Looking to get a deeper understanding of private equity fund structure? As a private company intelligence platform that works with many of today's leading firms, SourceScrub knows the ins and outs of private equity (PE). Continue reading to learn more about PE partners, fund lifecycles, exit strategies, and much more.
PE Fund Structure Basics
What Is Private Equity?
Private equity is a type of investment where private funds are provided by institutions and wealthy individuals. These funds are then used to invest directly in private companies or to buy out and delist public companies from public stock exchanges. It's a longer-term, closed-end investment play, which means that there is a finite window of time in which funds can be raised. Private equity funding can take many forms, some of the more popular of which are venture capital, real estate, funds-of-funds, and distressed funding.
What Is Fund Size?
Fund size refers to the amount of money in a particular fund. The more money that's in the fund, the larger the size. Fund size is determined by multiple factors including the number of investors, estimated deal size, average number of expected deals, and more. While bigger funds attract more attention and generate higher management fees, there is also greater risk involved, and some research shows that smaller funds actually generate higher IRR.
What Is the Goal of PE for Investors?
Private equity’s primary goal is to manage pools of capital and invest them in companies that generate a high rate of return. This is often done by injecting capital into growing or underperforming businesses to increase their operational efficiencies and subsequent earnings and profitability. Investors make money when a company either goes public and garners an increased value per share, or is sold at a profit to another firm or buyer.
Private equity is a longer-term investment, which frees founders and operators from the stress of quarterly performance reviews.
Interest rates are typically lower and spread out over longer time periods compared to other investment forms.
Private capital allows businesses to experiment without being under the microscope of public markets.
PE firms often bring proprietary insights and market resources to the table that portfolio companies can leverage.
Funds can be used to fund acquisitions, explore new markets, accelerate operations, increase headcount, etc.
Key Roles Within Private Equity Fund Structures
PE funds involve 4 key entities, each with their own responsibilities, rewards, and risks.
The Management Company
The management company, or private equity firm, is essentially an operating entity that employs General Partners and their investment teams.
General Partners
General Partners (GPs), or fund managers, are employed by and represent the private equity firm or management company. They are responsible for defining fund size, securing capital commitments from Limited Partners, and choosing which portfolio companies to invest in. On one hand they assume all liability for the fund, but on the other they can earn hefty performance fees if the fund is successful.
Limited Partners (LPs), or simply Investors, are institutions and wealthy individuals responsible for providing the capital for the private equity fund. LPs have limited liability for the fund, but they also don't have any say in the exact companies that the fund invests in. They make money by collecting performance fees for successful funds.
The Private Equity Fund
Most private equity funds are established as a Limited Liability Company (LLC) or a Limited Partnership (LP). This has two key benefits for Limited Partners:
They can only be held liable up to the amount that they personally invest in the fund.
Both LLCs and LPs are considered pass-through tax entities.
The following video provides a comprehensive overview of a private equity fund's structure and roles:
Limited Partnership Agreements
Limited Partnership Agreements (LPAs) are the investment terms that are agreed upon between General Partners or Private Equity Firms and Limited Partners. LPAs cover a number of stipulations, including:
Roles and associated risks and liabilities for each party
The duration, term, or lifecycle of the fund
Fund fees and payout structure
Portfolio company restrictions (e.g. company size, industry, location, etc.)
Limits for how much of the fund can be allotted to any one investment
Diversification requirements
Fund term extension guidelines
Fees and How PE Firms Make Money
PE funds make money primarily through two types of fees: management and performance.
Management Fees
These are the annual fees collected by the management company or PE firm to cover the expenses associated with managing the fund. These include marketing, technology platforms, firm salaries, etc. Management fees are usually 2%of assets under management (AUM), and are charged regardless of whether the fund generates a positive return.
Performance Fees
This fee is collected only when a fund turns a profit. Sometimes referred to as "carried interest," performance fees are paid out to General Partners after Limited Partners have received their cuts. Performance fees are usually 20% of gross profits.
Private equity fund lifecycles are categorized differently across firms, and durations vary. However, many experts agree that the typical term can be broken down into 4 phases, and lasts between 10 - 15 years:
Phase 1: Fundraising
Average Duration: 1-2 years
During this first phase, the General Partners must find investors to raise capital for the fund. They also assemble the PE firm team that will assist in sourcing and managing portfolio companies, as well as draft the limited partnership agreement. Once sufficient funds have been raised, the fund will hold its initial closing.
