Private investors find solace in Luxembourg funds

Speaking at an event in London held by the Luxembourg Private Equity and Venture Capital Association in March, Withers partner Ceri Vokes highlighted the appeal of Luxembourg-domiciled funds to the growing number of high-net-worth individuals and family offices in Europe.

"Luxembourg is a reputable, flexible, onshore jurisdiction that generally minimises tax leakage for investors in funds," said Vokes, speaking to unquote" after the event.

Traditionally, private clients have created wealth-holding structures in low-tax jurisdictions that do not have any double-tax treaties, said Vokes, which can create tax leakage for private investors when investing in tax-transparent private equity funds, due to the lack of treaty protection from tax in underlying portfolio jurisdictions.

Private investors bring a new set of finer points for GPs to iron out

"This tax leakage can be made worse where a private equity fund assumes its investors get tax treaty protection and private clients are bounced into undesirable tax and reporting obligations," said Vokes.

Luxembourg, therefore, with its wide double-tax treaty network, is an ideal jurisdiction for investing in private equity funds: "Its wide treaty network can actually improve the tax treatment for investors, compared to investing directly," said Vokes.

Plugging the gap
As firms struggle to raise cash from traditional institutional investors due to an influx of regulatory changes, private investors have been stepping in to plug the funding gap in Luxembourg. The increasing wealth of private clients, coupled with their long-term outlook when it comes to investing that wealth, has caused the asset class to start paying more attention to this LP base.

"In spite of the backdrop of the financial crisis and the combined headwinds of political and economic uncertainty, the rich are indeed getting richer, with the number of high-net-worth individuals continuing to march upwards," said Vokes. "It seems that many GPs are targeting high-net-worth individuals, with their increasing wealth bringing them within the sights of the minimum capital contributions for private equity.

"Private clients, who have been a dependable source of capital for many years, are now an increasing focus for GPs. Both individuals and family offices are either dipping their toes into private equity as an asset class or increasingly allocating a greater part of their portfolio to private equity."

However, private clients bring with them a new set of finer points to iron out. More complex side letters are a regular occurrence with high-net-worth individuals, Vokes pointed out at the event.

Death and taxes
"The major headache for many private clients that we encounter is tax," Vokes told unquote". "They want to invest in tax-transparent structures like limited partnerships for the same reasons everybody else does – to minimise the tax drag on investments. But the problems they face are quite different, as tax can produce different concerns for private clients than they do for other tax-exempt investors.

"By investing in a private equity fund, individuals give away control over how their capital is invested, but the tax consequences can still come back to haunt them due to the tax-transparent nature of those limited partnerships. And they have to keep an eye not just on the tax in their home jurisdiction, but on the potential tax consequences in all the jurisdictions in which a fund invests."

This means that private investors are far more interested than their institutional counterparts on any compromises that private equity firms are willing to make when it comes to the fund's terms. As well as largely having a focus on the tax implications of investing in a fund, the personal moral or philosophical views of private clients can bring with them requests to GPs regarding certain areas of investment.

But with an increasingly thinning pool of institutional investors willing to commit to private equity, firms must be prepared to consider a more complex array of side letters alongside their limited partner agreements, for the growing host of private clients and their specific demands. As Vokes out it: "Flexibility on the part of GPs is key to attracting this investor base."

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