Investments in private equity funds are a feature of some ‘big money’ divorce cases. In some cases, investments have been made in private equity funds and those investments, or profit sharing entitlements deriving from them, form part of the matrimonial or non-matrimonial property of the parties. The main difficulty in this type of litigation is that the value of such investments is often difficult to ascertain reliably, and, in any event, they are often highly illiquid and realisable only at some future point. Those are not difficulties which are unique to private equity investments, and they are often capable of resolution by way of a Wells v Wells1 sharing of the value when it is ultimately realised. Greater complexities tend to arise where one of the parties to the marriage is also professionally involved in the ongoing management of a private equity fund, particularly where that involvement continues in the period following the separation of the parties until the private equity investments mature at some point in the future. There is a limited body of reported case law in which these issues have been discussed.

Private equity in context

The private equity finance sector serves both investors and businesses. It enables wealthy investors (both individuals and institutions) to have access to investments which require a commitment of significant capital for a period of several years, with the prospect of potentially high returns, but with a consequently high degree of risk. On the other side of the equation, it enables new businesses to raise capital necessary for their development and growth, or for more mature businesses to be bought out or have capital injected in order to increase their value. Generally speaking, venture capital funds tend to invest in new businesses and startups, while private equity funds tend to invest in more mature companies, usually by acquiring such businesses and either increasing their value or otherwise extracting their value before exiting the investment a few years after acquisition. Both venture capital and private equity funds, as well as some other very specialist types of investment funds, share many common features and we use the term ‘private equity’ in this article in this broader sense.

The UK private equity market continues to be buoyant – it is estimated to have reached £4.6 billion in 2024.2 Private equity-backed companies are believed to account for c.5% of UK private sector revenue every year and c.15% of UK corporate debt. Private equity deals reached a peak of 1,900 in 2021, with an estimated £152 billion being spent within 12 months, according to data from Pitchbook. City AM has reported that a trillion pounds has been spent in UK private equity deals since 2014.3 Whilst the US represents the largest market for private equity investments globally, the UK is increasingly seen as the European hub. Aside from the direct fiscal impact of these large financial institutions in managing investments and assets, private equity also has a broader impact on the economy. It is estimated that private-equity-backed businesses generated £286 billion in GDP in 2023, accounting for 6% of the UK’s total.4

London is the home to many large private equity funds, usually structured as partnerships or LLPs, with a significant number of people working in the sector.

It is against this backdrop that practitioners need to be aware of the features of this asset class, particularly as regards remuneration structures for those working within such funds. This will often involve significant capital interests in the fund(s), usually including potential future capital distributions. In some cases, analysis of a party’s remuneration package and the fund terms may require involvement from a transactional funds lawyer. This article aims to serve two purposes: to provide a primer on private equity for those less familiar, before turning to how private equity interests and receipts/remuneration have been treated in recent case law.

The fundamentals of private equity

On the one hand there are ‘traditional’ investments, which include cash, bonds, and holdings in public companies. On the other, there are ‘alternative’ investments, which include complex and private investments focussing on typically illiquid holdings. The latter asset classes include private equity, infrastructure, real estate, and private credit.

Private equity is simply defined as equity (or equivalent) investments in private companies or assets (i.e. not listed on a public stock exchange). Originating from the 1980s, private equity as we currently know it has been traditionally associated with family offices and institutional investors that meet specific requirements for income, wealth, or financial acumen, i.e. qualified purchasers that can participate in relatively long-term illiquid investments. More recently, private equity investing has become more widely accessible. Investors can access private equity in the three ways. First, by direct purchase of an equity interest in a privately owned asset/company. This offers good upside prospects if the investor chooses well. The limitation intrinsic to this route is one of access, which may not be easy, as well as the risk of concentrating monies in one private equity investment. Secondly, an investor can access private equity through a fund (i.e. by investing in a fund which itself is invested in private equity). Sometimes these are listed investment funds which carry tax advantages for those investing in them, such as Venture Capital Trusts or Enterprise Investment Schemes. However, larger investments tend to be in a pooled investment vehicle where a private equity manager, or general partner (GP), is professionally engaged to identify, assess, acquire, and manage investments using capital from investors, known as limited partners (LPs). The terminology refers to the fact that most investment vehicles are structured so that the GP controls the partnership vehicle operationally (often a ‘fund’ comprises multiple legal entities, often in more than one jurisdiction). The GP will have a general liability for the actions of the fund, whilst the LPs are limited to the capital that they have committed by way of investment. This is the traditional private equity business model, and oftentimes when the phrase ‘private equity’ is used it is referring to this arrangement.

