Alternative Investment Vehicle

What is an alternative investment vehicle?

An alternative investment vehicle is a separate entity a fund manager forms so that some or all of a fund's investors can make one particular investment outside the fund, for legal, tax or regulatory reasons. It is controlled and managed by the same general partner, runs on substantially the same terms, and its results fold back into the fund's accounting.

What is an AIV in private equity?

It is the deal-by-deal structuring tool. When a single investment would create a tax or regulatory problem for the fund or for particular investors, the manager routes that one investment through a parallel entity instead of putting it on the fund's balance sheet. The investors still fund it out of their existing commitments, and the economics are computed as though the fund had made the investment directly.

What does AIV stand for?

Alternative investment vehicle. Note the naming inconsistency before relying on the acronym: the Institutional Limited Partners Association's model limited partnership agreement calls the structure an Alternative Vehicle and defines it in its Section 2.9, while real sponsor agreements use Alternative Investment Vehicle as the defined term. Carlyle's form of limited partnership agreement, filed as an exhibit to its Form S-1/A in February 2012, has a Section 2.09 titled Alternative Investment Vehicles and a separate Section 2.10 titled Feeder Fund.

Why an AIV gets formed

The trigger is always a constraint rather than an investment thesis. The ILPA model agreement states it directly: if at any time the general partner determines that for legal, tax or regulatory reasons it would be in the best interests of the limited partners for certain or all of them to participate in a portfolio investment through one or more alternative investment structures, the general partner may effect the making of all or any portion of that investment outside the fund by requiring certain or all limited partners to make capital contributions for that investment to a limited partnership or other similar vehicle.

ILPA's Principles 3.0 give the same rationale at the level of policy: to accommodate legal, tax, regulatory or other considerations of certain investors, general partners should be able to form pooled investment vehicles, parallel or alternative investment vehicles as necessary, and alternative vehicles should be managed by the general partner or an affiliate and governed by documents containing substantially the same terms and provisions as the original fund.

Carlyle's agreement supplies the sharpest phrase for what the vehicle does. It defines an Alternative Investment Vehicle as a partnership or other similar vehicle organized by or at the request of the general partner that will invest on behalf of the participating partners in lieu of the partnership. In lieu of is the whole mechanic: the AIV replaces the fund in that one deal rather than investing alongside it.

What the documents actually say

Four provisions do the work, and a limited partner reading an AIV notice should check each.

Control and terms. Each alternative vehicle shall be controlled by the general partner or an affiliate, shall be managed by the fund manager or an affiliate, and shall be governed by organizational documents containing provisions substantially the same in all material respects as those of the fund, with only such differences as may be required to accommodate the legal, tax or regulatory requirements that triggered it.

Consent. Under the ILPA model, no limited partner will be required to participate in an investment through an alternative vehicle unless either all limited partners are participating through that vehicle, or the general partner obtains prior written consent from that limited partner.

Notice. The general partner shall provide each limited partner with a copy of the organizational documents governing each alternative vehicle not less than ten business days before those documents are signed.

Aggregation. The investment results of an alternative vehicle shall be aggregated with the investment results of the fund for all purposes, unless at the time the investment is made the general partner determines otherwise with the consent of the advisory committee and prior notice to the limited partners, on the grounds that aggregation increases the risk of adverse tax consequences or imposes legal or regulatory constraints. ILPA's Principles 3.0 state the same rule for distribution purposes. Carlyle's agreement reaches the same result from the other direction: distributions and allocations from an AIV, and the determination of distributions and of any clawback amount, shall be determined as if the partners had participated in the investment through the partnership.

A worked example, on commitments and fees

The two provisions that matter economically are the commitment reduction and the fee offset. Under the ILPA model, each limited partner investing in an alternative vehicle is obliged to make contributions to it consistently with the fund's capital contributions article, and that partner's remaining commitment shall be reduced by the amount of those contributions to the same extent as if they had been made to the fund. Separately, any management fee funded by a limited partner with respect to an alternative vehicle shall reduce that partner's share of the management fee payable to the fund manager by the fund by a corresponding amount.

Take a limited partner with a $25,000,000 commitment that has already contributed $10,000,000. Figures are hypothetical; the mechanics are from the model agreement.

• Remaining commitment before the AIV: $25,000,000 - $10,000,000 = $15,000,000.
• The general partner forms an AIV for one deal and calls $3,000,000 through it.
• Contributions to date, counting the AIV: $10,000,000 + $3,000,000 = $13,000,000.
• Remaining commitment after: $15,000,000 - $3,000,000 = $12,000,000, exactly as if the call had come through the fund.
• If the AIV itself charges that partner $60,000 of management fee for the period, the fee the partner funds to the fund manager through the fund drops by $60,000, so the total across both vehicles is unchanged.

Read those two rules together and the design intent is clear. An AIV is meant to be structurally invisible in economic terms. If a limited partner's total commitment usage, total fees or total distributions change because a deal went through an AIV rather than the fund, something has gone wrong with the drafting.

AIV versus parallel fund, feeder and blocker

Four structures, routinely confused, all present in the same documents.

• An alternative vehicle is formed for one investment, after the fact, and invests in lieu of the fund in that deal.
• A parallel vehicle is formed at fundraising and invests alongside the fund. The ILPA model describes forming one or more pooled investment vehicles to co-invest with the fund, each governed by organizational documents substantially the same in all material respects as the fund's.
• A feeder is itself a limited partner of the fund. The ILPA model defines a feeder entity as a limited partner managed and controlled by the general partner for the benefit of one or more investors that are not interested persons. Carlyle's agreement likewise treats its Feeder Fund in a separate section from its Alternative Investment Vehicles.
• A blocker is a corporation inserted to interrupt the flow-through of income for tax purposes. It is a tax entity, not a fund vehicle, and it can sit inside any of the three above.

One practical filing point. An AIV is sometimes swept into the main fund's securities filing rather than filing its own. ACON Equity Partners III's Form D, filed in November 2019, carries the clarification that the form is being filed on behalf of the issuer and each alternative investment vehicle of the issuer.

Common mistakes

• Assuming an AIV means extra capacity. It does not. Contributions to it reduce the same remaining commitment.
• Assuming it means extra fees. The model agreement offsets AIV management fees against the fund-level fee.
• Treating an AIV as a co-investment. A co-investment adds capital alongside the fund; an AIV substitutes for the fund in the deal.
• Missing the ten business day document window. That notice period is the limited partner's only real opportunity to read the terms before they are signed.
• Assuming results are always aggregated. Aggregation is the default, but the general partner can depart from it with advisory committee consent, and that is precisely the case worth reading closely.
• Treating AIV as a term with a settled definition. It is not. One filed custody agreement defines alternative investment vehicle so broadly that it means any entity formed by the company, which bears no relation to the private-equity usage.

How it relates to adjacent terms

A feeder fund solves an investor-side problem by aggregating investors into one limited partner; an AIV solves a deal-side problem by moving one investment out of the fund. The two are often described interchangeably and almost never are.

A blocker corporation is what frequently sits inside an AIV when the structuring reason is tax. The AIV is the vehicle the limited partners fund; the blocker is the entity that changes the character of the income.

Capital calls are where a limited partner encounters the whole thing in practice. A call notice that names a vehicle other than the fund is the moment to check three things: whether the remaining commitment is being reduced correctly, whether the management fee is being offset, and whether results are being aggregated.