Private Equity Fund Structure

The fund is organized as a 'Limited Partnership' arrangement. Where a private equity firm acts as the 'General Partner' of the fund, overseeing its management and investors become 'Limited Partners' by investing capital.
Private Equity Fund Structure
3 min
11-June-2024

Private equity (PE) funds are like investment pools where investors put their money to support unlisted companies in enhancing their operations and market presence. The ultimate aim is to boost the companies' value and later sell the investments for profits. Let’s understand the private equity structure, how it operates, the fees involved, and how you can become a PE investor.

Overview of Private equity

Private equity (PE) refers to investments made in companies, public or private, that are not publicly traded on a stock exchange. Private equity firms typically acquire ownership stakes in these companies with the aim of:

  • Restructuring
  • Improving operations, or
  • Growing them before selling them for a profit.

Three major types or structures of private equity funds

Below mentioned are three major structures of Private Equity Funds:

Buyout funds

  • These funds acquire a controlling stake in a company to:
    • Improve its operations, and
    • Ultimately sell it for a profit.
  • Buyout funds often focus on mature companies that have stable cash flows but need operational improvements or strategic direction.

Venture capital funds

  • Venture capital funds invest in early-stage or startup companies with high growth potential.
  • These investments are typically riskier but can yield high returns if the startup is successful.
  • Venture capitalists help the company grow by providing:
    • Funding
    • Mentorship, and
    • Strategic guidance

Mezzanine funds

  • Mezzanine funds provide a combination of debt and equity financing to companies.
  • They typically invest in more established companies that are not able to access traditional bank financing.
  • Mezzanine financing is often used to fund:
    • Acquisitions
    • Expansions, or
    • Buyouts.

Fees of Private Equity Funds

Private equity funds typically charge various fees to investors. This is usually done to cover the costs of managing the fund and to compensate the fund managers for their efforts and expertise. The main types of fees in private equity are:

Private equity funds charge investors for managing the fund and achieving profits:

  • Management fees: Cover fund expenses like salaries and rent, usually 1-2% yearly.
  • Performance fees (carried interest): Reward fund managers with a share of profits, typically 20%.
  • Other fees and expenses: Include transaction and monitoring fees, among others.

Partners and Responsibilities of Private Equity Funds

Private equity funds engage in various investment strategies like:

  • Leveraged buyouts
  • Mezzanine debt
  • Private placement loans
  • Distressed debt

Sometimes, these funds are part of the funds of a portfolio. Mostly, they operate as “limited partnerships”. To better understand the structure of a private equity fund, you must become familiar with two key roles:

  • General partners (GPs) and
  • Limited partners (LPs)

General partners manage the fund and make investment decisions. They also secure capital commitments from limited partners, who are usually institutions like:

  • Pension funds
  • University endowments
  • Insurance companies, and
  • High-net-worth individuals

On the other hand, limited partners do not influence investment choices. Also, they do not know the exact investments included in the fund when they commit capital. If dissatisfied, they can choose not to invest further.

Limited Partnership Agreement in Private Equity Funds

It is noteworthy to mention that when a private equity fund raises money, investors agree to terms in a limited partnership agreement (LPA). This agreement distinguishes between general partners (GPs) and limited partners (LPs) based on their risk levels.

For those who are unaware:

  • LPs are only liable up to the amount they invest
  • GPs are fully liable for any debts or obligations if,
    • The fund incurs losses and
    • Its account turns negative

The LPA also defines the "duration of the fund," which is usually 10 years. This duration is divided into five stages:

  1. Organisation and formation
  2. Fund-raising, lasting about 12 months
  3. Deal-sourcing and investing
  4. Portfolio management, usually five years, with a possible one-year extension
  5. Exiting investments through IPOs, secondary markets, or trade sales

Also, investors must note that most PE funds aim to exit investments within a finite period. That’s because of the incentive structure and the possibility that GP might wish to raise new funds.

Furthermore, this period can also be influenced by negative market conditions, such as when an IPO fails to attract investors.