The various private equity fund phases are summarised below, but in short, the fund manager will draw down on the capital committed to invest in companies as and when appealing opportunities are identified. The investment in such opportunities is typically planned to remain in place over the course of many years before there is an exit event, most usually a sale of the underlying business which was invested in. The intention is to substantially increase the value of the fund’s stake in a business and realise profit when the time comes to exit through a liquidity event (e.g. a sale or public offering). As exits occur, the fruits of the investment are returned to the investors until, ultimately, the final investment is realised, and the fund itself is liquidated. Clearly, there is substantial risk that the investment may not realise a profit and the investors will therefore receive back less than they invested.

The third way that an investor can access private equity is via a multi-manager fund. This is similar structurally to a private equity fund, save that instead of investing in individual companies, the umbrella fund will invest in other private equity funds (a fund of funds). This is seen as providing broader diversification, but not necessarily eliminating the risk of loss, by allowing the investor to simultaneously access diverse asset classes, sectors, managers, and investment strategies.

Key private equity strategies

There are three or four general private equity strategies, depending on whether distressed assets are included. They each target a different phase of the business lifecycle. All of the strategies require the construction and management of portfolios of investments in companies and businesses that are selected in return for a direct capital investment (primary investment) or as payment to an existing equity holder to buy the shares or interest in the business held by that equity holder (secondary investment). Rather than simple loans to the business, the private equity or venture capital fund will take shares in the underlying business, or at least convertible loan notes by which a loan can be converted to shares at the fund’s election.

Venture capital

Typically, these are new businesses that require funds to develop. They turn to private equity funds to finance activities such as R&D, the manufacturing of products, and hiring personnel. They are often in the technology sectors where an initial piece of design or technical development requires a large capital investment to put it into production or use. These investments in early-stage ventures target businesses that have the potential to grow fast. They rely on successive rounds of funding in order to achieve that growth. In other words, the fund manager is effectively adding cash to the balance sheet of the nascent business in exchange for equity, frequently as part of a syndicate of investors.

Growth

This refers to businesses that are already established. Monies are typically invested for the purpose of restructuring operations and facilitating acquisitions. The ownership stakes can range from a minority to a majority interest.

Buyout

This is the largest sector of private equity investment. A buyout usually involves the purchase of a controlling stake in a mature private company via a secondary investment. The purpose is to provide liquidity to the remaining initial investors and to invest funds to meet other ancillary purposes, such as improving efficiency, facilitating access to new markets, etc. These strategies look to longer-term value creation.

Distressed

A distressed private equity strategy looks to the end of the business’s typical lifespan. They target enterprises that need radical financial investment and, usually, restructuring and an overhaul of internal operations. This strategy sometimes involves a change in management with a view to achieving a turnaround.

Phases of private equity fund activity

Private equity funds have three broad phases, sometimes described as portfolio construction, value creation, and harvest (or analogous terms).5 The first involves finding investments that align with the fund’s investment strategy. Investors’ funds are committed to purchase those investments. The second phase is determined by the strategy pursued. In a broad sense it usually involves making operational, strategic, and sometimes structural changes to the businesses (i.e. measures to increase the value of the portfolio). The work undertaken by the fund managers, the GP, in each of the first two stages is time-consuming and complex. Typically, the fund will appoint directors to be involved in the management of the business it has invested in. The GP will be remunerated for the work done in managing the investments (see below). It is possible that during this second phase LPs may receive distributions resulting from the sale of portfolio interests. Finally, the ‘harvest phase’ is where the fund exits the various positions, either by IPOs or private sales, with profits being distributed to the investors.

