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Private Equity fund structure

Private equity fund structure

How are Private Equity funds structured?

A private equity fund structure has multiple players. The general partner is the investment team, which raises funds from investors, manages the fund and picks the investments. The limited partners are the investors who commit capital to the PE fund.

Then, you have the private equity fund itself. This is where the money of the general partner and the limited partners are pooled. This is the fund that acquires and owns the portfolio companies.

The management company employs the fund managers, the general partner and the investment team. Management companies are separate legal entities from the fund due to operational efficiency and legal liability.

These corporate structures are usually organized in individual limited liability companies.

What is Private Equity?

Private equity funds raise funds from multiple investors and use them to invest in private companies.

The capital infusion supports growth, acquisitions or operational improvements. The goal is to grow and improve the company and sell it for a profit after the holding period.

The typical investment period in private equity is about five years. Investors only realize their profits once they exit their target company through a sale or initial public offerings.

This investment strategy is riskier due to the lack of liquidity and regulations. However, the returns are also higher because you are directly investing in a company.

Overview of typical Private Equity fund structures

Private equity fund structure

General Partner

The General Partner is usually an investment firm or a group of individuals who manage the fund. They make investment decisions and oversee the day-to-day operations. The General Partner also contributes their capital to the fund, aligning their interests with those of the limited partners.

Limited Partners

Limited Partners are the investors who provide capital to the fund. They are not involved in the private equity fund's daily operations or investment process. Limited partners are passive investors and rely on the expertise of the GP to make investment decisions.

They have limited liability, meaning they cannot lose more than their initial investment. Investors in private equity funds can be mutual funds, insurance companies, pension funds, family offices and high-net-worth individuals.

The Private Equity fund itself

This is the actual private equity fund itself with the private equity capital. This is where capital commitments from the General Partner and limited partners are pooled.

The fund structure allows for operational flexibility. The General Partner manages the fund and makes investment decisions. The limited partners are passive investors. This is also the entity from which equity investments are deployed to acquire target companies.

Profits generated from the sale of portfolio companies are distributed among the limited partners. The General Partner also receives a share of the profits, often in the form of carried interest, which is a percentage of the fund's profits.

Private equity funds are usually established as a Limited Liability Company or a Limited Partnership.

Management company

The management company employs the fund managers, the general partner and the investment team. Here are all the people who handle the investments for limited partners (investors).

The management company is responsible for raising capital, sourcing investment opportunities, driving the investment process and monitoring the investments. This is the entity to which the management fee gets paid.

Management companies usually exist as legal entities separate from the fund itself. This structure enables the investment team to work efficiently across multiple funds simultaneously. This is useful when a private equity firm has various funds. The separation also protects investors in case of legal issues.

Portfolio companies

These are the target companies where private equity firms invest their funds. The private equity firm acquires stakes in these companies. The aim is to increase their performance and to sell the stakes for a profit at the end of the investment period. Profits generated for the private equity fund and the financial sponsor by making a profitable transaction.

A private equity fund's portfolio is diverse and depends on its investment process. A traditional private equity fund invests in mature and cash-flow-stable companies. On the other hand, venture capital funds invest in riskier early-stage companies.

What fees do Private Equity funds charge?

What fees do private equity funds charge? Management fees and performance fees

Management fees

Management fees are usually levied annually. Private equity companies charge around 2% of the capital invested as administrative fees. These fees cover a fund's day-to-day operating costs. Examples include salaries of personnel that monitor existing investments and rent costs. Management fees are paid in regular intervals, typically quarterly or semi-annually.

Performance fees or carried interest

Performance fees are typically paid out to the general partners of a fund after a successful sale of a private equity investment. It is a bonus representing the general partner's share of profits from a private equity fund. Performance fees align the general partner's earnings with the fund's returns. The typical carried interest is around 20% of an investment's profits.

However, receiving carried interest isn't guaranteed. It's only earned if the fund's profits surpass a minimum return, called the "hurdle rate." If the hurdle rate isn't met, the fund manager receives no carried interest.