Investment and payout structure of Private Equity Funds

One of the most critical aspects of any fund's Limited Partnership Agreement revolves around the:

  • Return on investment and
  • The costs associated with managing the fund

Alongside decision-making rights, General Partners (GPs) are compensated through a management fee and a share of the profits known as "carry."

Mostly, the LPA specifies the management fees that GPs receive for their role in running the fund. It is common for private equity funds to charge an annual management fee of 2% of the invested capital. This fee covers various expenses, including:

  • Salaries for the firm's employees
  • Costs related to sourcing deals and legal services
  • Expenses for data and research
  • Marketing, and
  • Other fixed and variable costs

For example:

Say a private equity firm raises a Rs. 500 crore fund. It would collect Rs. 100 crores annually to cover these expenses. Over a normal 10-year fund lifecycle, the firm would:

  • Gather Rs. 100 crores in fees and
  • Leave Rs. 400 crores available for actual investments

In addition to management fees, private equity firms earn a “carry”, which is a performance-based fee. This fee is traditionally 20% of the fund's excess gross profits.

Despite the high fees, investors are generally willing to pay because the private equity fund can address and mitigate corporate governance and management issues that negatively impact public companies.

What are popular private equity funds in India?

Some popular private equity funds in India include:

  • The Blackstone Group
  • Apollo Global Management LLC
  • Carlyle Group
  • KKR & Company LP
  • Warburg Pincus
  • Bain Capital
  • Premji Invest
  • JM Financial Private Equity

These firms have a strong presence in India and have invested in some of India's most promising companies. These pe fund structures offer a range of services to private companies, including:

  • Fundraising
  • Investment strategy development
  • Tax and regulatory services, and
  • Strategic planning

How can investors invest in a private equity fund?

Investing in structures of private equity funds offers:

  • Higher returns than traditional investments
  • Diversification benefits and
  • Access to opportunities for active value creation in privately held companies.

Let’s understand the process through simple steps:

Step I: Research and due diligence

  • Research various private equity funds available in the Indian market
  • Look into their:
    • Investment strategies
    • Track records
    • Fees, and
    • Reputations
  • Thoroughly under the private equity structure

Step II: Make a choice

  • Choose a private equity fund that aligns with your investment objectives and risk tolerance.
  • Consider factors such as:
    • The fund's sector focus and geographic focus
    • Investment stage (e.g., early-stage, growth, buyout), and
    • Expected returns

Step III: Contact fund managers

  • Reach out to the fund managers and express your interest in investing in the fund.
  • Request information about the fund's offering documents, which typically include:
    • The private placement memorandum (PPM) or offering memorandum
    • The partnership agreement, and
    • Subscription documents

Step IV: Submit subscription documents

  • Complete and sign the subscription documents provided by the fund
  • Also, get your Know Your Customer (KYC) documentation done.

Step V: Transfer funds

  • Transfer the investment amount as specified in the subscription documents to the designated bank account of the private equity fund.
  • Follow the instructions provided by the fund manager for investing.

Step VI: Exit strategy

  • Understand the fund's exit strategy and timeline for realising returns on your investment.
  • Be prepared to participate in exit events, such as:
    • Sales of portfolio companies or
    • Distributions of proceeds

How do private equity funds generate returns for investors?

Private equity funds generate returns for their investors using several “exit strategies”, which refers to the process of selling or exiting investments in portfolio companies. These strategies help private equity firms to:

  • Realise profits and
  • Distribute capital back to their limited partners

Let’s have a look at some popular exit strategies:

Exit strategies Meaning When is it executed?
Initial Public Offering (IPO) An IPO involves listing a portfolio company's shares on a public stock exchange, allowing the company's shares to be traded by the public.

Private equity firms pursue an IPO as an exit strategy when the portfolio company:

  • Has demonstrated strong growth potential and
  • Is well-positioned for the public markets
Trade sale or Strategic acquisition A trade sale involves selling the portfolio company to another company. Private equity firms pursue a trade sale when they receive an attractive acquisition offer from a strategic buyer.
Liquidation or Wind-up The portfolio company is liquidated or wound up by selling its assets and distributing the proceeds to investors. Liquidation occurs when a portfolio company fails to meet performance expectations.

