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4. INITIAL OPERATIONS

d. Risk Management

Personal Liability

Fund management companies are usually organized as corporations or limited liability companies (LLC's). Private equity funds are usually organized as LLC's or limited partnerships (LP's). The corporation, LLC, and LP forms generally protect their owners from personal liability for the debts and obligations of the entities. Instead, the owners are usually responsible only for making initial capital contributions in exchange for ownership interests. The only exception regards the general partners of LP's, who bear joint and several liability for the debts and obligations of their entities.

In addition, directors, officers, managers, and employees are agents of their companies. Applicable law usually protects agents from personal liability for the debts and obligations of the companies they serve. The companies may also agree to indemnify its agents from any business-related claims of third parties.

However, the liability protections of corporations, LLC's, and LP's are not airtight. The individual managers of private equity funds and firms may incur personal liability under certain circumstances, such as the following:

1.The managers commit a crime or violate a civil statute.

2.The managers commit fraud in connection with a securities offering.

3.The managers breach a fiduciary duty owed to the investors.

4.The managers agree contractually to a personal guarantee.

Minimizing Risk

To minimize the risk of personal liability, fund managers should do the following at all times:

• do not commit any crimes, torts, or statutory violations in connection with your business
• when conducting a securities offering, accurately disclose all material information
• do not breach the fiduciary duties owed to your investors and co-owners
• do not refer to the co-owners or investors as your “partners”
• execute written governing documents drafted by a competent business attorney
• act in accordance with the governing documents
• amend the documents from time to time to reflect changed circumstances
• capitalize your entities sufficiently to meet their initial expenses
• arrange for additional contributions, loans, or gifts to the entities to meet start-up expenses
• open bank accounts for every new entity and obtain credit cards for the fund management company
• pay company expenses only with company funds
• do not commingle company funds with the funds of any other entity or person
• when managing a fund, do not use the fund capital for any unauthorized purpose
• maintain separate operations and financial records from all other entities and persons
• identify each entity as a corporation, LLC, or LP in all marketing materials and legal documents
• obtain the consent of the investors to any "major decision"
• hold formal meetings as required by law or your governing documents
• take minutes at any formal meeting
• execute written votes, resolutions, or consents
• keep clear records of major business activities
• for transactions with a conflict of interest, (i) have the company represented by someone other than the conflicted person; (ii) execute a formal written agreement between the parties; and (iii) disclose the transaction to the other owners and get their approval in writing
• execute all business letters, agreements, checks, or other documents in the name of the applicable entity and only by authorized personnel
• withhold and pay payroll taxes in connection with any employees
• do not make distributions that result in the insolvency of the entity
• do not execute personal guarantees, or at least limit the recourse rights of the creditor
• obtain adequate insurance coverage

Insurance

With regard to the last bullet point, you should meet with an insurance broker and discuss appropriate coverage for your business. In general, business insurance may be divided into two types: “property” and “liability”. Property insurance protects the company from damage to its own property. Liability insurance protects the company and possibly its individual agents from damages caused to third parties.

Insurance is usually optional. However, applicable law may require insurance in some cases. For example, California requires all employers to carry workers' compensation insurance.

Ask your insurance broker about the following types of policies:

• errors and omissions (E&O)
• directors and officers (D&O)
• commercial general liability (CGL)
• advertising injury
• property
• workers’ compensation
• automobile
• business interruption
• life and disability insurance for key personnel

Life and disability policies are especially appropriate for companies that are obligated contractually to repurchase stock or membership interests upon the death or disability of an owner. In such event, the insurance provides the funds for the company to buy back the ownership interests.