Phase 2:Sourcing and Transacting
Average Duration: 2-5 years
This is the time when the General Partners work with their investment teams to find and close promising investment opportunities. These companies must align with the partners' investment thesis and the portfolio company restrictions set forth in the LPA.
While many of these opportunities arise through partner networking and relationships, more PE firms are investing in direct deal sourcing. However, manually finding and researching promising companies is time-consuming and tedious, so many PE firms are accelerating this process by using deal sourcing platforms.
Phase 3:Managing Portfolio Companies
Average Duration: 3-7+ years
Phase 3 is usually the longest of the 4 lifecycle stages. It represents the time when General Partners and their firms work with each of the companies they chose to invest in to maximize their returns. This is done by providing resources, expertise, and support to help these businesses improve operational efficiencies, hire top talent, enter into new markets, sunset or develop products, and achieve other key strategic milestones.
Phase 4:Exiting
Average Duration: Varies
Once it's possible for a portfolio company to meet the fund's desired rate of return, it's time to exit. While it's important for GPs to wait for the right buyer and/or market conditions prior to exiting, it's also worth noting that the longer an investment stays in a portfolio, the harder it is to hit the target internal rate of return (IRR).
Follow-on Investments
Sometimes a portfolio company may require more capital in addition to a fund's initial investment. In these cases, a "follow-on" investment is made, usually during phase 3 of the fund lifecycle.
Term Extensions
Once a fund's agreed upon lifespan has been met, some LPAs allow General Partners to extend the fund's term. This is often allowed twice, for a period of one year each time. During term extensions, General Partners work hard to improve remaining portfolio companies' rates of return and secure successful and lucrative exits.
Initial Public Offerings (IPOs): When private company shares are offered to buyers on the public stock exchange.
Strategic Acquisitions: When another company takes ownership of a portfolio investment.
Secondary Sales: When one PEfirm sells its stake in a business to another firm.
Repurchase by Promotors: When company executives buy back the portion of the company owned by the firm.
Other Common PEFund Structure Questions
Who Can Invest in Private Equity Funds?
According to Forbes, just 2% of the USpopulation is eligible to personally invest in PE funds. Investing in a PE fund requires a minimum of $1,000,000 in personal assets (minus your primary residence), or $200,000 in annual income. PE funds with more than 100 investors require $5 million in investments. This is why private equity funds are composed largely of institutional investors like family offices and endowments.
What's the Difference Between Private Equity and Venture Capital?
"Private equity" and "venture capital" are often used interchangeably. However, venture capital (VC) is a common type of private equity focused specifically on raising funds for newer, smaller companies, or start-ups, that are usually later acquired by another company or taken public. "Buyouts" are another common type of PE focused on investing in more mature public or private companies and then selling them at a profit. Other forms of PE exist as well.
What Is Fund of Funds in Private Equity?
"Funds-of-funds" is a specific type of private equity investment. It refers to private equity funds that invest in PE funds, which in turn invest in portfolio companies. Funds-of-funds have many benefits, including diversification, but also present their own challenges, risks, and considerations.
Learn More About Private Equity
Private equity is a complex and ever-evolving space. Many of the traditional tools and tactics are no longer as effective as they used to be. Modern dealmakers that are ready to embrace data and technology as part of their fund structure strategy and lifecycle are rising to the top.
SourceScrub works with many of these leading new school firms, including Silversmith Capital Partners, TAAssociates, and LFM Capital. To learn more about how these modern dealmakers approach PE fund structure, deal sourcing, building teams, and more, download this free 5-step playbook to taking control of your deal flow.
A stand-alone fund structure comprises three entities: 1) the fund (the entity holding the securities through which the investors participate), 2) the general partner of the fund (the company responsible for the day-to-day operations of the fund) and 3) the investment manager of the fund (the company responsible for ...
A FOF may be structured as a mutual fund, a hedge fund, a private equity fund, or an investment trust. The FOF may be fettered, meaning it only invests in portfolios managed by one investment company.
Step 1: Determine the sector weights for both the fund and the index. Step 2: Calculate the contribution of each sector for the fund by multiplying the sector weight by the sector return. Repeat for the index. Step 3: Calculate the rate of return for the fund by adding the contribution of each sector together.
Investors generally should consider Class A shares (the initial sales charge alternative) if they expect to hold the investment over the long term. Class C shares (the level sales charge alternative) should generally be considered for shorter-term holding periods.
