The Legal Issues Relating To Organizations And Regulation Of Private Equity Funds

In recent years, the rapid growth of private equity funds is one of the most remarkable developments in international financial market. After 30 years of development,private equity funds in the United States and Europe have become the mainstream of the capital market, only next to bank loans and IPO as an important means of financing.China’s market has now become the focus of foreign private equity funds,while domestic private equity funds develop rapidly. However, the legal and regulatory system in China is far from perfect. Domestic research on private equity obviously lacks, especially from the perspective of law. Thus,regulation of private equity funds by adopting foreign experience has become a very urgent and realistic issue in our country. This dissertation,in light of the development demand of China’s private equity funds, makes a discussion of the organizations and regulatory issues of private equity funds, and puts forward some suggestions to further reform and perfect China’s private equity law and regulatory system. It consists of four chapters except introduction.Chapterl.The Fundamentals of Private Equity Funds. After distinguishing private equity from private equity fund, this chapter defines the concept of private equity fund.In broad sense, private equity fund is used to describe a private placement fund which mainly invests in non-publicly traded securities.It enhances the value of the enterprise by transformation and management to achieve capital gain through exit from capital market.In narrow sense,private equity fund is buyout fund which invests in certain size enterprises having continuous cash flow.Private equity fund as the object of study is in broad sense.It studies private equity funds’ characteristics and classifications,compares private equity funds with venture capital funds, private placement funds,private security investment funds and industrial investment funds. It analyses the operating mechanism of private equity funds. There are three types of participants(investors,managers and other service agencies)and three stages(raising stage,investing stage and exiting stage) in a cycle of private equity funds.It also analyses the functions and risks of private equity funds. Private equity funds are important to the whole society and economy:including providing a new financing channel for enterprises, fulfilling investors’needs, optimizing the allocation of resources,promoting industrial integration and upgrade, capital market and the whole economy.On the other hand, private equity funds’ investment activities will cause a variety of risks and problems, which include excessive leverage,thin capitalization,conflict of interests,market opacity,impact on employee rights,capital market and the national industrial security.Chapter2.The Organizations of Private Equity Funds.Private equity funds have three main organizations:corporation, limited partnership(LP) and trust. There are many factors affecting the choice of organizations,among which the investor’s interests and the manager’s interests are deciding.An effective organization must be able to balance the interests between the investor and manager. This chapter makes a comprehensive study on the three organizations of private equity funds with agency theory.Limited liability corporations and closely corporations are the two common forms for private equity funds in corporation form.There are also private equity funds in limited liability company in the United States.Private equity funds in corporation form can take two management models:self-management and entrust management. Private equity funds in corporation form have different governance structure from common companies.In entrust management model,private equity funds have to deal with relationship between the fund and the custodian and that between the fund and the manager. Although private equity funds in corporation form have strong structural stability and can provide more comprehensive legal protection for investors,they have no remarkable advantages in resolving the agency problem, and double taxation increases their operating costs.LP at present is the main organization for private equity funds. It consists of general partner and limited partner, in which the general partner who is responsible for fund management has unlimited liability and the limited partner who is not involved in management has limited liability. LP agreement is the main legal document that defines the rights and duties between the general partner and the limited partner.This chapter emphasizes on the incentive clauses, covenants clauses and relevant system.LP agreement promotes the general partner to pursue the best interest of fund by flexible incentive arrangement,and controls opportunistic behavior and risk-taking behavior by covenants clauses. The main advantages of private equity funds in LP include:different liabilities,flexible operation, low operating costs and effective incentive and constraint mechanism,all of which make LPs become the main organizations for private equity funds. The disadvantages of private equity funds in LP form are embodied in the insufficiency of cost control of signing contract,reputation mechanism and structural stability. Private equity funds in trust are funds established by trust contracts. They are combinations of trusts and contracts. The relationship between the investor and the manager is trust relationship other than clientage relationship. Although trusts have such advantages as property independence,clear legal relationships, they are rarely used by private equity funds, because they lack control of principal agency risks, effective incentive and constraint mechanism and structural stability.Chapter3.Regulation of Private Equity Funds. This chapter firstly discusses the need of regulation. The externalities theory and the incomplete law theory provide basis for regulation of private equity funds.Because the goal of the private equity fund is pursuing maximal profit, it would not pay much attention to the future development of the portfolio company after getting control,which would cause externalities. Compared with regulation of mutual funds, regulatory law concerning private equity funds is almost incomplete. It is necessary to strengthen the regulation of private equity funds.Secondly,it studies the regulation of private equity funds in foreign countries. In the US,private equity funds are regulated by Federal Securities Act, the Investment Company Act and the Investment Advisor Act, but private equity funds can usually seek various immunities, so the regulatory level is very low. In the UK, private equity funds are regulated by the Financial Services and Market Act. If private equity funds do not make financial promotion to the public,they will remain as "unregulated collective investment scheme".However, the private equity fund management company may be engaged in business activities which are "regulated activities" and need the approval of the Financial Services Authority to become an authorized person. It must meet certain conditions to become an authorized person. After becoming such a person,it will also need to comply with considerable rules.Chapter4.The Development of Private Equity Funds in China and Perfection of Legal System.This chapter firstly demonstrates the history and present status of private equity funds in China. After analysing the organizations of private equity funds and legislature thereof in our country, it concludes that each of the organizations (corporation, LP, trust) has its reasonableness,however, LP should be the main option in the future.Several suggestions have been put forward about the perfection of corporation law and partnership law.At last, this chapter discusses the perfection of China’s regulatory system.It is suggested that China improve its regulatory system under certain guiding principles.