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A PE fund is a stand-alone investment vehicle managed by a PE firm on behalf of a group of investors. The capital is raised with a clear mandate to acquire equity stakes in private companies and divest them over time.

Most PE funds globally are set up as closed-end limited partnerships and operate as “blind pool” vehicles. Closed-end funds have a finite lifespan and require investors to commit capital for the fund’s entire term – typically 10 years – without early redemption (or withdrawal) rights.5 While investors in a PE fund have a clear idea of its broad mandate (for example, mid-market European buyouts), they have no say in the choice of the individual companies that a fund will invest in, hence the term “blind pool.” Certain jurisdictions use limited liability companies or corporate structures as the vehicle of choice for a PE fund, but they are the exception.

We will start with a closer look at the parties involved in a limited partnership PE fund structure, as shown in Exhibit 1.1.

Exhibit 1.1 Limited Partnership PE Fund Structure

PE FIRM: A PE firm is a company with expertise in executing a venture, growth or buyout investment strategy. It raises and advises a fund – and, if successful, over time a family of funds – generally through two separate yet affiliated legal entities: the GP and the investment manager. Members of a PE firm typically hold all the key directorships and other decision-making positions of both the GP and the investment manager for every fund raised by the firm. Establishing these separate legal entities insulates the PE firm from liabilities related to and its principals from any claims on the PE fund. Examples of notable PE firms are buyout firms Kohlberg Kravis Roberts (KKR) and APAX Partners as well as venture firms Sequoia Capital and Kleiner Perkins Caufield Byers.

LIMITED PARTNERS: Investors or LPs contribute by far the largest share of capital to any PE fund raised. LPs participate merely as passive investors, with an individual LP’s liability limited to the capital committed to the fund. Investors active in PE include private and public pension funds, endowments, insurance companies, banks, corporations, family offices, and fund of funds.6 LPs are purely financial investors and cannot be involved in the day-to-day operation or management of the fund or its investee companies without running the risk of forfeiting their limited liability rights. LPs legally commit to provide capital for investment when it is drawn down (or “called”) by the PE fund and they receive distributions of capital – including a share of profits – upon successful exit of the fund’s investments.

GENERAL PARTNER: A fund’s GP is wholly responsible for all aspects related to managing the fund and has a fiduciary duty to act solely in the interest of the fund’s investors. It will issue capital calls to LPs and make all investment and divestment decisions for the fund in line with the mandate set out in its Limited Partnership Agreement (LPA). The GP may delegate some of the management functions to the investment manager or a PE firm’s investment committee (IC),7 but remains fully and personally liable for all debts and liabilities of the fund and is contractually obligated to invest the fund’s capital in line with its mandate.8 A GP – and in turn a PE firm’s partners and senior professionals – will also commit capital to the fund to align its interest with that of the fund’s LPs by ensuring that the firm’s partners have “skin in the game”; the GP stake typically ranges from 1 to 5 % and rarely exceeds 10 % of a fund’s total capital raised.

INVESTMENT MANAGER: In practice, the investment manager9 conducts the day-to-day activities of a PE fund; it evaluates potential investment opportunities, provides advisory services to the fund’s portfolio companies, and manages the fund’s audit and reporting processes. The manager is paid a management fee by the fund for providing these services, some of which may be passed on to a subadvisor. The management fee is typically set at around 1.5−2 % of committed capital during the investment period of the fund; after the end of the investment period, it is calculated on invested capital and may step down to a lower rate. More information on fee structures can be found later in this chapter.

PORTFOLIO COMPANY: Over its lifecycle, a PE fund will invest in a limited number of companies, 10−15 on average, which represent its investment portfolio. These companies are also referred to as investee companies or (during the due diligence process) as target companies. A PE firm’s ability to sell its stakes in these companies at a profit after a three- to seven-year holding period will determine the success or failure of the fund.

From the perspective of the PE firm and its affiliated entities, the business of PE comes down to two simple yet distinct relationships: on the one hand, the firm’s fiduciary duty towards its LPs and on the other hand its engagement with entrepreneurs, business owners and management teams in its portfolio companies (Exhibit 1.2). Establishing a reputation of professional conduct and value-add will ensure access to both future fundraising and investment opportunities.

Exhibit 1.2 Key Relationships GPs Must Manage