 

Other considerations of Private Equity Funds

In addition to the general guidelines governing private equity investments, the Limited Partnership Agreement often imposes specific restrictions on General Partners regarding the types of investments they can make. These restrictions cover various aspects, such as:

  • The industry sectors they can invest in
  • The size of the companies they target
  • Requirements for diversification, and
  • The geographic locations of potential acquisitions

Moreover, it has been commonly observed that the LPA limits the amount of money GPs can allocate to any single investment. To meet the financing needs of each deal, GPs often have to borrow additional funds from banks. These banks lend based on different cash flow multiples, which can impact the profitability of the deals.

Limiting the amount of funding for individual deals is beneficial for limited partners because it incentivises GPs to carefully manage their investments as well as diversify them.

By spreading the investments across multiple companies, GPs face a balanced risk profile. This diversification means that even if one deal performs poorly, the overall impact on the fund is minimised. This protects potential returns (or "carry") that GPs receive.

Furthermore, investors must note that LPs usually outnumber GPs in a fund but do not have veto rights over specific investments. This lack of veto power is significant because if LPs could block individual investments, it could lead to frequent objections based on governance issues, especially in the early stages of evaluating and funding companies. Such vetoes can also disrupt the positive incentives that come from pooling investments together within the funds.

Summary

Private equity funds are investment pools that allow investors to invest in unlisted private companies showcasing strong growth potential. The PE funds are often structured into various types such as buyout, venture capital, and mezzanine funds.

Private equity investments are often more lucrative and provide higher returns in comparison to traditional investments. However, investors looking to engage with private equity funds must conduct thorough research, select funds aligned with their objectives, and understand fee structures and exit strategies. Alternatively, you can also consider investing in mutual funds. The Bajaj Finserv Platform has listed 1,000+ mutual fund schemes. Start your SIP investment today and accumulate wealth!

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Private equity (PE) refers to investments made in companies, public or private, that are not publicly traded on a stock exchange. Private equity firms typically acquire ownership stakes in these companies with the aim of:
 
Restructuring
Improving operations, or
Growing them before selling them for a profit.
 
Three major types or structures of private equity funds
 
Below mentioned are three major structures of Private Equity Funds:
 
Buyout funds
 
These funds acquire a controlling stake in a company to:
Improve its operations, and
Ultimately sell it for a profit. 
 
Buyout funds often focus on mature companies that have stable cash flows but need operational improvements or strategic direction.
 
Venture capital funds
 
Venture capital funds invest in early-stage or startup companies with high growth potential.
 
These investments are typically riskier but can yield high returns if the startup is successful.
 
Venture capitalists help the company grow by providing:
Funding
Mentorship, and
Strategic guidance 
 
Mezzanine funds
 
Mezzanine funds provide a combination of debt and equity financing to companies.
 
They typically invest in more established companies that are not able to access traditional bank financing. 
 
Mezzanine financing is often used to fund:
Acquisitions
Expansions, or
Buyouts.
 
Fees of Private Equity Funds
Private equity funds typically charge various fees to investors. This is usually done to cover the costs of managing the fund and to compensate the fund managers for their efforts and expertise. The main types of fees in private equity are:
Private equity funds charge investors for managing the fund and achieving profits:
 
Management fees: Cover fund expenses like salaries and rent, usually 1-2% yearly.
Performance fees (carried interest): Reward fund managers with a share of profits, typically 20%.
Other fees and expenses: Include transaction and monitoring fees, among others.
 
Partners and Responsibilities of Private Equity Funds   
 
Private equity funds engage in various investment strategies like:
Leveraged buyouts
Mezzanine debt
Private placement loans
Distressed debt
 
Sometimes, these funds are part of the funds of a portfolio. Mostly, they operate as “limited partnerships”. To better understand the structure of a private equity fund, you must become familiar with two key roles:
 
General partners (GPs)
and
Limited partners (LPs)
General partners manage the fund and make investment decisions. They also secure capital commitments from limited partners, who are usually institutions like:
 
Pension funds
University endowments
Insurance companies, and
High-net-worth individuals
On the other hand, limited partners do not influence investment choices. Also, they do not know the exact investments included in the fund when they commit capital. If dissatisfied, they can choose not to invest further.
 
