What a Subscription Agreement Is (and Isn’t)
A subscription agreement is a legally binding contract that outlines an investor’s commitment to purchase an equity ownership interest in a pooled investment vehicle, also known as a private fund entity.
A subscription agreement primarily identifies the investor and establishes legal title to specific ownership interest within the fund entity. It’s critical for the fund to accurately determine the legal identity of the investor at the beginning of the investor relationship, and to maintain the accuracy of that identity throughout the fund’s life cycle.
The investor’s legal identity determines who will receive financial benefits from the fund and be legally responsible for any taxes due. It also specifies who can exercise voting, consent, or objection privileges if the fund owners need to consult investors to make legal decisions or address other issues.
The investor’s legal identity is also vital for estate planning and for the investor’s beneficiaries — even the inclusion or omission of small words in the investor title (words such as and or or; abbreviations such as JTWROS, POA, IRA, or FBO; or dates such as a the date of a trust) can completely change the legal nature of beneficiaries’ ownership interest.
The subscription agreement also contains a series of investor disclosure questions and statements, including specifics about financial eligibility, tax status (or tax privileges through a retirement plan or charitable trust), and eligibility to participate in specific assets purchased by the fund (for example, if a U.S. investor is eligible to receive IPO income). These representations verify the investor’s suitability to invest in the fund, provide personal financial information that may direct investment participation criteria, and determine how the investor receives payments such as dividends and distributions, or assets like equities or cryptocurrency.
Finally, a subscription agreement sets the initial date and amount of the investor’s financial commitment to the fund. Because funds may create separate subgroups within a single legal structure to accommodate specific types of investors, or to capture market opportunities on specific purchase dates, the subscription agreement will name the fund, but may also set a class, a series, or a fund offering date. It’s essential to verify that these specifics are correct and represent the investor’s intent when purchasing the fund.
A subscription agreement is not necessarily a guarantee of fund ownership. Once a subscription agreement is signed, it must still be reviewed and be accepted by the fund representative with a countersignature by the fund manager, general partner (GP), managing member, or directors. Once the subscription agreement is fully approved, the investor’s status as an official owner and partner, member, or shareholder participant is legally formalized.
A subscription agreement is different from a shareholder purchase agreement, a shares warrant, or a stock warrant. A shareholder purchase agreementis generally used when purchasing the shares of a single commercial business entity, and governs the ongoing relationship between shareholders and the business after shares are purchased. Shares warrants and stock warrants are financial contracts that give a holder the right to purchase a set number of stock shares at a fixed price.
In summary, a subscription agreement is a written legal document that defines an investor’s binding agreement to join a pooled investment vehicle (private fund) naming the fund, the investor, and, records the investor’s initial disclosures to the fund, including banking information and contact details like street address, phone number, email address.
Who’s Involved and Each Party’s Role
The fund entity issuing the subscription agreement could be a partnership, a limited liability company, a corporation, or another similar legal structure that allows for the pooling of investor purchase proceeds, but also designates supervising and responsible party to make allocation decisions and manage the fund’s daily operations.
For a partnership, that is usually a GP, and investors are typically called limited partners (LPs). For a limited liability company (LLC), the supervising and responsible party is normally the managing member with investors termed members. For a corporation, it’s the board of directors and shareholders. There are, however, variations: the fund entity may assign specific tasks to separate legal entities, like an investment manager (IM) or investment advisor (IA). Very commonly, critical investor onboarding and compliance tasks are outsourced to an independent external fund administrator.
The fund administrator normally provides investor compliance recordkeeping to the fund, and independent accounting reporting detailing the fund’s financial performance directly to investors via periodic investor statements.
The fund administrator performs a major role in processing subscription agreements on behalf of the fund. The administrator not only performs and documents key operational tasks around Know Your Client (KYC) compliance and Anti-Money Laundering (AML) controls, they also issue confirmations and statements that serve as receipts of investor transactions, including subscription payments, capital calls, redemption payments, and capital dividend or distribution payments.
The fund administrator also reconciles the fund’s bank and other asset accounts (brokerage accounts, exchange assets, or counterparty accounts like cryptocurrency or financial securities instruments) to prepare periodic financial accounting reports―balance sheet, income statement, and register of members. The fund administrator performs these important financial calculations independently, functioning as a trusted and reliable third party to provide investors with ongoing, direct financial reporting of fund performance that is less prone to influence by fund managers.
The Investor Onboarding Process
1. Indication of Interest
Before any documents change hands, most funds begin with a non-binding signal of interest from an investor that they are actively considering an investment in the fund. At this stage, investors share personal data and anticipated commitment size, which sets up the initial subscription process once a commitment is formalized.
The fund may also request information regarding the investor’s legal structure, tax status, or financial standing, but discussions aren’t typically legally binding at this stage. The investor may choose to increase, decrease, or delay the amount of their financial commitment, or even to walk away entirely without obligation.
2. Due Diligence
Before a prospective investor initiates a subscription, the fund will provide due diligence documentation, usually consisting of multiple documents―each with separate, important functions―in a Subscription Packet.
- Private placement memorandum (PPM): Also known as the offering memorandum (OM), the PPM discloses the fund’s investment strategy; specifies any fees an investor will pay; indicates if there is a minimum initial investment amount; outlines if and when the Investor can withdraw or exit from the fund; when periodic Investor statements and performance reporting will be distributed; how the fund will approach risks to its strategy and operations; and other essential legal terms including tax considerations, other disclosures specific to legal jurisdictions, and channels for dispute resolution.