Private equity in matrimonial finance

As noted by Mostyn J in A v M,6 the nature and structure of a typical private equity fund was described with helpful clarity by Coleridge J in B v B.7 This case featured ‘M’, a ‘prominent private equity house in the UK’:

‘25. M’s modus operandi is the de facto standard private equity model:

i) (exclusively institutional) investors are invited to commit monies to an investment fund;

ii) once the commitments have been received the fund managers, typically led by the husband, then seek out existing and established businesses to acquire normally a controlling ownership interest;

iii) having acquired a business M inserts board members, typically a chairman and typically the husband, and runs the newly acquired business with the primary strategy of adding value to the business;

iv) at an opportune moment in the cycle of the market but, more importantly, the business itself, the business is sold and the investment in it liquidated hopefully at a profit. Sometimes there may be a partial sale and, obviously in such a high-risk enterprise, occasional disasters.

26. M has raised a number of funds since its inception. As each fund nears full investment (i.e. the commitments to the fund have been almost exhausted in acquiring businesses), a new fund is “opened” seeking investors to make fresh commitments. The current funds in existence are designated A, B and C. All earlier funds have been fully realised and the proceeds distributed to the investors and to M.’

Coleridge J went on (at [27]) to explain how the fund and its managers are rewarded for the work done by them:

‘i) the fund is debited with fees (generally 1.5% p.a. reducing to 1% p.a. after a fixed period, typically 5 years), paid to M, which fund the overheads including remuneration for the partners and staff for running the fund by way of salary and bonuses – these fees are not directly performance related;

ii) the individual investment executives, including partners, are required to “coinvest” with the outside investors into each business into which the fund invests, so that they have “skin in the game”, and the values of those coinvestments will vary proportionately with the success or failure of the businesses into which the investment has been made; and

iii) for the purpose of this case most significantly, the investment executives are entitled to a “carried interest” (or “carry”) in the fund overall, so that provided that the monies returned to the outside investors include a positive return exceeding the contractual “hurdle” rate, they will retain 20% of the profits made. If that “carry” has been earned by the clearing of the hurdle, it is divided in pre-determined proportions between the individual partners, including the husband.’

Although the fees charged and the hurdle rate will vary from fund to fund and private investment to private investment, the business model described above is common in the private equity sector.

The focus of the comparatively small pool of cases dealing with private equity funds is that of remuneration and receipts, which may be historic or anticipated, and in particular the way in which co-investment capital and carried interests should be categorised and dealt with on divorce. Coleridge J neatly described the three streams of return for an individual operating as the GP of a private equity fund as follows:

‘28. So it is that the husband’s potential future receipts from M comprise (or, at least, depending upon the success of the underlying businesses, may comprise):

i) salary and bonuses (it is not suggested by the wife that these will be shared going forward) which are paid from M fund management profits;

ii) any realisations of existing co-investments (whether made during the marriage or since the separation);

iiii) any “carry” received by the husband (whether from investments in businesses made by the funds before or after the separation, or in the future, and whether or not the “success” of those businesses is achieved before or after the separation or in the future).’

In view of the clear explanation of the law as to post-separation earnings by the Court of Appeal in Waggott v Waggott8 the wife’s concession in B v B that she was not entitled to share in the salary and bonuses earned by the husband after the separation was clearly correctly made, and this element of remuneration from a private equity fund for the day-to-day work done in managing it presents little controversy or difficulty.

Likewise, capital contributed to a private equity fund to form the co-investment is also unlikely to present difficulty in most cases. It will usually be regarded as a capital asset like other capital assets. Where matrimonial capital has been used to make the co-investment the value of the co-investment is likely to be shared equally. In B v B it was conceded by the husband that the wife was entitled to share equally in the fruits of the co-investments made within the marriage, but he disputed her right to share in co-investments made to a new fund where the funds for those investments came from the husband’s post-separation accrual. Coleridge J decided that the wife was entitled to 50% of those post-separation investments as well on the basis that ‘the respondent’s [post-separation] efforts are merely a seamless continuum of similar pre-separation activity and there is no obvious delay in the proceedings’.9 It can be questioned whether such an analysis could be applied now in the light of the Court of Appeal’s more recent decisions in Waggott v Waggott8 and Standish v Standish.11 In A v M, Mostyn J also shared equally the co-investments which had been made during the marriage. However, to keep the Wells sharing ‘as limited as much as possible in its size and range’ he allocated the whole of the wife’s share in the co-investments to only one of the two funds so that the wife would be a shadow partner in only one rather than two funds.12

Complications may arise in relation to the sharing of co-investments where the terms of the private equity fund provide for future capital to be committed to the fund. Solutions to this might be that both parties should contribute in proportion to their ultimate shares in the co-investment, or if only one party will contribute this should result in an adjustment of the sharing of the co-investment which takes into account the further contribution being made by only one party.

