The blocker that blocks the exit.

A blocker is a company placed between a fund and an asset so that something about the asset stops at the blocker and does not reach the fund or its holders. The something is usually one of three things. A tax characteristic: income that would be taxable in the hands of the fund's holders if received directly, or that would make the fund's holders taxable in the asset's state, but that arrives as a dividend from a company and is treated differently. A regulatory status: an asset whose direct holders would themselves become regulated, reportable or subject to a consent, which a company between them and the asset absorbs. An unlimited liability: a partnership interest or a position that exposes its holders to the venture's debts, which a company with limited liability cuts off. The blocker is designed for the holding period, against the characteristic it blocks, and for the holding period it works. Then the fund wants to sell, and the blocker is between the fund and every route out, a company nobody designed for the day it matters most.

This note sets out the three characteristics and how each is blocked, what the blocker does at each of the four exit routes, the parallel vehicle's compounding of it, what a blocker designed for the three routes looks like, the cost that was not counted, the blocker's own substance, the tax opinion's scope, a comparison of blocked and unblocked exits, a worked blocker as a type, cases, what each party holds, the sequence, questions, terms and what to read.

The three characteristics

A tax characteristic is blocked by interposing a company whose receipt of the asset's income converts it into dividends from the company, in a jurisdiction whose treatment of the company's own income and of its distributions produces the result the adviser intends: no look-through to the holders, no filing obligation on them in the asset's state, no tax character that travels. The adviser names the characteristic, the jurisdiction and the treatment, and the opinion is conditional on the blocker's substance and on the rules of the asset's state and the blocker's jurisdiction as they stand.

A regulatory status is blocked by interposing a company that becomes the regulated, reportable or consenting person in place of the fund's holders: a company that holds a licensed business so that the fund's holders are not themselves subject to the licence's ownership rules, or that holds a stake above a notification threshold so that the notification is the company's. The blocker's effect depends on whether the regulator looks through it, which is a question the regulator's own rules answer and counsel in the state reads.

An unlimited liability is blocked by a limited company holding the interest, so that the venture's creditors reach the company's assets and not the fund's. The block depends on the company's jurisdiction recognising the limitation and on the fund not having guaranteed the company's obligations, which a fund asked for a guarantee has to remember.

What the blocker does at each exit

A sale of the asset is a sale by the blocker, and the proceeds sit in the blocker until they are distributed, under the blocker's own law and its own tax position, which may tax the gain in the blocker's jurisdiction, or withhold on the distribution up, or both. A blocker chosen for its treatment of income may have a different treatment of gains.

A sale of the blocker is a sale of a company the buyer did not ask for, in a jurisdiction the buyer may not know, with a history the buyer must diligence and with the blocker's own tax attributes travelling with it. A trade buyer wants the asset; a financial buyer may take the company; both price the company's jurisdiction, its history and its attributes.

A distribution in kind passes the asset up through the blocker to the holders, which is the very transaction the blocker was formed to prevent, and which produces in the holders' hands exactly the characteristic the structure paid to block. A blocker cannot be distributed through; it can only be distributed, which is a sale of the blocker's shares to the holders in proportion, with every holder now holding shares in a company in a jurisdiction its own regime may not welcome.

An admission to trading of the structure above requires a chain the exchange can read, and a blocker with an opaque history or an unusual jurisdiction is a chain the listing authority questions.

The parallel vehicle compounds it

A fund with parallel vehicles either shares one blocker, which needs a shareholders' agreement between the parallels and makes one parallel's exit dependent on the other's consent, or has one blocker per parallel, which doubles the chain and the cost and makes a sale of the whole a sale of two companies to one buyer. A shared blocker without a drag between the parallels is a blocker that cannot sell half an asset when one parallel wants out; separate blockers without a co-ordination agreement on exit are two sellers with one buyer's patience.

Designing for the three routes

A blocker designed at formation for the three routes looks different from one designed for the holding period alone, in four respects.

Its jurisdiction is chosen so that a buyer from the likely market will accept it as the thing purchased: a jurisdiction the buyer's counsel knows, with a companies registry that records transfers quickly, with a tax treatment of a share sale the buyer can read, and with a reputation that does not itself become a diligence item. A blocker in a jurisdiction chosen only for the characteristic it blocks is a blocker the buyer discounts.

Its constitution permits a distribution of proceeds on the day of sale, without a retained balance the local regime taxes, with a mechanism for the holders to receive the proceeds in the form and the currency they need, and with a liquidation route that takes weeks rather than years.

