Legal & Regulatory Bulletin

SPEC I A L FE AT UR E: A LT ER N AT I V E FU N D S T RUC T U R ES

Deal-By-Deal and Pledge Fund Models

By Geoffrey Kittredge and John W. Rife III, Debevoise & Plimpton LLP
A manager seeking to deepen its track record or build a
relationship with a prospective investor may seek to raise
capital on a deal-by-deal basis or by offering investors a
pledge fund structure.
In a deal-by-deal fund, a dedicated vehicle will be created for
purposes of making an investment in a single target opportunity (or single portfolio of target opportunities). Unlike a
traditional private equity fund model, where investors commit capital to the fund on a blind-pool basis and depend on
the funds investment team to identify and execute investment opportunities going forward, investors considering an
investment in a deal-by-deal fund have full transparency on
the underlying investments that will be made by the deal-bydeal fund and are able to perform M&A-style diligence on
such investments (in addition to the traditional fund investment diligence on the fund managers investment team) prior
to deciding whether to commit to the deal-by-deal fund.
By contrast, in a pledge fund, investors make soft commitments to the pledge fund prior to its investments being
identified. Unlike a traditional private equity fund, however,
investors are given the right to opt out of (or opt in to)
each investment opportunity that the manager of the pledge
fund presents to investors. In this way, each of the investors
is able to make its own decision whether or not to participate
in each investment opportunity instead of being required
to participate in each investment (subject to narrow excuse
rights) as is the case in traditional private equity funds.
When managers are choosing between a deal-by-deal fund
model or a pledge fund model, there are a number of considerations that they should bear in mind.

costs may be recouped when the deal-by-deal fund closes,

or sometimes earlier through a cost sharing agreement
with prospective investors. In a pledge fund model, these
preliminary costs can be paid by the fund itself or, if necessary, partially covered by the manager out of a management
fee charged on subscribed capital.

Economic Terms
In general, there is a less well defined set of market terms
for deal-by-deal and pledge funds than there is for traditional private equity funds, so investors expectations about
market-standard terms are less fixed, with the result that
terms for these alternative structures tend to show a greater
degree of variability than traditional fund models.
Some deal-by-deal funds do not pay a management fee
at all, though the manager may charge a one-off transaction fee from investors upon successful completion of the
underlying investment. To the extent that a management
fee is charged, that fee tends to be based purely on invested
capital and to be a lower percentage than the 2% typical for
traditional small and mid-sized private equity funds. Pledge
funds, on the other hand, are likely to charge a low management fee on subscribed capital (whether or not drawn)
during a pledge funds investment period plus a higher fee
on deployed capital.
Sponsors of both deal-by-deal and pledge funds typically
receive some carried interest on the profits of the fund.
While the carried interest rates for pledge funds tend to be
close to (though lower than) full carry charged by traditional
funds, deal-by-deal funds tend to be subject to lower carried
interest rates.

Deal Execution Uncertainty & Costs

As a result of the need for investors to diligence and approve
an investment opportunity prior to participating in such an
investment, both deal-by-deal funds and pledge funds can
face a degree of deal execution uncertainty (and delay). This
can place such funds at a disadvantage in a competitive
acquisition process, as a seller may be reluctant to engage
and progress the sale process with a buyer that has limited
control over its ultimate ability to fund the acquisition.
In addition, a deal-by-deal model requires the manager to
front the costs of identifying, investigating and negotiating
the investment opportunity prior to consideration by prospective investors in the deal-by-deal fund, although these

Unlike a traditional private

equity fund, however, investors
are given the right to opt
out of (or opt in to) each
investment opportunity that
the manager of the pledge fund
presents to investors.

 SPEC I A L FE AT UR E: A LT ER N AT I V E FU N D S T RUC T U R ES

Sponsors of both deal-by-deal

and pledge funds typically
receive some carried interest on
the profits of the fund. While the
carried interest rates for pledge
funds tend to be close to (though
lower than) full carry charged
by traditional funds, deal-bydeal funds tend to be subject to
lower carried interest rates.

Complexity
Unlike deal-by-deal funds (and traditional private equity
funds), the management, administration and documentation associated with a pledge fund is generally more
complicated because the exercise of opt-out/opt-in rights
by different investors changes the composition of the investor group for each portfolio investment. As a result, there
are multiple pools of investment portfolio within a pledge
fund organized as a single vehicle, which raises issues
regarding the tracking and allocation of expenses (e.g., broken deal expenses) and other liabilities, and the potential
cross-collateralization of the different pools. Alternatively,
establishing a new fund vehicle for each portfolio investment made by the pledge fund can simplify some of the
internal complexity by eliminating the need for multiple
pools within a single pledge fund vehicle, but substantially
increases the administrative burden of the overall structure.
By the same token, a sponsor considering raising a number of deal-by-deal funds will face a greater administrative
burden than if those investment vehicles were housed in a
single private equity fund structure.

Investor Protections
Investors in deal-by-deal funds are more likely than investors
in a pledge fund to view their participation as that of an
active co-investor rather than a passive fund investor. As a
result, it is not uncommon for investors in deal-by-deal funds
to seek a range of investor protections, including exit conditions, anti-dilution rights (including pre-emption rights in
connection with the funding of any follow-on investments),
consent rights over certain key decisions (a.k.a. reserved
matters) taken with respect to the underlying investment
and the ability to appoint a representative to the board of
directors of the relevant company.

2014 Emerging Markets Private Equity Association

Conclusion
Deal-by-deal and pledge fund models provide alternative
fundraising possibilities to the traditional private equity
fund model. While these alternatives can be useful for a
manager developing its track record or seeking to build
relationships with one or more prospective investors, they
are generally used as stepping stones toward the sponsorship of a traditional private equity fund rather than as a
long term product line. While an investor that is getting to
know a manager is likely to appreciate the degree of control
these alternative models provide over the deployment of its
capital in the short term, many institutional investors are
not staffed or equipped to participate in the enhanced level
of investor involvement required from these structures over
the longer term (or across many regions and investment
strategies) and, as a result, continue to seek discretionary
blind pool products as a core part of their private equity
investment allocation.

About the Authors

Geoff Kittredge is a Partner in the London
office of Debevoise & Plimpton LLP.

John W. Rife III is an Associate in the London

office of Debevoise & Plimpton LLP.