Private Equity fund lifecycle

Private Equity fund lifecycle

Stage 1: Fundraising (1-2 years)

This is the beginning. The General Partners will be raising capital for the fund. They pitch institutional investors to commit capital to the PE fund by showing how their investment process will find promising portfolio companies. Investors in private equity funds can be mutual funds, insurance companies, pension funds, family offices and high-net-worth individuals. We will have a new fund once enough funds are raised and the limited partnership agreement is finalized.

Stage 2: Deal sourcing and execution (2-5 years)

The private equity company will screen the market for promising investment opportunities during this stage. Once a promising opportunity is found, they will execute the acquisition process until completion and add the portfolio company to the fund.

Stage 3: Holding period (3-7+ years)

This is usually the longest stage of the lifecycle. Here, a private equity company manages its existing investments. They work with its portfolio companies to maximize returns. Usually, PE funds try to increase EBITDA by increasing operational efficiencies, entering new markets or developing new products.

Stage 4: Exiting

The final stage is exiting. This is when a private equity firm aims to sell its portfolio companies to realize a return on its investment. The exit usually occurs when a portfolio company has grown significantly and can meet the fund's desired rate of return. Another reason is when the private equity fund reaches its maturity date, typically after 10 to 15 years, and it's time to liquidate the fund. This is done to return the capital and profits to the investors.

Types of Private Equity funds

Types of Private Equity Funds

Leveraged buyouts (LBOs)

Leveraged buyouts funds are common when talking about private equity industry. It is an investment strategy where a target company is acquired using a significant amount of debt. The cash flows of the acquired company are then used to pay the debt.

The aim is to acquire with little capital investment to increase returns. The ultimate goal is to improve the operations and profitability of the acquired company to either sell it later at a higher price or to pay down the debt.

This investment strategy only works with mature private companies with predictable cash flows. Publicly traded companies are rarely involved in such transactions. The private equity fund will always acquire the majority in an LBO and work closely with the management team.

Growth capital

Growth capital focuses on purchasing minority stakes in fast-growing companies. These companies are too mature for venture capital but not stable enough for a leveraged buyout. Growth equity does not use leverage and sits between LBOs and venture capital.

The aim is to accelerate the company's growth and help scale its operations, enter new markets or launch new products. Unlike LBOs, growth capital can also invest in a minority role and does not use leverage for financing.

The current owners will remain in control, but the fund manager will sit on the advisory board with veto rights.

Venture Capital

In Venture Capital, investors provide capital to startups with exponential growth potential. This investment strategy mainly focuses on the tech and software sectors. Part of the investment strategy is betting their companies can scale and grow exponentially.

Venture capital investments are riskier than LBOs or growth equity deals. Startups have a high failure rate. However, the few successful ventures often yield exponential returns, compensating for the losses.

Like growth equity, venture capital funds do not use leverage or acquire minority shares. The current owners will remain in control, but the fund manager will sit on the advisory board with veto rights.

Real estate

Some private equity firms exclusively focus on real estate investments. The investments can be direct, as in purchasing properties, or indirect, like investing in real estate operating companies or Real Estate Investment Trusts (REITs).

The objective is to generate returns through rental income, capital appreciation from selling properties or operational improvements.

A real estate private equity fund usually acquires majority stakes in properties. Debt is often a significant component in real estate private equity transactions. High leverage is possible because rental income is very stable. Since real estate is a lower-risk asset class, leverage is one of the critical drivers of the return.

Why do companies want to work with a Private Equity fund?

Funding the next growth phase

Private equity firms can provide capital for expansion, acquisition, or operational improvements. This can be particularly beneficial for growing businesses that may need more resources. Shareholders seeking to exit their business entirely is another common reason to sell to private equity.

In addition to providing capital, PE firms often bring significant industry knowledge and operational expertise, which can help improve efficiency and profitability. A private equity firm will work closely with the existing management team to cut costs and grow revenue. The goal is to get a higher return when it sells the business after the investment period.

Becoming part of a buy-and-build strategy

The buy-and-build strategy starts with a nucleus acquisition. Smaller acquisitions of similar businesses then follow suit, broadening the geographical base. This strategy has been growing in popularity. The revenues of the combined company grow due to acquisitions. On the cost side, overhead functions are consolidated into combined entities to increase operation efficiency. Buy-and-build strategies work well with location-based businesses.


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