Understanding private equity and private markets means more than simply understanding the structure of a fund. It means understanding what happens at each point in a fund’s life, why, and what that means for investors and the fund’s managers.
This article begins with a reminder of the structure of a private equity fund and how it operates, followed by a detailed look at the life of a fund from formation to close.
Private equity fund structure
We covered the basic structure of a private equity fund in What is private equity?, but here is a quick refresher of the key parties before going through how they interact.
A private equity fund is a pool of capital used to invest in private companies that fit within a predetermined investment strategy.
The fund is managed by a private equity firm that serves as the ‘General Partner’ of the fund. By contributing capital, investors become ‘Limited Partners’ of the fund. As such, the fund is structured as a ‘Limited Partnership’.
Tax benefits. A Limited Partnership is - as the name suggests - treated as a partnership as opposed to a corporation. This means that the only tax responsibility is at the investor level. If it were a corporate entity (such as a ‘C corporation’ in the United States) then the fund would pay tax at both the corporate and the investor (dividend) level.
General Partner control. The primary expertise of a private equity firm lies in managing a fund, so the Limited Partners delegate all control to the General Partner. The only exception comes in the form of Limited Partner Advisory Committees ("LPACs") which the General Partner can call on for advice at their discretion.
Limited Liability. Since the Limited Partners are not involved in managing the fund, their liability for losses is limited. This means that the maximum loss they can suffer is the total value of their own committed capital (though this is extremely rare), while the General Partner takes on all liability. Private equity firms generally shield the individuals within the firm from this liability by structuring themselves as Limited Liability Companies (“LLCs”)
Tried-and-tested. The Limited Partnership structure has been in operation within the private equity industry for many decades now and has proven beneficial for all parties. It’s becoming increasingly popular to structure the funds themselves as an LLC (not just the General Partner) as they offer even greater flexibility, especially from a tax perspective.
As explained above, we have four key parties involved in the life of a fund:
The General Partner - a private equity firm
The Limited Partnership - the private equity fund
Limited Partners - investors in the private equity fund
Companies - the recipients of investment from the fund
The timeline of a private equity fund
The technical life of a fund is called the Fund Term. Unlike public equity funds - which usually operate on a rolling basis - the Fund Term is finite. The most common term is ten years, with optional extensions (usually two or three years).
A fund’s life is generally viewed in three components, as defined below:
Formation – The period prior to launch of a fund, during which the partnership is created, the strategy determined, offering documents are created, and initial target companies are identified.
Investment – The period during which the fund makes investments in target companies, issues capital calls to investors, and works with the target companies to maximise the potential return to investors.
Harvesting –The period during which the manager arranges exits from target companies and makes distributions of capital back to investors.
Note: This timeline is just for illustration. Each fund has a different schedule (particularly when it comes to the investment period and number of extensions), the details of which are laid out in the Offering Materials in formation period. Also, the investment and harvesting periods are not clearly defined: they overlap heavily. For example, an investment made early on may begin providing cash flows to the fund before later deals have even closed. Finally, the fund term can be extended beyond the term laid out in the formation materials.
Please note: For Moonfare investors, the process of becoming a Limited Partner is simplified and automated through the Moonfare platform. Click here to learn more about how private equity investing works with Moonfare.
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Important notice: This content is for informational purposes only. Moonfare does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorised advisor. Past performance is not a reliable guide to future returns. Don’t invest unless you’re prepared to lose all the money you invest. Private equity is a high-risk investment and you are unlikely to be protected if something goes wrong. Subject to eligibility. Please see https://www.moonfare.com/disclaimers.
A private equity fund is a pool of capital used to invest in private companies that fit within a predetermined investment strategy. The fund is managed by a private equity firm that serves as the 'General Partner' of the fund. By contributing capital, investors become 'Limited Partners' of the fund.
The typical split in profits between LPs and GP is 80 / 20. That means, the LP gets distributed 80% of the profits on an exit (after returning their initial capital) and the GP keeps 20% of the profits.
Private equity is ownership or interest in entities that aren't publicly listed or traded. A source of investment capital, private equity comes from firms that buy stakes in private companies or take control of public companies with plans to take them private and delist them from stock exchanges.
Private equity firms buy companies and overhaul them to earn a profit when the business is sold again. Capital for the acquisitions comes from outside investors in the private equity funds the firms establish and manage, usually supplemented by debt.
It suggests that the sum of a company's top line year over year growth rate (annual recurring revenue growth percentage) and its EBITDA margin should ideally be at least 40%. This rule helps buyers and investors evaluate whether a company is effectively balancing growth with profitability.
Do you know the Rule of 72? It's an easy way to calculate just how long it's going to take for your money to double. Just take the number 72 and divide it by the interest rate you hope to earn. That number gives you the approximate number of years it will take for your investment to double.
Private equity (PE) describes investments that represent an equity interest in a privately held company. Any business that is not a public company is part of the substantial private company universe, which includes millions of US businesses compared with the few thousand that are public companies.
A private equity fund is a pool of capital used to invest in private companies that fit within a predetermined investment strategy. The fund is managed by a private equity firm that serves as the 'General Partner' of the fund. By contributing capital, investors become 'Limited Partners' of the fund.
Skeptics contend that some private equity firms prioritize short-term gains over long-term value creation, leading to cost-cutting measures, layoffs, and divestitures that may erode the long-term viability of portfolio companies and harm employees and communities.
Private equity firms make money through carried interest, management fees, and dividend recaps. Carried interest: This is the profit paid to a fund's general partners (GP).
There are several standard metrics used to measure returns in private equity, including the internal rate of return (IRR), the multiple (also known as Multiple on Invested Capital [MOIC] or Total Value to Paid In [TVPI]), and the Distributed Capital to Paid-in Capital ratio (DPI).
Private equity professionals work long hours and are highly competitive and must think critically, and have a passion for financial investing deals, not just following the markets. Other requirements to start a career in private equity are: Excellent grades and a notable transcript in school.
What Is Private Equity (PE) And How Does It Work? Definition of Private Equity: Private equity firms raise capital from outside investors, called Limited Partners (LP), and then use this capital to buy companies, operate and improve them, and then sell them to realize a return on their investment.
Private equity strategies generally involve investing in companies that are not publicly traded on stock exchanges. Private equity fund managers (also known as general partners or GPs) often seek to generate returns by enhancing the performance of their portfolio companies over the course of their holding period.
Ownership stake – Growth equity investments tend to be minority, non-controlling stakes (e.g. less than 50% ownership), whereas LBO buyout transactions of private equity firms involves a majority controlling stake.
The Pareto principle states that for many outcomes, roughly 80% of consequences come from 20% of causes. In other words, a small percentage of causes have an outsized effect.
This is also known as the “2 and 20” fee structure and it's a common fee arrangement in private equity funds. It means that the GP's management fee is 2% of the investment and the incentive fee is 20% of the profits. Both components of the GPs fees are clearly detailed in the partnership's investment agreement.
The 80/20 rule, also known as the Pareto principle, suggests that a small number of causes (20%) often lead to a large number of effects (80%). In the context of fundraising, this principle suggests that a small number of donors (20%) may contribute the majority of funds (80%).
For example, 80% of wealth is owned by 20% of the population. The same is true of investment costs: if 20% of assets are invested in private markets (private equity, private debt, infrastructure, real estate etc) they may well account for 80% of total costs.
Introduction: My name is Rueben Jacobs, I am a cooperative, beautiful, kind, comfortable, glamorous, open, magnificent person who loves writing and wants to share my knowledge and understanding with you.
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