PUERTO RICO Law and Practice Contributed by: Miguel E Otero-Sobrino and Alexis R González-Pagani, Ferraiuoli LLC
default. However, the Puerto Rico Internal Revenue Code of 2011, as amended (PR IRC), allows LLCs to elect to be treated as partnerships or disregarded entities for income tax purposes, even if the LLC has only one member. As with tax elections made pursu - ant to the IRC, the election to be taxed as a partner - ship under the PR IRC allows LLCs (including PEFs and PR-PEFs) to be transparent for Puerto Rico tax purposes, making the members of the parties respon - sible for the tax liability instead of the fund. Furthermore, the PR IRC provides that every LLC that is treated as a partnership by reason of its election or provision of law or regulation under the IRC, or the similar provision of a foreign country, or whose income and expenses are attributed to its members for federal income tax purposes or those of the foreign country, will be treated as a partnership for the purposes of the PR IRC and will not be eligible to be taxed as a corporation. As mentioned in 5.1 Structure of the Acquisition , most PEFs tend to use SPVs in the transaction, there - by separating the fund from the target investment. The PEF backing the SPV buyer is typically structured as a “qualifying private fund” exempt from registration under SEC Rule 203 (m)-1. The term “qualifying pri - vate fund” refers to any private fund that is not reg - istered under Section 8 of the Federal Investment Company Act of 1940, (as amended) (ICA), and has not elected to be treated as a business development company pursuant to Section 54 of the ICA. It is common for the general partners/members to manage the acquisition (or sale) documentation. As the general partners/members oversee the day-to-day operations of the fund and manage the portfolio com - panies, they will lead the acquisition (or sale). Depend - ing on the complexity of the transaction, on some occasions the general partners/members engage the investment adviser of the fund or a third-party sub - ject matter expert adviser for additional support dur - ing the due diligence process. From a documentation standpoint, very few general partners/members or investment advisers have sufficient expertise to draft and review the transactional documents; therefore, a law firm should be hired to assist in the drafting of complex documents. In the past 12 months, due
to the evolving nature of the transactions, increased complexity and entrance of more sophisticated inves - tors in the Puerto Rico market, the use of large law firms with expertise in these matters has become an essential condition for the transactions to be carried out effectively. 5.3 Funding Structure of Private Equity Transactions Generally, private equity deals are financed through capital contributions in the fund, either directly by the limited partners/members in their personal capacity or by an SPV wholly owned by the limited partners/ members. Typically, the fund provides investors with an approximate target for the fund size and the mini - mum amount of investment that must be committed by the investors prior to becoming partners/members in the fund (ie, the capital commitment). Once the fund determines the investment it wishes to pursue, the general partner/member or investment adviser will notify the limited partners/members of the amount of capital that they must provide the fund (ie, the capital call) and the timeframe in which they must provide it. In the past 12 months, the authors have seen more Puerto Rico-based banks becoming more open to providing money to investors, in lieu of lending money directly to the fund managers or portfolio companies. This has mainly been due to the willingness of Puerto Rico banks to structure the required funding and take the requirements of the Incentives Code into consid - eration with respect to the transactions. The capital call should not exceed the capital commit - ment made by the limited partners/members, unless the limited partners/members and the fund reach such an agreement. Once the fund has sufficient funds, it deploys them in pursuit of the investment. Most pri - vate equity deals are geared towards the fund obtain - ing a majority ownership interest in the investment, debt issuance or a combination of both, through what is known as mezzanine financing. Private equity deals have become more competitive in the past 12 months because of the amicable environment in Puerto Rico, characterised by the availability of tax incentives and overall benefits for both investors and sponsors.
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