The area of great difficulty is the carried interest. In B v B, Coleridge J took the view that the carried interest ‘is in the nature of a bonus for effort earned for generating a super profit and is only ascertainable as the very end of the investment management process’.13 He awarded the wife 50% of the carry in fund A (where the carry hurdle had already been crossed before the parties separated), 20% of the carry in fund B where the hurdle had not yet been met, and nothing from the carry on fund C where pretty much all the investments in the fund post-dated the separation.

In A v M, there was some debate as to whether carried interest constituted a return on capital investment or an earned bonus. Mostyn J was not bound by the first-instance decision of Coleridge J in B v B and did not even cite Coleridge J’s characterisation of the carried interest as ‘in the nature of a bonus’. Mostyn J held the view (at [10]) that it was neither exclusively a return on capital nor an earned bonus, but rather a hybrid resource with the characteristics of both. Various points of interest arise out of that authority:

• Firstly, the marital acquest was to be calculated at the date of trial, as Coleridge J did in B v B. Mostyn J observed that this should be the general rule save in circumstances where there has been needless delay in bringing the case to trial (the reasons for his view are set out in his decision in E v L14). In A v M, Mostyn J elaborated (at [14]):

‘it is normally the right date because the economic features of the parties’ marital partnership will have remained alive and entangled up to that point. The fruits of the partnership will not have been divided and distributed. The share of one party in the partnership assets is likely to have been unilaterally traded with by the other. I accept that a different view might be taken in respect of a completely new asset brought into being during the interregnum between separation and trial. But that is not the case here. Here we are concerned with assets acquired pre-separation but worked on during the period up to trial.’

• In that case, Mostyn J decided that the marital, and therefore shareable, element of the carried interest should be calculated linearly over time by reference to a formula. The formula applied was A ÷ B = C, where: (i) ‘A’ is the period (measured in months) from the establishment of the fund to the date of trial; (ii) ‘B’ is the number of months from establishment to first close plus, in that case, 180 months, being 9 years from first close, which Mostyn J had determined on the evidence (at [12]) to be the term of the fund; and (iii) ‘C’ is the marital fraction of the recipient party’s carry, expressed as a percentage.15 The projected value of the carry is then multiplied by C to give the marital carry which is to be shared.
• In that case, the marital carry was to be shared equally, a decision which Mostyn J found to resonate with fairness based on the facts of the case.16
• Mostyn J dismissed ‘briefly but emphatically’ the submission that the wife should be entitled to share in carry generated by the husband following the date of trial by virtue of her ‘contributions to the family’ (caring for the parties’ 12-year-old daughter, who was at boarding school). He found that the argument was completely untenable (at [17]):

‘The concept of the sharing of the acquest is predicated on the parties being in an economic partnership. The decision of the judge at trial is to dissolve the partnership and to distribute fairly, which means normally equally, the partnership assets. The idea that a valid claim can be made to share assets which have already been divided and distributed, or to share earnings or profits which have been generated after the dissolution of the partnership, is completely unprincipled. It would be a good thing if this argument were finally to bite the dust.’

• It was observed that Wells sharing (discussed further below) should be as limited as possible both in its size and in its range. Acknowledging the husband’s dissatisfaction with a scenario where the wife would be a shadow carry partner of both funds, Mostyn J reallocated the wife’s share of the husband’s carry in Fund 2 to his carry in Fund 1. Co-investments were allocated in the same way.17
• The wife was to receive her share of the carry and co-investment by means of contingent lump sum orders against the husband. It would be ‘unreasonable and unrealistic for her to seek to be granted a formal transfer of part of the husband’s proprietary interests in the funds’ (at [29]). Mostyn J was satisfied on the balance of probability that the wife would in 4.5 years’ time receive the sums calculated (and that the husband would receive the sums calculated in respect of his interests in 4.5 and 6.5 years’ time). It was acknowledged that they would not get those exact sums, but it was more likely than not that amounts of that order would be received. The authority refers in that regard to the standard of civil judging (balance of probabilities) and the decision of Lord Diplock in Mallett v McMonagle:18 ‘In determining what did happen in the past the court decides on the balance of probabilities. Anything that is more probable than not it treats as certain’. This binary rule, it was said, ought to apply to judicial findings about the likelihood of future events, and in the context of s 25 Matrimonial Causes Act 1973, the court should be entitled to take into account both the probability of a future event occurring, and also the probability of it not occurring and another event happening. Mostyn J commented that the risk that the wife would receive nothing was negligible.
• Although, the decision was reached ‘with the assistance of mathematics’, it retained at its heart a broad evaluation of fairness.19

