Optimal fund structures for Private Debt strategies.
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Closed-ended vs. Open-ended
Traditional closed-ended structures remain predominant in private debt, reflecting the asset class’s origins in private equity conventions. These vehicles feature specific characteristics that align with certain lending strategies:
Closed-ended:
- Predictable capital base throughout the investment period
- Alignment with finite deployment windows
- Investor comfort with established carried interest mechanics
- Avoidance of potential maturity mismatches
- Clear vintage-year performance benchmarking
However, these structures present limitations that have driven structural innovation. By design, closed-ended vehicles require repeated fundraising cycles, creating potential disruption to origination capabilities and relationship continuity. They also introduce inefficiencies through the J-curve effect as management fees apply to committed rather than deployed capital during ramp-up phases.
Open-ended structures address certain limitations but introduce different challenges for private debt. While conceptually attractive for strategies with recurring deployment opportunities, true open-ended approaches face fundamental liquidity mismatches when underlying assets lack reliable secondary markets. Redemption demands can force distressed asset sales or disproportionate cash holdings that dilute returns.
The legal documentation for these structures differs significantly. Closed-ended vehicles require detailed distribution waterfalls, carried interest calculations, and clawback provisions. Open-ended vehicles demand sophisticated redemption mechanisms, gates, and side pocket provisions that add substantial complexity.
Hybrid/Evergreen structures
The private debt market has responded with innovative hybrid structures that combine elements of both approaches. These “evergreen” or semi-liquid vehicles represent the most significant structural evolution in recent years.
From a legal perspective, these structures employ several innovative features:
Staggered liquidity windows: Rather than quarterly liquidity common in hedge funds, these vehicles typically offer redemption opportunities semi-annually or annually, subject to extended notice periods (often 90-180 days). This provides the manager operational runway to manage liquidity without maintaining excessive cash reserves.
Multi-Tiered gate provisions: Sophisticated documentation implements both investor-level and fund-level gates, typically limiting individual investors to redeeming 10-25% of their investment per window, while capping aggregate redemptions at 10-20% of NAV regardless of demand.
Slow-Pay mechanics: Advanced structures employ “slow-pay” provisions that segregate an investor’s share of assets and return capital in alignment with underlying asset maturities – effectively creating a personalised liquidating trust.
Vintage sleeve structure: Some innovative vehicles create sequential “sleeves” or sub-funds that close to new investors after reaching target capitalisation, creating vintage-year performance tracking while maintaining overall fund continuity.
The jurisdictional aspects of these hybrid structures require careful consideration. Luxembourg has emerged as the favoured domicile for European hybrid vehicles through the Reserved Alternative Investment Fund (RAIF) regime, while Delaware statutory trusts provide flexibility in U.S. markets.
Matching structure to investment horizon and liquidity profile
The alignment between fund structure and specific private debt strategy is the key determinant for vehicle selection. I have seen some patterns emerge:
Direct lending – These strategies feature 3-5 year loan tenors and typically operate effectively through closed-ended structures with 8-10 year terms, providing adequate runway for deployment and harvesting. However, platforms with consistent dealflow increasingly migrate toward hybrid structures that avoid fundraising cycles.
Mezzanine – These strategies with longer tenors and equity components align naturally with closed-ended vehicles that accommodate extended harvesting periods and complex carried interest calculations incorporating equity upside.
Specialty finance – This approach focuses on shorter-duration assets (receivables, inventory financing) function effectively in hybrid structures due to natural liquidity from rapid asset turnover. However, the complexity of these assets often necessitates enhanced disclosure and investor education.
Distressed debt – These strategies have unpredictable realisation timelines and present particular challenges. While closed-ended structures accommodate uncertain exit horizons, specialised hybrid approaches featuring extended lock-ups (3-5 years) with subsequent redemption rights can provide enhanced flexibility.
Structural evolution and investor preferences
Fund structures continue to evolve, driven by both investor preferences and manager objectives. I have seen some trends emerge:
Perpetual capital vehicles have gained significant traction, particularly for established managers with consistent deployment opportunities. These structures eliminate the inefficiencies of repeated fundraising cycles while providing managers more predictable AUM and fee streams.
Structure customisation has become increasingly prevalent, with many managers now offering multiple access points to their strategies. Major institutional investors increasingly demand tailored vehicles that accommodate their specific requirements, while managers simultaneously maintain commingled flagship funds.
Investor control mechanisms continue to expand beyond traditional advisory boards. Modern fund documentation frequently incorporates enhanced transparency requirements, strategy drift limitations, key person provisions with gradations of consequence, and sophisticated excuse provisions for specific investments.
Liquidity innovation continues to accelerate. Managers now offer some form of redemption rights. The liquidity spectrum has expanded dramatically from purely illiquid to various semi-liquid constructs tailored to specific investor segments.
To sum up
Fund structure selection is a strategic decision. The appropriate vehicle creates alignment between manager capabilities, investment strategy, and investor requirements. This is important for successful private debt deployment. As the market continues to evolve, I expect further structural innovation particularly around investor liquidity preferences. This will likely accelerate as private debt increasingly targets wealth management channels alongside traditional institutional allocators.
This article provides general perspectives only and should not be construed as legal, tax or investment advice. Specific strategies require tailored analysis to address specific objectives and regulatory requirements.
Date: 15 May 2025
Written by: Asad Bukhory