An investment structure refers to the way your investments are legally owned. Many people simply purchase assets in their own name or joint names, when other ownership structures may be more suitable.
The structure of Mutual Funds in India is a three-tier one. There are three distinct entities involved in the process – the sponsor (who creates a Mutual Fund), trustees and the asset management company (which oversees the fund management).
Fund of funds is basically a different type of mutual fund that invests in other mutual funds instead of directly investing in stocks, securities, commodities and bonds. Investing in a fund of funds is never a bad idea.
Mutual fund analysis typically consists of an elementary analysis of the fund's strategy (growth or value), median market cap, rolling returns, standard deviation, and perhaps a breakdown of its portfolio by sector, region, and so on.
Fund flow analysis is the analysis of flow of fund from current asset to fixed asset or current asset to long term liabilities or vice-versa. Fund refers to working capital. Funds flow statement is an assertion of sources and uses of funds. It describes changes in net working capital between two balance sheet dates.
To evaluate the performance of a fund manager for a five-year period using annual intervals would require also examining the fund's annual returns minus the risk-free return for each year and relating it to the annual return on the market portfolio minus the same risk-free rate.
Class B shares are lower in payment priority than Class A shares. That means if a company were to go bankrupt and be forced into liquidation, Class A shareholders would be paid out first, then Class B. Class B shares can also be issued for reasons that aren't only to benefit the company and executives.
Class C shares do not impose a front-end sales charge on the purchase, so the full dollar amount that you pay is invested. Often Class C shares impose a small charge (often 1 percent) if you sell your shares within a short time, usually one year.
Mutual fund Class B shares may be one class of shares that investors can purchase when investing in a mutual fund. They do not have a front-end sales charge (like many Class A shares do), but they often have a sales charge when shares are sold. This is why Class B shares are also known as back-loaded shares.
Capital structure refers to the specific mix of debt and equity used to finance a company's assets and operations. From a corporate perspective, equity represents a more expensive, permanent source of capital with greater financial flexibility.
Most mutual funds fall into one of four main categories – money market funds, bond funds, stock funds, and target date funds. Each type has different features, risks, and rewards.
A mutual fund is a pool of money managed by a professional Fund Manager. It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities.
The Purpose of mutual funds is to provide liquidity and higher returns with optimum degree of safety to investors at minimum risk. Based on these goals, various types of mutual fund schemes have evolved over a period of time.
When following a standard index, ETFs are more tax-efficient and more liquid than mutual funds. This can be great for investors looking to build wealth over the long haul. It is generally cheaper to buy mutual funds directly through a fund family than through a broker.
What Is the Purpose of a Fund? The purpose of a fund is to set aside a certain amount of money for a specific need. An emergency fund is used by individuals and families to use in times of emergency. Investment funds are used by investors to pool capital and generate a return.
Whereas owning one mutual fund reduces risk by owning several stocks, an FOF spreads risk among hundreds or even thousands of stocks contained in the mutual funds it invests in. FOFs also provide the opportunity to reduce the risk of investing with a single fund manager.
Similar to a mutual fund or hedge fund, a private equity fund is a pooled investment vehicle where the adviser pools together the money invested in the fund by all the investors and uses that money to make investments on behalf of the fund.
– Under Equity category, Large, Mid and Small cap stocks have now been defined. – Balanced / Hybrid funds are further categorised into conservative hybrid fund, balanced hybrid fund and aggressive hybrid fund.
Low Fees or Expenses. Mutual funds with relatively low expense ratios are generally always desirable, and low expenses do not mean low performance. ...
A mutual fund is an SEC-registered open-end investment company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instru- ments, other securities or assets, or some combination of these investments.
Fund flow is the sum of all cash inflows/outflows from and into different financial assets. Fund flow is usually calculated on a monthly or quarterly basis; no account is taken of the output of an asset or fund. It is only the share redemptions or outflows, and share purchases or inflows.
A sources and uses of funds statement is a summary of a firm's changes in financial position from one period to another. It is also called a flow of funds statement or a statement of changes in financial position.
Funds from operations (FFO) refers to the figure used by real estate investment trusts (REITs) to define the cash flow from their operations. Real estate companies use FFO as a measurement of operating performance.
It is calculated by deducting interest income and gains on asset sales from net income for the period and adding interest expense, depreciation, and losses on asset sales.
Analyzing the flow of funds helps stockholders and creditors determine how a company used its additional resources derived from profitable operations and to identify the financial strengths and weaknesses of the business.