- Limited partnership agreement (LPA) for partnerships or an operating agreement for LLCs: This is the fund’s governing document, detailing the parties operating the fund, official procedures regarding what investors can expect to receive and how they will be represented or participate in fund matters, key man provisions, and often, secondary provisions for the closure or wind-down of the fund, if and when that becomes necessary.
The subscription packet may also contain supplemental documents as addendums that offer additional flexibility, increased restrictions, or information from the fund manager applicable after the initial launch of the fund to clarify or supersede provisions in prior documents.
Prospective investors should carefully review all due diligence documents to fully assess the implications, risks, and opportunities presented by the fund offering.
3.Subscription Agreement
The subscription agreement is also generally part of the subscription packet. Investors will need to fully complete and sign it, as well as provide additional required supporting documents to validate their identity and eligibility. In the U.S., this will nearly always include a separate signature on any applicable, completed IRS tax forms (such as Form W9 or Form W-8BEN).The investor may also be required to provide a copy of their personal identification (passport or driver’s license) and a copy of a trust document if they are using a trust to invest.
Fund administrators typically manage the subscription process. Admins with a sophisticated technology infrastructure often offer an online portal and workflow that enables investors to quickly, conveniently and securely complete and electronically sign a digital subscription agreement. It’s vital for investors to fill out all applicable sections of the subscription agreement and submit supporting documentation as quickly as practical.
Investors should also keep a full copy of the original subscription documents for their own files and estate records. Any subsequent errors or omissions can often be easily resolved by referring to original file copies.
Because bottlenecks in collecting and processing initial subscription agreements can delay the investment process, fund managers and administrators need to closely monitor the investor subscription workflow to keep it moving smoothly and efficiently.
A fund entity is a collective and collaborative effort, and problems in the workflow will inevitably affect all parties, causing problems and delays. Clear communication, simple workflows, and competent fund managers and fund administrators go a long way toward minimizing frustration and optimizing the investment opportunity for the fund and its investors.
4.Supporting Documentation
Most fund administrators collect investor identification documents with the initial subscription agreement and the Form W9. These are critical legal documents for both investor subscription and future transactions. For example, in the case of an investor set up as a trust, a trust agreement may specify other trustees who can represent the trust if the initial trustee is unable to act.
For an individual investor, state-issued photo identification legally authenticates them, both for their own security and to prevent fraud. These documents are now required in all jurisdictions so the fund can demonstrate KYC compliance―crucial for the fund’s bank and brokerage relationships―and to avoid financial penalties or other disruptions due to noncompliance or sanctions violations.
Entity Investors such as LLCs, corporations, trusts, pensions, and other legal structures have formalized documents that specify their participants, official representatives, and legal contacts. A copy of these documents will be required for submission as part of the subscription agreement for these investor types.
To avoid transmission of confidential documents with unsecured email, most fund managers and fund administrators provide secure channel communications, including upload with an encrypted website link or transmission via encrypted file transfer protocol.
5.Payment
Subscription agreements define the fund’s bank details for investor payment. Due to pervasive spoofing emails that can appear highly authentic, it’s a highly recommended best practice to verify the fund’s printed bank details by calling the fund manager or fund administrator using an independently received phone number. Don’t not rely solely on a phone number provided in email.
In some cases, the investor pays the full subscription amount when submitting the Subscription Agreement. In other cases, the investor may need to wait, or opt not to pay until they receive a specific notice for payment (for example, when the fund issues a capital call).
In all situations, the investor should only use the fund’s verified payment details when making payments and always be skeptical if they receive any communication claiming that the fund has recently changed its bank payment details.
6.Countersigning
The last step and legal conclusion of investor onboarding is the fund countersignature on the subscription agreement. This is another important piece of the investor file that investors should export and save, or print and store, to add to their fund purchase transaction records.
7.Investor Statements
For the typical private fund with a monthly liquidity cycle, there may be a longer delay for the investor to receive their first monthly investor statement at the beginning of the relationship. Investors typically subscribe and pay the fund in advance of their first month of participation, meaning they will need to wait until well into their second month to receive an initial statement. This allows the fund administrator the necessary time to accurately compile all financial records for that first month, finalize the fund’s books, and prepare and publish the monthly investor statement.
All told, a new investor may have to wait six to eight weeks for their first monthly investor statement (the one or two weeks prior to active participation in the fund, plus the period waiting for their first investor statement). Successive investor statements will be delivered on a routine and predictable interval, but sometimes the initial delay can create uncertainty, so investors should be aware of and prepared for this possibility.
Fund managers and administrators commonly provide investors with transaction receipts and payment confirmations to confirm their capital has been received and document the fund’s deployment of the capital. Additionally, many fund managers and fund administrators now offer portal logins that give investors convenient 24/7 access to their initial fund documents and fund transaction confirmations not only while they wait for that first investment statement, but on an ongoing basis throughout their relationship with the fund.
These documents offer tangible reassurance to new Investors that their payment has been safely received and is being put to work by a capable and experienced fund manager.
For additional information or questions about subscription agreements or how a fund administrator can help with efficient investor onboarding, contact us. NAV Fund Services has been helping fund entities and investors for more than 35 years and maintains a 99% client retention rate.
