We have written at length about Alternative Investment Funds in our blog. On how they compare with closed-end funds (the ever popular FIZs), as well as the process of registering an AIF with the Registry of AIF Managers administered by the Polish Financial Supervision Authority, about the practical aspects of running an AIF, along with the reporting and information obligations. On this occasion we are focusing on the opportunities offered by this popular investment vehicle. Using our experiences as examples we demonstrate how it is used in practice.
Permissible activities for an AIF what and is actually possible?
It is worth noting that the sole object of an Alternative Investment Fund should be to aggregate assets from multiple investors to redeploy them on their behalf and to their benefit. It is not about the statute or what is disclosed in the National Court Register of entrepreneurs, but about the activity actually performed by AIF! The legislator has assumed that this activity is to solely consist of the acquisition of assets, generically listed in internal documents (investment policies/strategies) with the intention of further investments in the manner chosen by the AIF.
What does this mean in practice? A business is free to choose how to invest its assets, with the proviso that all actions taken by the AIF in this respect are aimed at benefiting the investors of the AIF. It means that any “additional” activity undertaken by an AIF creates the risk of losing accreditation by the Polish Financial Supervision Authority and the removal from its register. However, trade practice has made it possible to distinguish certain activities considered as additional, but still acceptable by the AIF manager (internal or external). These include in particular customer service activities, administration of units and shares, activities related to the assets of the AIF, such as providing typified advice within a capital structure. To qualify as acceptable, all those activities must strictly relate to the investment activities of the AIF or the companies it manages. Only in this case will they be considered acceptable and linked to the purpose of the AIF. Example activities are:
- conducting pre-investment analyses;
- carrying out due diligence of assets of entities considered potential investment targets for the AIF;
- advising on the acquisition or disposal of parts of investments;
- carrying due diligence of the legal, financial or factual status of investments;
- current management activities regarding the AIF’s existing assets, related to business activities or the exercise of the AIF’s corporate rights;
- negotiating investment terms;
- updating the AIF’s investment policies;
- risk management of the activities performed by the AIF, including undertaking activities aimed at optimising investment risks in relation to the financing possibilities and objectives of the AIF’s operations.
How to structure an AIF – practical examples
AIF as a private investment vehicle
A Client of ours decided to rebuild their closed-end investment portfolio and establish an AIF. The decision was made to liquidate the FIZ, the maintenance costs of which were extremely high for the Client. The solution was to repackage the Client’s assets out of the fund into a newly created AIF, and then liquidating the former. Of course the main reason for this decision was a significant reduction in costs (by over PLN 25,000 per month!) The significant costs related to the running of the fund that have dropped off were the remuneration of the Investment Fund Company, the depositary, the costs of quarterly valuations and audits. What’s more the cost related to fulfilling the reporting obligations towards the regulator have also gone down. Those obligations are incomparably smaller for Alternative Investment Companies registered with the registry of AIF managers and thus do not generate as much cost as in the case of managing a FIZ.
A portfolio of companies managed under an AIF structure is a classic investment structure built for a single private investor. Wait a minute – an attentive reader might say – but the law regulating alternative mutual funds introduces a requirement for AIFs to have multiple investors! However, as the PFSA explains, the main criteria may be met even if the entity actually has only one investor. The concept of having multiple investors should not (according to the PFSA) be interpreted as an obligation for AIFs to have a minimum of two investors at all times. This means that having only one investor in a given situation will not always be a circumstance that excludes the entity from being classed as an AIF. However, it must be permanently open to external capital.
Starting an AIF from nothing
Another way of using AIFs is to build a track record which will allow to attract investors. In this way, the newly founded AIF starts its business on the basis of specific underlying instruments such as shares, exchange rates, interest rates or raw materials, with funding capital and goes on to build results from there that allow it to raise capital from the market.
In this instance the strategy of introducing investors plays a key role, because one of the main goals of the founders was to avoid dilution. Hence why it was important to select the most adequate form of investor participation, which on the one hand should be optimal in terms of business and tax, and on the other hand should allow to preserve the objectives of the founders.
Should the choice perhaps be a simple joint-stock company
There is a new form of capital company, called simple joint-stock company (P.S.A.) which could also be an interesting structure for businesses based on investors’ capital.
It is an altogether different matter whether a simple joint-stock company can achieve alternative investment company status. The website of the Polish Financial Supervision Authority asks this question “What forms of AIFs are allowed by law?” And provides the following answer: AIFs can operate in the form of a capital company, including a European company.” Furthermore, the Commercial Companies Code clearly states that a simple joint-stock company is also considered to be a capital company. Does this mean that a simple joint-stock company can be an AIF?
Despite the above, the answer should (likely) be in the negative, and that’s because the Investment Funds Act does not refer to “capital companies” but directly lists what legal forms of companies can become AIFs (internally or externally managed) and among the former are: limited companies, joint-stock companies and European companies. Simple joint-stock companies are not listed, which is incomprehensible and seems to be an oversight from the legislator, who when introducing the provisions for a simple joint-stock company into the Commercial Code of Companies, forgot to add it to the Investment Funds Act as an acceptable form of AIF (the same happened with the Act on Taxation on Civil Law Transactions). This is probably the reason why, among almost 300 entities, P.S.A.s are not listed in the register of internally managed AIFs. However, I would not be surprised if simple joint-stock companies started to appear as AIFs through market practice. All you need is a determined investor and a deftly arguing lawyer, and perhaps the KNF will succumb to such pressure 😉
Truthfully a simple joint-stock company is only simple in name, as over 130 new legal articles have been introduced to regulate it, all this creates a completely new and comprehensive set of rules for P.S.A.s, but it also puts in place several interesting flexible solutions for start-ups, such as the opportunity to include the provision of sweat equity as a contribution to a company, a straightforward way to dispose of shares, which is helpful in various forms of investor participation, e.g. crowdfunding. At the same time, it gives the opportunity to avoid dilution of the founders’ share capital. So far, it has not gained too much popularity, but the uptake was initially similarly low with AIFs themselves.
Undoubtedly AIFs are very flexible instruments for conducting investment activities. In order to take advantage of them for specific activities requires proper planning out of all the accompanying mechanisms such as for example: investor entry, payment of coupons, maintaining control and the flow of information to all stakeholders.
Alternative options should also be considered when planning and structuring the overall arrangement of such an investment tool. A good example is the simple joint-stock company mentioned above. But this is not the only option. Sometimes an ordinary limited liability company will be sufficient, and sometimes one can look more broadly and consider building their corporate structure around a foreign entity. There are multiple solutions and a thorough analysis should always be carried out to choose the instruments that best fit the business plans of individual businesses.