The cash flow will record a company's inflow and outflow of actual cash (cash and cash equivalents).The fund flow records the movement of cash in and out of the company. Both help provide investors and the market with a snapshot of how the company is doing on a periodic basis.
Investment performance is the return on an investment portfolio. The investment portfolio can contain a single asset or multiple assets. The investment performance is measured over a specific period of time and in a specific currency. Investors often distinguish different types of return.
Class C mutual fund shares may be best for economically-minded investors who have a short investment time horizon of one to three years. While there are no front-end fees with Class C shares, a back-end load is charged if funds are withdrawn within the first year.
Investors purchasing Class B shares may instead pay a fee when selling their shares, but the fee may be waived when holding the shares five years or longer. In addition, Class B shares may convert to Class A shares if held long term.
What is Class F Stock? Class F stock is founders stock that is a unique class of common stock, which was generated by the Funded Founder Institute. This type of stock has become sufficiently common that I feel the need to explain it as part of this general venture financing lecture series.
Class-B shares, held primarily by Brin and Page, have 10 votes per share.Class-C shares are typically held by employees and have no voting rights. The structure gives most voting control to the founders, although similar setups have proven unpopular with average shareholders in the past.
Z-shares are the class of mutual funds that employees of the fund's management company are allowed to own. Typically, Z-shares are offered as part of employees' benefits packages, and some employers even match the number of Z-shares purchased.
P-Class. This is a no-load class that offers shares with a fee structure that includes a .25% 12b-1 fee. P-Class shares are onlyavailable for purchase through financial intermediaries.
Mutual funds with R-class shares are meant for retirement-minded investors or those nearing the end of their career. For this reason, they are often referred to as retirement shares.
Fund of funds is basically a different type of mutual fund that invests in other mutual funds instead of directly investing in stocks, securities, commodities and bonds. Investing in a fund of funds is never a bad idea.
Hedge funds are privately owned unlike ETFs, RICs, REITS, and bond funds which are publicly traded vehicles. Most hedge funds use one of the following organization structures: 1) a single entity fund, 2) a master feeder fund, 3) a parallel fund, or 4) a fund of funds.
A feeder fund (“Feeder”) is an investment vehicle, often a limited partnership, that pools capital commitments of investors and invests or “feeds” such capital into an umbrella fund, often called a master fund (“Master”), which directs and oversees all investments held in the Master portfolio.
What Is the Purpose of a Fund? The purpose of a fund is to set aside a certain amount of money for a specific need. An emergency fund is used by individuals and families to use in times of emergency. Investment funds are used by investors to pool capital and generate a return.
(Entry 1 of 3) 1a : a sum of money or other resources whose principal or interest is set apart for a specific objective. b : money on deposit on which checks or drafts can be drawn —usually used in plural. c : capital. d funds plural : the stock of the British national debt —usually used with the.
Similar to a mutual fund or hedge fund, a private equity fund is a pooled investment vehicle where the adviser pools together the money invested in the fund by all the investors and uses that money to make investments on behalf of the fund.
Due to regulations on who can invest and the unregistered nature of private equity investments, the government says that only institutional investors and accredited investors can provide capital to these funds.
Can You Legally Invest Other People's Money? Yes, but if you plan to invest other people's money you'll need the proper licenses. You may also need to be registered with the Securities and Exchange Commission.
Two refers to the standard management fee of 2% of assets annually, while 20 means the incentive fee of 20% of profits above a certain threshold known as the hurdle rate.
Mini-Master: The mini-master structure generally is comprised of two entities; an offshore feeder and a master entity. While the offshore feeder is taxed as a corporation to benefit U.S. tax exempt investors and block UBTI, the master entity may be structured for tax purposes as a partnership.
Private equity firms are structured as partnerships with one GP making the investments and several LPs investing capital. All institutional partners of the fund will agree on set terms laid out in a Limited Partnership Agreement (LPA). Some LPs may also ask for special terms outlined in a side letter.
Investors put capital into their respective feeder funds, which ultimately invest assets into a centralized vehicle known as the master fund. The master fund is responsible for making all portfolio investments and conducting all trading activity. Management and performance fees are paid at the feeder-fund level.
An Umbrella Fund is a retirement fund which allows multiple unrelated employers to join the fund, compared to a stand-alone fund which is usually set up by a single employer for its employees.
comprised of mutual funds, segregated funds, closed-end funds, hedge funds and insurance company group segregated funds that are not wrapped or repackaged into managed assets.
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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