Although not explicitly explained in the judgment, the rationale to Mostyn J’s linear formulaic approach to sharing a carried interest explained in A v M is to treat the overall fruits of the carry as a capital sum which is then identified as being matrimonial or non-matrimonial in direct proportion to the number of years of work performed by the husband on the fund during the marital partnership and after the marital partnership ended. In other words, each year of work on the fund during the carry period is deemed to be equal in terms of its effect on the ultimate value of the carry. The carry is essentially assumed to start with a nil value and the value is then allocated to every year thereafter in an equal way. It was really just an application of the so-called ‘straight line’ apportionment method that Mostyn J had deployed in WM v HM20 in relation to a business asset. This contrasts to the approach of Coleridge J in B v B (above) where he gave considerable weight to the time when the hurdle rate was met. Where it was met before separation with carry was shared equally but where it was not yet met, the share was reduced. While having simplicity and consistency to commend it, it might be questioned whether Mostyn J’s linear approach is fair in the event that the evidence indicates that the carry hurdle was met before the separation, or if there was something exceptional about the work done in either the marital period or the post-separation period which had a disproportionate effect on the value of the fund.

The parties in A v M have had two further outings resulting in reported decisions. In A v M (No 2), a dispute was ventilated as to the construction of Mostyn J’s order in circumstances where part of the husband’s investments in Fund 1 were transferred into a continuation fund rather than being realised.21 The wife complained that she had not been given the opportunity to participate in the continuation fund and was instead forcibly cashed out against what would have been her will if she had known that the husband was to remain invested. Sir Jonathan Cohen identified his sole task as being to construe the final order, specifically considering whether it provided the wife with the option to elect to carry over to the continuation fund or whether it required the husband to pay lump sums calculated in accordance with the percentages determined by Mostyn J (in respect of the husband’s interests in Fund 1).

The parties’ substantive positions are summarised at [29]. In short, the wife asserted that the whole rationale of the order was to give the husband the time with his colleagues to build up the value of Fund 1’s assets. She argued inter alia that no consideration was given to the possibility of any part of the investments in Fund 1 being transferred to a continuation fund, and further, that the wife should not be deprived of the opportunity of sharing in the growth of the husband’s assets (which on his interpretation, he alone would benefit from), and nor should she be worse off for being a shadow partner rather than a shareholder. For his part, the husband argued that the order was a contingent lump sum order, rather than an order providing the wife with an interest in any of the underlying assets. In the event of breach of the mandatory obligation to pay the lump sums, the wife could enforce payment. Among other arguments, it was also said that had the husband rolled over the wife’s proportion of what he had invested in the continuation fund, rather than paying her its value, he would be in breach.

The judgement cites the decision of Barnard v Brandon, the agreed applicable law on the construction of court orders.22 Sir Jonathan Cohen concluded (at [32]) that the order was clear insofar as the husband’s obligation was to pay the appropriate percentage of the proceeds due to or received by him from respectively the co-invest or carry funds net of tax and transactional costs, and that was exactly what the husband had done. The wife received full value for her interest. Having paid the wife, the fact that the husband invested, as a matter of obligation, some of the proceeds into the continuation fund did not lead to any requirement for him to give the wife the same opportunity. Whilst what happened was unforeseen, it did not follow that if Mostyn J had been asked to consider this possibility he would have given the wife the opportunity to roll over her interest into the continuation fund. Moreover, whilst the event was unforeseen, that was not a ground for going behind the words of the order, which were clear ([38]). Sir Jonathan Cohen concluded that he saw no unfairness arising from how things had turned out.

