Why in the world would anyone want to do anything in Luxembourg? It is a country socially divided between French and Flemish, it is filled with bankers, almost none of which are from the country itself, its small and gossipy, the local language, one of three official langauges, is a mish-mash of French, German and Flemish. It was an important feature in the Battle of the Bulge, and is therefore the site of General George S. Patton's grave and its cliff faces and gorges are lined with the ruins of old fortresses, most of which have their origins in The Great War, but some that date back to 1000 AD.
KKR, however, like many foreign financial entities, found a more attractive use for the jurisdiction.
We expect that any investments in issuers that are based outside the United States or in private equity funds whose investments are focused outside the United States will be made through KKR PEI SICAR, a wholly-owned subsidiary of the Investment Partnership. KKR PEI SICAR qualifies as a risk capital investment company (soci´et´e d’investissement en capital `a risque), or a ‘‘SICAR,’’ under the laws of Luxembourg. A SICAR is a newly established vehicle for investment in risk-bearing capital for which the tax rules are still developing. Under Luxembourg law, distributions from SICARs are free of withholding tax and gains recognized by SICARs are not subject to capital gains tax....
Not a bad gig. Smart development for a small EU country focused on financial services and where there are over licensed 900 banks. But, warns KKR:
...the applicability of European Union directives and bilateral tax treaties to SICARs by certain other countries has not been definitively determined. If KKR PEI SICAR is not entitled to the benefits of European Union directives or relevant tax treaties, including Council Directive 90/435/EEC, KKR PEI SICAR could be subject to a withholding tax on distributions from portfolio companies of KKR’s private equity funds as well as a capital gains tax on dispositions of investments, any of which could have a material adverse effect on the price of our common units. Furthermore, the SICAR tax regime may be challenged by the European Commission if it is considered to have infringed upon the European Union’s state aid rules. In February 2006, a request for information was made to the Luxembourg government by the European Commission on the compatibility of the Luxembourg law SICAR vehicles with the European Union Treaty provisions on state aid. As of the date of this offering memorandum, it is not clear whether, as a consequence of this request, Luxembourg laws on SICARs and certain tax provisions thereunder as currently in force will ultimately be affected and whether the tax regime applicable to KKR PEI SICAR could ultimately be denied, with or without retroactive effect.
Wouldn't that be a rude awakening? It is around this time that readers of the prospectus wonder "how complex is this entity... exactly?" Luckily, a diagram about 10 pages later answers that question.
The KKR memorandum also brings to the surface something that isn't often talked about in the buyout world. Overcommitments. For the unwashed, investors in private equity don't typically write a check for the entire amount of their proposed investment the day they invest in the fund. Instead, they make a "commitment" for the entire amount and tender some or none of that at closing. The "commitment" is drawn down on by the private equity fund when it needs capital via a "capital call" to the limited partners. Since the private equity fund cannot really invest the entire amount of its fund on day one, this makes some sense as it allows the investor to manage its own money according to its own treasury policies while the cash sits on the sidelines. Some institutional investors, however, practice "overcommitment," whereby they commit more funds than they actually have to invest betting that enough time will pass for them to raise more, sell assets, etc., before a capital call that exhausts their free cash is made. Overcommitment can, however, cause problems. Specifically:
As is common with private equity investments, we expect that the Investment Partnership and its subsidiaries will generally follow an over-commitment approach when making investments in KKR’s private equity funds. When an over-commitment approach is followed, the aggregate amount of capital committed by us to private equity funds at any given time may exceed the aggregate amount of capital available for immediate investment. Depending on the circumstances, the Investment Partnership and its subsidiaries may need to dispose of investments at unfavorable prices or at times when the holding of the investments would be more advantageous in order to fund capital calls that are made by private equity funds to which they have made commitments. In addition, under such circumstances, legal, practical, contractual or other restrictions may limit the flexibility that the Investment Partnership and its subsidiaries have in selecting investments for disposal.