Its own tax position on a sale of the asset, on a sale of its own shares, and on a distribution up is read by the tax adviser at formation, in the adviser's own name, route by route, rather than discovered at exit. The adviser's opinion names the rate, the withholding and the treaty position of the holders above for each route, and the structure paper carries the numbers.

And its function is tested against the exit test's four routes: which routes the blocker permits cleanly, which it taxes, which it prevents. A blocker that prevents the route the policy contemplates is redesigned or removed before it is formed.

The cost that was not counted

The blocker's running cost is counted: a board, an audit, an office, a substance requirement, a bank account. Its exit cost is rarely counted, and it is the larger number. A buyer's discount for a company it must take and diligence. A tax on a gain in the blocker's jurisdiction that a direct sale by the fund would not have borne. A withholding on the distribution up that the blocker's jurisdiction imposes on payments to the fund's jurisdiction. A delay while the blocker's jurisdiction processes a transfer or a liquidation. And the opportunity cost of a route closed: a distribution in kind the policy contemplated and the blocker prevents. A structure paper carries the blocker's function, its cost to hold and its cost to exit, and the three are compared against the characteristic it blocks before the blocker exists. A characteristic whose cost, unblocked, is smaller than the blocker's cost to hold and exit is a characteristic the fund bears, and the comparison is made on the adviser's numbers rather than on the adviser's habit.

Why blockers are formed for the hold alone

Blockers are formed when the asset is bought, by the adviser who identified the characteristic, for the problem in front of everybody, which is the holding period's tax or regulatory position. The exit is years away and the adviser was not asked about it. The manager is closing an acquisition and the blocker is a line on the closing checklist. Nobody is paid to read the blocker for year six, and so nobody does, and the blocker is designed for the four years it is asked about and not the six it will live. The cure is the exit test, run at formation through every layer including the blocker, with the adviser's opinion commissioned for the routes as well as the hold, and it costs a week and a wider scope in the engagement letter.

The blocker's jurisdiction, read for the buyer

A buyer's counsel reads the blocker's jurisdiction for five things before the buyer takes the company. Whether the jurisdiction's companies registry records a transfer quickly and cleanly. Whether the jurisdiction's tax rules treat the buyer's acquisition of the shares and the buyer's later distributions the way the buyer's own adviser expects. Whether the jurisdiction's reputation is itself a question the buyer's own regulator or investors will ask. Whether the jurisdiction's substance rules will, in the buyer's hands, require the buyer to staff the company. And whether the blocker's history in that jurisdiction, its filings, its minutes, its prior dealings, can be diligenced from records that exist. A blocker in a jurisdiction that passes all five is a company the buyer takes at no discount; one that fails two is a company the buyer prices or refuses.

The distribution-in-kind problem, read closely

The distribution in kind is the route the blocker most often closes, and it is closed in two ways. Distributing the asset up through the blocker defeats the block: the asset arrives in the holders' hands with the characteristic attached, which is the outcome the structure paid to avoid. Distributing the blocker's own shares to the holders avoids that and creates a new problem: every holder now holds shares in a company in the blocker's jurisdiction, with that jurisdiction's filings, substance rules and tax treatment in each holder's own hands, and a sovereign or a pension institution may not be permitted by its own rules to hold such a company directly. A policy that contemplates a distribution in kind and a chain with a blocker are in tension from the first day, and the tension is resolved at formation by naming the route: a sale, with the proceeds distributed, and no in-kind distribution beneath the blocker.

Where it surfaces

At the exit test, if it is run; at the exit itself, if it is not.

At the buyer's refusal to take the company, when the asset sale the buyer insists on bears a tax the blocker's jurisdiction imposes on gains.

At the parallels' disagreement about timing, when the shared blocker cannot sell half.

At the distribution in kind the policy promised and the blocker prevents.

At the liquidation, when the blocker's jurisdiction takes a year to wind it up and the fund's term has ended.

The cost of getting it wrong

A blocker designed for the hold alone costs, at exit, the discount, the tax, the withholding and the delay, and at worst the route the policy promised. Over the holding it cost its running cost, which it would have cost anyway. The comparison against the characteristic borne unblocked is made at formation on numbers, and a blocker that loses the comparison is not formed. A blocker that wins is designed for the routes, at the cost of a wider opinion and a better jurisdiction, which is a fraction of the exit cost it avoids.

The blocker's substance

A blocker is a layer, and it passes the same substance test as every layer: resident directors, meetings, decisions, records, a bank account, a provider, a budget. A blocker whose function is a tax characteristic is the layer most exposed to a look-through, because the characteristic it blocks is the one the asset state's authority is most interested in seeing through, and a blocker with no substance is a blocker that blocks nothing when examined. The substance is a budget line for the life of the holding.