Limited Partnership Agreement in Private Equity Funds
 
It is noteworthy to mention that when a private equity fund raises money, investors agree to terms in a limited partnership agreement (LPA). This agreement distinguishes between general partners (GPs) and limited partners (LPs) based on their risk levels.
 
For those who are unaware:
 
LPs are only liable up to the amount they invest
GPs are fully liable for any debts or obligations if,
The fund incurs losses
and
Its account turns negative
 
The LPA also defines the "duration of the fund," which is usually 10 years. This duration is divided into five stages:
 
1. Organisation and formation
2. Fund-raising, lasting about 12 months
3. Deal-sourcing and investing
4. Portfolio management, usually five years, with a possible one-year extension
5. Exiting investments through IPOs, secondary markets, or trade sales
 
Also, investors must note that most PE funds aim to exit investments within a finite period. That’s because of the incentive structure and the possibility that GP might wish to raise new funds. 
 
Furthermore, this period can also be influenced by negative market conditions, such as when an IPO fails to attract investors.
 
Investment and payout structure of Private Equity Funds
 
One of the most critical aspects of any fund's Limited Partnership Agreement revolves around the:
 
Return on investment 
and
The costs associated with managing the fund
 
Alongside decision-making rights, General Partners (GPs) are compensated through a management fee and a share of the profits known as "carry."
 
Mostly, the LPA specifies the management fees that GPs receive for their role in running the fund. It is common for private equity funds to charge an annual management fee of 2% of the invested capital. This fee covers various expenses, including:
 
Salaries for the firm's employees
Costs related to sourcing deals and legal services
Expenses for data and research
Marketing, and
Other fixed and variable costs
 
For example:
 
Say a private equity firm raises a Rs. 500 crore fund. It would collect Rs. 100 crores annually to cover these expenses. Over a normal 10-year fund lifecycle, the firm would:
 
Gather Rs. 100 crores in fees 
and
Leave Rs. 400 crores available for actual investments
 
In addition to management fees, private equity firms earn a “carry”, which is a performance-based fee. This fee is traditionally 20% of the fund's excess gross profits. 
 
Despite the high fees, investors are generally willing to pay because the private equity fund can address and mitigate corporate governance and management issues that negatively impact public companies.
What are popular private equity funds in India?
Some popular private equity funds in India include:
 
The Blackstone Group
Apollo Global Management LLC
Carlyle Group
KKR & Company LP
Warburg Pincus
Bain Capital
Premji Invest
JM Financial Private Equity
 
These firms have a strong presence in India and have invested in some of India's most promising companies. These pe fund structures offer a range of services to private companies, including:
 
Fundraising
Investment strategy development
Tax and regulatory services, and
Strategic planning
How can investors invest in a private equity fund?
 
Investing in structures of private equity funds offers:
 
Higher returns than traditional investments
Diversification benefits and
Access to opportunities for active value creation in privately held companies.
 
Let’s understand the process through simple steps:
 
Step I: Research and due diligence
Research various private equity funds available in the Indian market
Look into their:
Investment strategies
Track records
Fees, and
Reputations
Thoroughly under the private equity structure
 
Step II: Make a choice
Choose a private equity fund that aligns with your investment objectives and risk tolerance.
Consider factors such as:
The fund's sector focus and geographic focus
Investment stage (e.g., early-stage, growth, buyout), and
Expected returns
 
Step III: Contact fund managers
Reach out to the fund managers and express your interest in investing in the fund. 
Request information about the fund's offering documents, which typically include:
The private placement memorandum (PPM) or offering memorandum
The partnership agreement, and
Subscription documents
 
Step VI: Submit subscription documents
Complete and sign the subscription documents provided by the fund
Also, get your Know Your Customer (KYC) documentation done.
 
