Fund
• Create term sheet and fund documentation.
• Meet with prospective LPs to explain
opportunity/strategy and communicate terms
of offering.
• Identify lead anchor LPs and pre-negotiate
final offering terms.
• Circulate final documentation.

22. C. Craig Lilly
600 Hansen Way
Palo Alto, California 94304-1043
650.843.3232
This presentation is intended only as a general
discussion and should not be regarded as legal
advice. For more information, please contact Craig
Lilly at 650.843.3232.