The tax opinion's scope

The adviser's opinion on a blocker is read for what it covers. An opinion on the treatment of income during the holding period does not cover the treatment of a gain on sale, of a distribution up, of a liquidation or of a distribution in kind, and a manager that relied on the holding-period opinion at exit relied on an opinion that did not address the exit. The opinion is commissioned for the four routes at formation, and its conditions, substance, purpose, the rules as they stand, are carried as facts the structure must produce.

By route · by blocker	Unblocked	Blocked, designed for the hold only	Blocked, designed for the routes
Sale of the asset	By the fund's holding company; proceeds up on the chain's terms	By the blocker; gain taxed in the blocker's jurisdiction; withholding on the way up	By the blocker; treatment read and priced; distribution on the day of sale
Sale of the vehicle	The holding company, which the buyer knows	The blocker, which the buyer discounts	The blocker, in a jurisdiction the buyer accepts
Distribution in kind	The asset to the holders, with the characteristic	Through the blocker, which defeats the block; or the blocker's shares to the holders	The blocker's shares, or a sale; the route the policy named
Admission to trading	A chain the exchange can read	A chain with a company the listing authority questions	A chain designed to be read
Cost	The characteristic, borne	Running cost; exit cost unknown	Running cost; exit cost priced

A timeline, as a type

Month one: the asset is identified; the adviser names a characteristic; the manager asks for the four routes. Month two: the comparison of the blocker's cost to hold and exit against the characteristic borne; the blocker wins on the numbers for the sale routes and loses on the in-kind route, which the policy then excludes. Month three: the jurisdiction chosen for the buyer; the opinion commissioned for sale, distribution and liquidation; the constitution drafted to distribute on the day of sale; the parallels' agreement drafted with a drag. Month four: the blocker formed with resident directors, a provider and a budget; the acquisition. Year three: the asset state changes a rule; the adviser's watching brief catches it; the blocker's function is re-tested and stands. Year six: the sale by the blocker; the proceeds distributed in the week; the blocker liquidated in the quarter; the holders receive what the opinion said.

The structure paper's page

The structure paper's blocker page carries: the characteristic named; the comparison of costs; the jurisdiction and the five readings for the buyer; the opinion's scope and conditions for each route; the constitution's distribution and liquidation provisions; the substance budget; the parallels' arrangement; and the exit test's four routes with the blocker's effect on each. The page is the answer to the buyer's counsel in year six and to the committee in year nine, and it is the reason the blocker is a design rather than a line on a closing checklist.

Regulatory blockers, read closely

A blocker formed for a regulatory status is read against the regulator's own look-through rules, which differ from a tax authority's. A regulator that licenses a business reads the ownership of the licensee up the chain to the persons who control it, and a blocker that interposes a company between the fund and the licensee may or may not stop the regulator's reading, depending on the regulator's thresholds and its rules on indirect control. A blocker that the regulator looks through has not blocked the status; it has added a company. Counsel in the state reads the regulator's rules before the blocker is relied on, and the exit test reads them again for the buyer, who will be read the same way.

The liability blocker and the guarantee

A blocker formed to cut off an unlimited liability works only while the fund has not undertaken the liability itself. A lender to the venture, a landlord, a counterparty or a regulator that asks the fund for a guarantee, a letter of comfort or an undertaking to fund has asked the fund to step around the blocker, and a fund that gives it has given away the block. The constitution's limits on guarantees, the fund's power to give them and the committee's approval of any support are the blocker's protection from above, and a manager asked for support reads the blocker's function before it answers.

Reading the blocker with the register

The register's counsel reads the blocker for what it does to the holders' own positions: whether the characteristic it blocks would otherwise have reached them, whether the blocker's jurisdiction is one their own rules permit money to pass through, and whether a distribution of the blocker's shares at the end is something they could hold. A sovereign's or a pension institution's rules may exclude particular jurisdictions, and a blocker in one of them is a holder lost before the first approach. The blocker's page is shown to the register's counsel, and a blocker that fails a holder's rule is re-sited or the holder is not approached.

A blocker, as a type

A fund in a centre takes a position in an operating company in a state whose tax rules would treat the fund's holders as taxable there on a direct holding. The adviser names the characteristic and proposes a blocker in a jurisdiction with a treaty with the asset state and a domestic regime that does not tax the blocker's gains or withhold on its distributions to the centre. The structure paper asks the four routes. A sale of the asset by the blocker: the gain is exempt in the blocker's jurisdiction and the treaty removes the asset state's tax, on the adviser's opinion, with substance. A sale of the blocker: the jurisdiction is one a financial buyer knows, and the opinion covers the buyer's position. A distribution in kind: prevented, because it defeats the block; the policy names a sale instead. An admission: not contemplated. The blocker is formed with resident directors, a provider, a budget and a constitution that distributes on the day of sale. At exit in year six the asset is sold by the blocker, the proceeds are distributed up within the week, and the holders receive what the opinion said they would.

