This post describes some of the differences between a hedge fund and a private equity fund under Canadian securities laws.
Insights in Brief
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Canadian securities laws do not define the term “hedge fund” or “private equity fund”. However, a staff notice that Canadian securities regulators published in 2007 refers to a hedge fund as an entity that uses alternative investment strategies to capitalize on market conditions, and guidance that those regulators published in 2009 characterizes a private equity fund as an entity that becomes actively involved in the management of the companies in which it invests.
The following table summarizes some of the similarities and differences between a typical Canadian hedge fund and a typical Canadian private equity fund, based on the aforementioned publications and our firm’s recent fund-formation experience:
| Hedge Fund | Private Equity Fund | |
| Structure: | The fund is structured as a limited partnership under provincial partnership laws, or as a mutual fund trust or quasi-mutual fund trust under provincial trust laws and federal income tax laws. | The fund is structured as a limited partnership under provincial partnership laws. |
| Registration: | Provincial securities laws require the fund manager to register as a dealer, an adviser, and an investment fund manager. | There is an exemption from the requirement to register as a dealer, an adviser, or an investment fund manager available to private equity managers that satisfy certain statutory conditions. |
| Fundraising: | The fund raises capital under the “accredited investor” prospectus exemption in provincial securities laws. | The fund raises capital under the “accredited investor” prospectus exemption in provincial securities laws. |
| Fundraising Period: | The fund’s governing documents authorize the fund to issue securities throughout the fund’s term. | The fund’s governing documents usually authorize the fund to issue securities during the first 12 to 18 months of the fund’s term. |
| Initial Disclosure Requirements: | Provincial securities laws do not require the fund to provide initial disclosure to its security holders. | Provincial securities laws do not require the fund to provide initial disclosure to its security holders. |
| Continuous Disclosure Requirements: | Provincial securities laws do not require the fund to provide continuous disclosure to its security holders unless the fund is domiciled in Saskatchewan, Ontario, Québec, New Brunswick or Nova Scotia. | Provincial securities laws do not require the fund to provide continuous disclosure to its security holders. |
| Liquidity: | The fund’s securities are redeemable on demand or within a specified period after demand, at an amount computed by reference to the value of a security holder’s proportionate interest in the fund’s net assets. | The fund’s securities are non-redeemable. |
| Investments: | The fund manager invests in the debt and equity securities of publicly-traded companies. | The fund manager invests in the equity securities of privately-held companies. |
| Investment Strategies: | The fund manager uses long and short positions and other alternative investment strategies to capitalize on market conditions. | The fund manager invests for the purpose of being actively involved in the management of its portfolio companies. |
| Leverage: | The fund usually borrows capital for the purpose of increasing investment returns. | The fund usually borrows capital for the purpose of increasing investment returns unless the fund is a venture capital investor, in which case debt capital may not be readily available. |
| Investment Period: | The fund’s governing documents authorize the fund to invest in portfolio securities throughout the fund’s term. | The fund’s governing documents usually authorize the fund to invest in portfolio securities during a four- to six-year period. |
| Divestment Period: | The fund’s governing documents authorize the fund to divest portfolio securities throughout the fund’s term. | The fund’s governing documents usually authorize the fund to divest portfolio securities during a four- to six-year period. |
| Management Fees: | The fund manager is entitled to an annual management fee equal to a percentage (usually 1% to 2%) of the fund’s net asset value. | The fund manager is entitled to an annual management fee equal to a percentage (usually 2%) of the fund’s committed capital. |
| Performance Fees: | The fund manager is entitled to an annual performance fee equal to a percentage (usually 20%) of the fund’s profits after the fund has exceeded its highest net-asset-value to date, known as its “high water mark”. | The fund manager is entitled to an annual performance fee equal to a percentage (usually 20%) of the fund’s profits after the fund has provided a prescribed return (usually 8%) to security holders, known as the fund’s “hurdle rate”. |
A small number of hedge funds in Canada, known as “hybrid funds”, have adopted some of the investment strategies traditionally associated with private equity funds, such as investing in privately-held companies and becoming actively involved in the management of those companies. Hybrid funds present a number of legal, tax, accounting, and operational challenges, and are usually only formed and capitalized by highly-experienced fund managers with exceptional track-records.
Invitation for discussion
If you would like to discuss this blog in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Linmac LLP.
Disclaimer
The foregoing is for general discussion purposes only and should not be construed as legal advice to any one firm. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.