The difficulties arising on A v M (No 2) could have been avoided by the final order making specific provision for the wife to have the right to elect to rollover her share of the carry into the continuation fund. However, whether it would be fair to include such a provision in an order is another question. It will be recalled that in his original decision in A v M, Mostyn J deliberately placed the entirety of the wife’s deferred Wells v Wells share of the co-investments and the carried interests against only one of the two funds in order to limit the parties’ ties to each other. The purpose of a Wells v Wells sharing is to fairly share the value of a difficult to value asset whose value is illiquid until a future time. It is not intended as a means by which divorced parties should be compelled to enter into further joint investments in the future once the liquidity issues are resolved.

This litigation is ongoing. The wife applied to set aside the final order made by Mostyn J on the grounds of misrepresentation as to the period over which the carried interest was to be earned. In A v M (No 3), an interim decision, Sir Jonathan Cohen declined to strike out the wife’s application to set aside.23 The rationale for that decision, essentially dealing with matters of procedure and alleged abuse of process, is beyond the scope of this article.

A final noteworthy authority where the Family Court considered private equity fund interests and remuneration was ES v SS, a 2023 decision, again from Sir Jonathan Cohen.24 That case highlighted the fragility of expert valuations and the solution offered by Wells sharing. It featured a fund, ‘XYZ’, which had arranged five investment opportunities that were funded and controlled by a single external investor. The husband would receive certain payments on sale of those investments. The value of those investments was estimated by forensic accountants. The speculative nature of those valuations was apparent when one investment, E Co, was sold and resulted in a payment that was 10x the amount attributed to it:

‘23. The sale of E Co in February 2023 has been a significant focus of the litigation. This is easily explained: as the proceedings developed, there was in the normal way a private FDR. It took place on 29 September 2022 and produced an agreement under which W was to receive £9m in liquid assets out of an agreed total of approx. £24.5m. This amounted to about 36.7% of the presumed assets, albeit that H took on the burden of a potential tax liability which had only just emerged in an uncertain, albeit anticipated not very large, amount. However, before the order was drawn up and within some 6 weeks after the agreement, W’s solicitors picked up on reports that there had been a sale of E Co for a very substantial sum.

24. W’s solicitors applied for disclosure, which was given in part voluntarily and in part following my orders, and it eventually emerged that H’s share of the receipts was no less than €49.9m gross, of which €1.1m was retained as working capital.

25. This needs to be seen in the context of the valuation that had been given of H’s interest at some £4m, on which W relied at the FDR; that is about 10% of what was actually received. The total amount obtained for the disposal of E Co was some 5 times the value attributed to it in XYZ’s financial models.’

The result was that the husband rapidly accepted that the agreement struck at FDR should be set aside. The authority deals with various issues but of particular interest is the analysis of the efficacy of Wells sharing. Sir Jonathan Cohen set out the relevant principles at [43]–[45], quoting King LJ in Versteegh v Versteegh at [151]: ‘I fully accept that the making of a Wells Order is something that should be approached with caution by the court and against the backdrop of a full consideration by the court of its duty to consider whether it would be appropriate (per Section 25a of the MCA 1973) to make an order which would achieve a clean break between the parties’.25 In the same case, Lewison LJ quoted Mostyn J in WH v HM (Financial Remedies: special contribution) at [24]: ‘Generally speaking a Wells sharing arrangement … should be a matter of last resort, as it is antithetical to the clean break. It is strongly counter intuitive, in circumstances where one is dissolving the marital bond and severing as many financial ties as possible, one should be thinking about inserting the wife as a shareholder into the husband’s company …’.26 Sir Jonathan Cohen also quoted [135] of the judgment where it was said that any other course might lead to ‘considerable unfairness’.26

The learned judge ultimately concluded that there is clear scope for events, whether foreseeable or not, to lead to a valuation being significantly out, with the risk of injustice to one or other party. The husband argued that the Wells approach was contrary to the clean break principle and suggested that that outcome had a potential for continued argument and ill-feeling between the parties. Sir Jonathan Cohen did not accept that argument: ‘H will provide W with the annual statement that he receives in receipt of the value of those companies and full information of the terms of any exit. This is not an onerous burden’.28

As suggested above, the body of case-law focussing on private equity funds and past or anticipated receipts is small. Despite cases featuring them being common enough, the key authorities discussed above are all first instance decisions. Whilst they provide helpful guidance, they are not binding. The approach taken by the court in these cases was what was deemed fair and appropriate in highly fact-specific scenarios. There is arguably plenty of scope to distinguish them in future cases.