A feeder fund (“Feeder”) is an investment vehicle, often a limited partnership, that pools capital commitments of investors and invests or “feeds” such capital into an umbrella fund, often called a master fund (“Master”), which directs and oversees all investments held in the Master portfolio. A Master/Feeder structure is commonly used by private equity funds or hedge funds (“Funds”) to pool investment capital. The Master’s profits may be split on a pro rata basis among its Feeders in proportion to their investment. A Feeder is a separate legal entity from the Master and is relevant to both lenders and Funds when discussed in the context of lending relationships, particularly in structuring a subscription-backed credit facility (“Facility”). Investment managers choose to form Feeders for a variety of reasons. For example, Feeders offer flexibility with respect to investor tax status, ERISA status, minimum capital investments, fee structures or other administrative features that can be tailored to the specific needs of any investor. In this article, we will focus on certain tax, ERISA and aggregation issues as they relate to the Master/Feeder structure of Funds.

Tax Concerns²

Tax-exempt investors and foreign investors are two significant sources of capital in the United States and both groups invest heavily in Funds. Most tax-exempt investors will want to minimize or eliminate the realization of unrelated business taxable income (“UBTI”) with respect to their investments. Similarly, most foreign investors will want to minimize or eliminate the realization of effectively connected income (“ECI”) and structure their investments in a manner that does not require them to file US income tax returns. If a Fund makes its investments in or through pass-through entities, the Fund’s tax-exempt investors may realize UBTI or its foreign investors may realize ECI and have to file US tax returns if the Fund is...