As those in the search fund community are aware, finding the right investors for a fund is critical to its success. Equity sources bring more than their capital to the table; the best investors serve as experienced advisers and trusted mentors to search funders as they navigate the acquisition phase and beyond. As the search fund model has proliferated both within and beyond the United States, today’s search funders may have more potential stops on their “roadshows” than their predecessors.
In seeking their ideal mix of initial investors, several of our recent search fund clients have ventured north of the border to raise a portion of their equity. For search funds, which are typically structured as U.S. limited liability companies (LLC) with heavily standardized investment documents, taking on Canadian investors in a U.S. search fund has raised some interesting legal and practical issues. Below are a few gating items for the search funder to consider in deciding whether to open the fund up to investors in Canada and elsewhere:
- What percentage of your investor base will be from Canada? The greater your percentage, the more likely it is that the search funder will want to structure the fund to cater to its Canadian investors.
- What type of tax treatment do your Canadian investors expect? Search funds generally utilize an LLC as the capitalized entity, which is treated as a partnership for U.S. tax purposes. However, for Canadian tax purposes, U.S. LLCs are treated as corporations, which are subject to an entity-level tax. This is a discrepancy that can significantly affect a Canadian investor’s economics. The search funder may want to explore with his or her attorney whether an alternative structure, such as a limited partnership, is a viable option.
- Do your investors have a tax presence in the United States, or will this be their only U.S. investment? Because partnerships are essentially pass-through entities to their partners for tax purposes, investors in a partnership are inherently U.S. taxpayers. For this reason, many non-U.S. investors prefer to invest in U.S. corporations, whereby the profits and losses of the entity are not passed through to its members. If this is a particular sensitivity to the search fund’s Canadian investors, then the search funder may consider implementing a structure which will not result in the investor being a U.S. taxpayer.
In evaluating these alternatives, search funders should always be cognizant of how their U.S. investors may be impacted. The above suggestions are not intended to be one-size-fits-all solutions. As a practical matter, implementing a non-standard fund structure may affect the fund’s marketability to traditional sources of search fund financing.
Part of a search funder’s ongoing challenge is determining how best to serve its investors. Experienced counsel can be a valuable resource in tailoring a fund to best accommodate both the search fund and its investors. If some of those investors are Canadian, then the search funder should be aware of the issues that might affect such financiers’ investment decisions.