Private Equity Funds and General Partners

Private equity funds are simply the reserve of capital that is invested by private equity companies. Private equity funds are usually set up as either a limited liability company or a limited partnership. There are, however, other types of structures that exist which are also controlled and managed by the specific private equity firm that is acting as the general partner.

A limited partnership is sometimes known as a "fund". In this case the general managers of the limited partnership are known as the "management company". Many times there will be a separate and unique company that is associated with the general partner. Equity funds get their capital commitments from investors who are qualified. This includes funds from financial institutions, pension funds, as well as money from individuals who have invested a certain amount of their funds. The investors who have provided this capital become a "passive" partner within the hierarchy of the partnership. The investor is permitted to "call" the equity capital when an investment opportunity is announced by the general partner. At this time the limited partner will fund a portion, or pro rata, of its share of the required commitment.

The general partner makes all of the decisions about the private equity fund and is also in charge of managing the fund's portfolio. The portfolio contains all of the fund's investments. During the span of a fund, which can be as long as ten years, the equity fund will make anywhere from 15 - 25 different types of investments. In most cases one particular investment won't exceed more than 10% of the total commitments of the fund.

The general partner of a private equity fund will be compensated, or paid, with a management fee. This management fee is a certain percentage of the total amount of the fund's capital. Usually the management fee will be 1% to 2 % annually of the total amount of capital that has been committed. As well, the general partner will earn what is called "carried interest". Carried interest is essentially a fee that is based on the total amount of profits that have been earned by the fund. Carried interest is also known as a performance fee. General partners will earn about 20% of the performance fee over and above the hurdle rate, otherwise known as the target rate of return.

A private equity fund will earn gross returns of over 20% annually. If a firm has buyout leverage this return will be mostly a result of the leverage. A portion of the 20% will be accounted for by the high level of risk that often comes along with any investment that is in its early stages. Limited partnership interests are usually part of a very limited market. Keep in mind that the interests from a limited partnership, unlike mutual funds, are not free to trade on the open market.

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