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Characteristics of a Typical Art Fund Investment

An investment in an art fund has a number of unique characteristics that should be considered by prospective investors. Such characteristics vary according to the specific attributes of the art fund; however, the following discussion focuses on the typical structure of most art funds namely that of closed-end private equity fund structures.

• Art fund investments are long-term. An investment in an art fund is a long-term undertaking with investors committing to make capital contributions to a fund for a period of between three to five years and which are typically not subject to return for between five and seven years with additional annual extensions ranging from two to four years at the discretion of the art fund manager.
• Art fund investments are based upon a belief in the art fund manager. Except in the case of pre-specified art acquisitions identified by art fund managers in the fund’s offering documentation, an investor in an art fund has no knowledge of what specific works of art will be acquired by the fund and has little, if any, ability to opt out of committing capital to a particular art acquisition. As a result, art fund investors must rely for the most part on the investment strategies, portfolio restrictions and investment criteria set forth in the fund’s private placement memorandum as well as the expertise and performance record of the art fund manager and the investment professionals governing the fund. Moreover, after making the initial decision to invest in the fund, an investor has little if any discretion over investment decision-making and fund governance, which reside entirely with the general partner of the fund.
• Art Fund investments are illiquid. Owing to the illiquid nature of an art fund’s underlying assets (i.e., the art comprising its investment portfolio), art funds as a general practice preclude withdrawals by investors of their contributed funds. In addition, art fund investors are typically prohibited from selling their equity interests in the art fund, except in limited circumstances such as with the consent of the art fund’s general partner. While art fund investors may receive cash distributions during the life of the fund, the timing is uncertain and in no way is guaranteed.
• Art Funds acquire art to sell and not own. Most art funds have a pre-specified investment period and end-date by which the fund’s art investments are to be sold. While art funds own their art for between five to seven years as an average, all art must be sold within the life of the art fund.
• An art fund’s investment manager and general partner are often one and the same. It is not unusual for the investment manager of an art fund (i.e., the entity charged with identifying and disposing of art investments) and the general partner of the fund (i.e., the entity charged with governing the fund) to be owned and operated by the same individuals. In fact, the roles are often divided between the two entities for U.S. tax purposes. Accordingly, owners of the investment manager and the general partner have in most instances complete control of fund strategy and governance.
• Art fund investors typically receive significant investor protections. Investors in an art fund are provided substantial information and disclosures as to the performance of the fund. Such disclosures come in the form of the fund’s provision of quarterly and annual financial statements. Depending upon the manner in which the fund receives its compensation, the financial statements will vary in the level of detail. For example, art funds that charge their management fee based on the current net asset value of the fund’s art portfolio will provide detailed information as to the manner in which such asset value was determined. In addition, investors are afforded the right to staff an advisory committee that the art fund charges with clearing any conflicts of interest between the art fund’s management and the fund.
• Art fund’s rarely drawdown an Investor’s capital commitment all at once. In order to achieve better rates of return, an art fund will seek to minimize the time in which it has received monies from its investors. As a result, art funds will usually drawdown on its investors’ capital commitments as it identifies potential art acquisitions (the timing and amounts of which are communicated to the investor two to four weeks in advance). Investor’s failing to make their capital contributions are subject to various penalties including late fees and forfeitures of all or part of their equity in the art fund. Accordingly, investors must therefore at all times have sufficient resources to meet their respective capital commitments during the fund’s pre-specified investment period.
• Most art funds are closed-ended funds with limited capital raising periods. As art funds are limited in their ability to liquidate the fund’s art investments to permit investor withdrawals, art funds are typically structured as close-ended funds that will seek to raise a certain minimum amount of capital commitments prior to launching the fund and will limit their total capital raising efforts to a fixed period of time (typically 9 to 15 months). Investors who commit capital at the end of such investment period compensate the early investors by contributing their portion of capital contributed as of the date of their investment plus interest. At the end of the pre-specified subscription period, the art fund is deemed closed and no additional investors are permitted to invest in the fund.
• Art funds often utilize multiple investment vehicles. In order for an art fund to accept monies from investors located in different countries without prejudicing such investors’ tax positions or adversely impacting their limited liability protections, art funds often find it necessary to create multiple investment vehicles – each with their own organizational structures and domiciles. U.S. based investment vehicles are referred to as “onshore funds” while foreign domiciled investment vehicles (usually registered in the Cayman Islands or the British Virgin Islands) are commonly known as “offshore funds”. The use of both an offshore fund and an onshore fund allows an art fund manager (often through the use of a master-feeder structure) to take in monies from both domestic and foreign sources, allocate art investments between the two funds and preserve the tax positions of the investors.