Four cases, as types

A fund blocks a trading characteristic through a company in a jurisdiction chosen for that purpose alone. At exit the trade buyer refuses to take the company and insists on an asset sale; the blocker's jurisdiction taxes the gain on the asset sale; the distribution up is withheld; the net to the holders is less than an unblocked structure would have produced over the whole life, and the characteristic, on the numbers, was cheaper to bear.

A fund with two parallels shares one blocker. Parallel one wants to sell in year six; parallel two wants to hold. The shareholders' agreement between them has no drag and no right of first offer, and the blocker cannot sell half an asset. Parallel one's holders wait two years for parallel two to agree, and the price in year eight is lower.

A fund's constitution contemplates a distribution in kind at the end of the term. Its asset sits beneath a blocker formed to keep a regulatory status away from the holders. The distribution in kind would put the asset in the holders' hands with the status attached, which is what the blocker prevented; the distribution is not available; the policy promised a route the chain cannot take, and the committee learns it in year nine.

A fund designs its blocker for the four routes: a jurisdiction the likely buyers know, a constitution that distributes on the day of sale, a tax opinion covering sale, distribution and liquidation, a drag between the parallels, and a policy that names the routes the blocker permits. At exit the buyer takes the company at a price that reflects no discount for it, and the proceeds reach the holders in the week.

What each party holds

The manager holds the decision to block, the reading of the four routes, the blocker's jurisdiction chosen for the exit, and the comparison of the blocker's cost against the characteristic's.

The tax adviser holds the opinion, commissioned for the four routes, in its own name, with its conditions.

Counsel in the asset's state holds the regulator's look-through position where the characteristic is regulatory.

The blocker's directors hold its substance.

The parallels hold the co-ordination agreement and the drag.

The buyer at exit holds its view of the blocker's jurisdiction and history, which it prices.

The sequence

1. The characteristic the blocker would block is named, and the adviser confirms that a blocker is the only way to block it.
2. The blocker's cost to hold and to exit is compared against the characteristic borne, and the blocker is formed only where it wins.
3. The blocker's jurisdiction is chosen for the exit as well as the hold.
4. The tax opinion is commissioned for the four routes at formation, and its conditions carried as facts.
5. The blocker's constitution is drafted to distribute on the day of sale and to liquidate in weeks.
6. The parallels' arrangements on the blocker are drafted with a drag and a first offer.
7. The exit test's four routes are run through the blocker, and the policy names the routes it permits.

Questions a manager asks

Is a blocker always needed for a foreign asset. No. It is needed where a named characteristic, unblocked, would cost more than the blocker's cost to hold and exit, and the comparison is made on numbers.

Can the blocker be removed later. By a collapse, which is a transfer of the asset or the holding company up the chain with the registry's recording, the lender's consent, the adviser's reading of the transfer and the blocker's liquidation; cheaper than running it, dearer than not forming it.

What does the buyer think of a blocker. A financial buyer in a familiar jurisdiction takes it; a trade buyer wants the asset; both diligence its history and price what they find.

Does the blocker need substance. More than most layers, because the characteristic it blocks is the one the asset state's authority most wants to see through.

What if the asset state's rules change. The adviser's watching brief catches it; the blocker's function is re-tested; a blocker that no longer blocks anything is collapsed before the exit.

Can the parallels share a blocker. With a shareholders' agreement that carries a drag, a right of first offer and an exit co-ordination, yes; without, each parallel's exit waits on the other's consent.

Terms used

Blocker: a company interposed between a fund and an asset so that a characteristic of the asset stops at the company.

Characteristic: the tax attribute, regulatory status or liability the blocker is formed to block.

Look-through: an authority's treatment of the blocker as transparent, for want of substance or purpose.

Exit cost: the tax, withholding, discount and delay a blocker adds at each route out.

Collapse: the removal of a blocker by transferring its asset up the chain and liquidating it.

Drag: a parallel's right to require the other to join a sale of the shared blocker's asset.

What to read

The tax adviser's opinion on the blocker's jurisdiction, its treatment of income, gains, distributions and liquidation, and the holders' position above, for each route; the blocker's constitution; the parallels' co-ordination agreement and shareholders' agreement; the asset state's look-through rules. On this site, the holding chains, parallel vehicles and exit design rooms under Structures.