Understanding the Structure of a Private Equity Firm

Overview of Private Equity Funds

• Closed-End Investment Vehicles:
  • Limited window to raise funds.
  • No further funds can be raised after the window closes.
• Formation:
  • Generally formed as a Limited Partnership (LP) or Limited Liability Company (LLC).

Advantages of Structure

1. Limited Liability:
   • Investors risk only the capital they have committed.
   • Protection against bankruptcy or lawsuits.
2. Pass-through Entities:
   • For federal income tax purposes, both LPs and LLCs are pass-through entities.

Fund Description

• Capital Pool:
  • Before investments, a private equity fund is a pool of capital.
  • "Dry Powder": Unallocated committed capital.
• Investment Professionals' Role:
  • Allocation of capital.
  • Investors and professionals connect via partnership agreements.

Capital Commitment and Contribution

• Investor's Interest:
  • Secured by contributing capital per partnership agreement.
• Capital Contribution Timing:
  • Typically funded in response to capital calls.
• Capital Calls:
  • Triggered by investment opportunities, fees, and expenses.

Investor Role

• Passive Role:
  • Investors (limited partners) have limited involvement.
  • Financial sponsor handles investment management.

Organizational Chart & Definitions

• Financial Sponsor:
  • Includes General Partner (GP) and Management Company.
  • GP: Legal authority and liability.
  • Management Company: Employs investment professionals.
• Investors:
  • Provide capital, often referred to as limited partners.
  • Sources: Institutional capital (pension plans, endowments), high-net-worth individuals.

Partnership Agreement

• Capital Commitment:
  • Agreement to return capital or assets typically within 10 years.
• Contents of Agreement:
  • Fund Mandate:
    • Parameters for acceptable investments (scale, geography, security type).
  • Fund Term:
    • Investment and divestment time horizons.
  • Management Fee:
    • Annual fee (1%-2%) on assets under management (AUM).
  • Distribution Waterfall:
    • Defines economic relations between GP and LPs.
    • Includes carried interest, typically 20% of proceeds after LPs receive original capital plus preferred return.

Additional Resources

• LBO Video Series:
  • Link provided for further understanding.
• Detailed Notes:
  • Additional details on partnership agreements available.

Conclusion

• This summary provides an insight into the structure and functioning of private equity firms and funds. For clearer understanding, refer to additional resources provided.