Collective Investment Vehicles aggregate capital from multiple investors into a single investment entity. Generally, the purpose of Collective Investment Vehicles is to invest in a portfolio of companies or projects, although, in some instances, special purpose vehicles are created for a single investment whose capital requirements exceed the available capital that a single investor is willing to commit.
Collective Investment Vehicles are managed by professional investment managers in order to leverage their professional experience, full time dedication, and comprehensive risk management practices.
The aggregation of capital in a single vehicle also improves economies of scale by spreading transaction costs (such as due diligence costs) over a larger pool of capital, as well as the risk return profile by diversifying the assets of the vehicle through a portfolio of investments.
Fund Managers’ view
Collective Investment Vehicles are managed by professional asset managers, who are the agents of the firm. The managers take investment decisions on behalf of the collective investment vehicle, and are remunerated for the management of the vehicle as well as for the performance of the investments.
In the impact investing industry, impact fund managers often have relevant industry investment and thematic experience, ability to operate in frontier or undercapitalized markets, and relevant professional networks which they can make available to investors in an investment vehicle.
Among the most important factors for managers are that the Collective Investment Vehicle be adequately capitalized and that the managers have the time and flexibility to execute their investment strategy.
For the investors in the Collective Investment Vehicles, it is important that the investment thesis implemented by the manager delivers the expected financial returns and social and environmental impact, while maintaining adequate risk mitigation practices.
The benefits of pooling capital into a single Collective Investment Vehicle include:
- Having access to a portfolio of investments
- Professional management team dedicated to managing investments
Traditional impact fund structure
Limited Partnership Closed Ended Fund
The most common structure for Collective Investment Vehicles in venture and private equity is the limited partnership. This structure separates the fund managers, the General Partners (GPs), who manage the fund and take investment decisions. The GPs bear unlimited liability for the obligations of the fund. They raise capital from investors in the fund known as Limited Partners (LPs), who are not involved in the investment decisions and have limited liability (for the amount the invested in the fund?). The limited partnership is a closed ended fund with a fixed life, and standard provisions that regulate the distribution of capital to protect the invested capital of Limited Partners before capital distributions are made to the General Partners.
“A Limited Partnership Agreement regulates the relationship between the General Partners and the Limited Partners, covering terms, fees, investment structures, and other items that require mutual agreement before investment.
A limited partnership model usually also includes an advisory committee and an investment committee.”
(Source: GIIN Developing a Private Equity Fund Foundation and Structure)
Compensation of the General Partners
Carried interest, also known as “carry” or “profit participation,” is the share in the profits generated through the investments that the general partner receives from the fund. The terms of the Carried Interest vary, and may or may not be payable to the GP only after achieving a Hurdle Rate.
The management fee is the fee charged by the General Partner to the fund for running the day-to-day operation of the fund, and is paid from the paid in capital annually.
Even though Limited Partnerships are the most common vehicle to structure funds in impact investing (GIIN), alternative terms or collective investment vehicles structures have emerged In impact investing to overcome intrinsic features of the Limited Partnership model.
Alternative performance incentives
In a conventional limited partnership, the Limited Partners handle all the investment decisions and management of the investment portfolio over to the General Partners. As a result of this delegation, the Limited Partners have no control over the impact management of the portfolio investment.
In order to better align the financial incentives of the General Partners to the impact expectations of the Limited Partners, innovative structures to align the financial remuneration of the General Partners to the impact results have emerged.
The Carried Interest is the profit participation of the General Partner in the fund, which is calculated on the returns of the fund that exceed the invested capital. The Carried Interest can be tiered or unlocked based on the achievement of specific social impact metrics.
Holding Company Structures
Holding Companies (HoldCos, or permanent capital vehicles, or evergreen investment structures) are deployed to extend the lifetime of an investment vehicle beyond the traditional 10 years plus extension of a close ended fund (limited partnership investment fund).
The longer lifetime of the investment vehicle gives additional flexibility to the fund manager in investing patiently in a social enterprise, and does not require exiting the investment within the closed ended lifetime of a traditional limited partnership structure. Patient capital and a longer investment period can facilitate a mission aligned exit of the investment in social enterprises when the company has fewer prospective target buyers and chances of an initial public offering.
Liquidity to investors
- Liquidity to investors
While limited partnerships must return the invested capital after returns and fees to the investors throughout the lifetime of the limited partnership, typically HoldCos do not have a limited lifetime. In order to provide liquidity to investors, in addition to providing dividends, HoldCos can redeem and buy back existing shares, facilitate secondary liquidity by transferring shares among investors, or list on the stock market to raise additional capital and provide liquidity to existing investors.
- Potential for listing on the stock market
Holding companies are investment vehicles that can offer secondary liquidity to investors, as well as attract new capital from new investors, through an Initial Public Offering.
While limited partnerships operate through the yearly management fee calculated on committed or invested capital, holding companies typically are managed on an operating budget. Innovative approaches to determine a cost based fee calculation have emerged, which limit the operational expenses to the actual operational expense and is capped to the invested capital.
- Dario Parziale, Toniic