Step VII: Transfer funds
Transfer the investment amount as specified in the subscription documents to the designated bank account of the private equity fund. 
Follow the instructions provided by the fund manager for investing.
 
Step VIII: Exit strategy
Understand the fund's exit strategy and timeline for realising returns on your investment.
Be prepared to participate in exit events, such as:
Sales of portfolio companies or
Distributions of proceeds
 
How do private equity funds generate returns for investors?
 
Private equity funds generate returns for their investors using several “exit strategies”, which refers to the process of selling or exiting investments in portfolio companies. These strategies help private equity firms to:
 
Realise profits and
Distribute capital back to their limited partners
 
Let’s have a look at some popular exit strategies:
 
Exit strategies Meaning When is it executed?
Initial Public Offering (IPO) An IPO involves listing a portfolio company's shares on a public stock exchange, allowing the company's shares to be traded by the public. Private equity firms pursue an IPO as an exit strategy when the portfolio company:
Has demonstrated strong growth potential and
Is well-positioned for the public markets
Trade sale or Strategic acquisition A trade sale involves selling the portfolio company to another company. Private equity firms pursue a trade sale when they receive an attractive acquisition offer from a strategic buyer.
Liquidation or Wind-up The portfolio company is liquidated or wound up by selling its assets and distributing the proceeds to investors. Liquidation occurs when a portfolio company fails to meet performance expectations.
 
 
Other considerations of Private Equity Funds     
In addition to the general guidelines governing private equity investments, the Limited Partnership Agreement often imposes specific restrictions on General Partners regarding the types of investments they can make. These restrictions cover various aspects, such as:
The industry sectors they can invest in
The size of the companies they target
Requirements for diversification, and
The geographic locations of potential acquisitions
Moreover, it has been commonly observed that the LPA limits the amount of money GPs can allocate to any single investment. To meet the financing needs of each deal, GPs often have to borrow additional funds from banks. These banks lend based on different cash flow multiples, which can impact the profitability of the deals.
Limiting the amount of funding for individual deals is beneficial for limited partners because it incentivises GPs to carefully manage their investments as well as diversify them.
By spreading the investments across multiple companies, GPs face a balanced risk profile. This diversification means that even if one deal performs poorly, the overall impact on the fund is minimised. This protects potential returns (or "carry") that GPs receive.
Furthermore, investors must note that LPs usually outnumber GPs in a fund but do not have veto rights over specific investments. This lack of veto power is significant because if LPs could block individual investments, it could lead to frequent objections based on governance issues, especially in the early stages of evaluating and funding companies. Such vetoes can also disrupt the positive incentives that come from pooling investments together within the funds.
Summary
Private equity funds are investment pools that allow investors to invest in unlisted private companies showcasing strong growth potential. The PE funds are often structured into various types such as buyout, venture capital, and mezzanine funds.
 
Private equity investments are often more lucrative and provide higher returns in comparison to traditional investments. However, investors looking to engage with private equity funds must conduct thorough research, select funds aligned with their objectives, and understand fee structures and exit strategies. Alternatively, you can also consider investing in mutual funds. The Bajaj Finserv Platform has listed 1,000+ mutual fund schemes. Start your SIP investment today and accumulate wealth!
 
 
Calculate your expected investment returns with the help of our investment calculators
 
Investment Calculator
 
SIP Calculator
Lumpsum Calculator
Step Up SIP Calculator
 
Mutual Fund Calculator
Brokerage Calculator
FD calculator
 

Frequently asked questions

What are the three types of private equity funds?
The three popular types of private equity funds are buyout funds, venture capital funds, and mezzanine funds.
What is a private equity fund model?
The private equity fund model involves raising capital from investors to buy ownership in unlisted companies. Later on, these investors sell their stakes for a profit.
How is a private equity fund set up?
A private equity fund is established by forming a legal structure (like a partnership) and attracting investors. Then terms are set for investments and profit sharing.
What is the life cycle of a PE fund?
A private equity fund typically goes through stages: fundraising, investing in companies, managing those investments, and finally, exiting them to realise returns for investors.
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The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

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