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LIFECYCLE OF A PE FUND

A traditional PE firm’s business model relies on success in both raising funds and meeting its target return by effectively deploying and harvesting fund capital. PE funds structured as limited partnerships are typically raised for a 10-year term plus two one-year extensions, commonly referred to as the “10+2” model. Generally speaking, a GP will deploy capital during the first four to five years of a fund’s life and harvest capital during the remaining years. The two optional years allow the GP to extend a fund’s lifespan at its discretion if and when additional time is needed to prudently exit all investments.

Exhibit 1.3 shows the overlapping timelines for the fundraising, investment, holding, and divestment periods of a closed-end fund.

Exhibit 1.3 Lifecycle of a PE Fund

FUNDRAISING: PE firms raise capital for a fund by securing capital commitments from investors (LPs) through a series of fund closings.10 A PE firm will establish a target fund size from the outset – at times defining a “hard cap” to limit the total amount raised in case of excess investor demand. Once an initial threshold of capital commitments has been reached, the fund’s GP will hold a first closing, at which time an initial group of LPs will subscribe to the fund and the GP can start to deploy capital. A fund holding its first closing in 2016 is referred to as a “vintage 2016 fund,” a fund with a first closing in 2017 will be known as a “vintage 2017 fund,” and so on. Fundraising will typically continue for a defined period – 12 to 18 months – from the date of the first closing until the fund reaches its target fund size and a “final closing” is held. The total amount raised by a PE firm is known as a fund’s committed capital.

INVESTMENT PERIOD: Rather than receiving the committed capital on day one, a GP draws down LP commitments over the course of a fund’s investment period. The length of the investment period is defined in a fund’s governing documents and typically lasts four to five years from the date of its first closing; a GP may at times extend the investment period by a year or two, with approval from its LPs. Once the investment period expires, the fund can no longer invest in new companies; however, follow-on investments in existing portfolio companies or add-on acquisitions are permitted throughout the holding period. A fund’s LPA may also permit its GP to finance new investments from a portion of fund realizations within a certain limited period after divestment (this is known as the recycling of capital), thus increasing a fund’s total investable capital.

GPs draw down investor capital by making “capital calls” to fund suitable investment opportunities or to pay fund fees and expenses. LPs must meet capital calls within a short period, typically 10 business days. If an LP fails to meet a capital call, various remedies are available to the GP. These include the right to charge high interest rates on late payments, the right to force a sale of the defaulting LP’s interest on the secondaries11 market and the right to continue to charge losses and expenses to the defaulting LP while cutting off their interest in future fund profits. The portion of LPs’ committed capital that has been called and invested is referred to as contributed capital. A fund’s uninvested committed capital is referred to as its “dry powder”; by extension, the total amount of uninvested committed capital across the industry is referred to as the industry’s “dry powder.” Exhibit 1.4 shows the increase of the industry’s dry powder since 2000; the 2015 data adds perspective on its origin by grouping dry powder according to vintage year.12

Exhibit 1.4 PE Industry Dry Powder

Source: Preqin

HOLDING PERIOD: Holding periods for individual portfolio companies typically range from three to seven years following investment, but may be significantly shorter in the case of successful companies or longer in the case of under-performing firms. During this time, a fund’s GP works closely with portfolio companies’ management teams to create value and prepare the company for exit.13

DIVESTMENT PERIOD: A key measure of success in PE is a GP’s ability to exit its investments profitably and within a fund’s term; as a result, exit strategies form an important part of the investment rationale from the start.14 Following a full or partial exit, invested capital and profits are distributed to a fund’s LPs and its GP. With the exception of a few well-defined reinvestment provisions,15 proceeds from exits are not available for reinvestment. When a fund remains invested in a company at the end of a fund’s life, the GP has the option to extend the fund’s term by one or two years to avoid a forced liquidation.16

Box 1.1

RAISING A SUCCESSOR FUND

Established PE firms will raise successor funds every three to four years and ask existing LPs to “re-up” – or reinvest – in their new vehicle. PE firms will typically begin raising a successor fund as soon as permitted by the LPA, usually once 75 % of the current fund’s capital is invested or has been reserved for fees and future deals.

PE firms see their business as a going concern, meaning they continuously work on a deal pipeline of potential investee companies, make investments and divestments. To efficiently capitalize on opportunities in the market, it is crucial for PE firms to have access to capital, ready to be drawn down and deployed, at all times. This also allows a firm to maintain stable operations, employ an investment team and maximize the efficiency of its resources.

Exhibit 1.5 shows the lifecycle of a successful PE firm with a family of four funds.

Exhibit 1.5 Lifecycle of a Successful PE Firm