Author: Gert-Tom Draisma / www.TristanFinance.com

First published: 24th of September 2026

Latest update: 24th of September 2026

1. The fund as the organising structure of private equity

Private equity begins with an apparent mismatch.

Investors such as pension funds, insurance companies, sovereign wealth funds, endowments and family offices possess capital, but they generally do not want to build organisations capable of finding, acquiring, governing and eventually selling individual private companies themselves.

Private equity managers possess that specialist capability, but they do not ordinarily possess enough of their own capital to finance all the investments they wish to make.

The private equity fund connects the two.

At its simplest, a private equity fund is a contractual arrangement under which investors commit capital to a manager for a defined period and authorise that manager to invest the capital within an agreed mandate.

This sounds straightforward. In practice, it creates one of the most distinctive institutional structures in finance.

The investors usually do not know precisely which companies will eventually be acquired when they make their commitment. They delegate those decisions to the manager.

The manager, meanwhile, does not ordinarily receive all the committed capital immediately. Investors promise to provide it when required.

The fund consequently combines three things:

capital, discretion and time.

Investors provide the capital.

The manager receives discretion over its deployment, subject to agreed limitations.

And the relationship is established for long enough to acquire, develop and ultimately realise investments that cannot normally be bought or sold instantaneously.

Understanding this structure is essential to understanding private equity—and ultimately carried interest.

2. Why have a fund at all?

A private equity manager could theoretically raise money separately for every transaction.

It could identify a company, negotiate an acquisition and then approach investors asking whether they wanted to participate.

Such models exist. They are commonly encountered in deal-by-deal investing, independent sponsorship and pledge-fund structures.

But they create an obvious problem.

The manager cannot be certain that the capital will be available when the transaction needs to complete.

A seller considering a €500 million offer wants to know whether the buyer can actually finance it. The seller is unlikely to give a prospective purchaser unlimited time to find investors after the commercial terms have already been agreed.

The private equity fund solves this problem by raising commitments before the individual investments are known.

Once investors have legally committed €5 billion to a fund, the manager knows that it can call upon that capital, subject to the fund documentation.

Capital raising and transaction execution have been separated.

That separation is one of the institutional innovations that allowed private equity to operate at scale.

3. A fund is not the private equity firm

A fundamental distinction must be made at the outset.

The private equity firm and the private equity fund are not the same thing.

Imagine a fictional manager called Atlas Capital.

Atlas Capital may employ:

• investment professionals;
• operating partners;
• finance professionals;
• lawyers;
• tax specialists;
• investor-relations staff;
• compliance professionals;
• technology specialists;
• and administrative personnel.

The organisation might exist for fifty years.

During those fifty years it might establish:

Atlas Capital Fund IAtlas Capital Fund IIAtlas Capital Fund IIIAtlas Capital Fund IV

It might simultaneously manage:

Atlas Growth Fund IIAtlas European Fund IIIAtlas Infrastructure Fund IAtlas Opportunities Fund II

Each fund is a separate investment vehicle.

Each can have different investors.

Each has its own commitments.

Each owns its own portfolio.

Each produces its own returns.

And each eventually terminates.

The firm continues.

The fund does not.

This distinction becomes particularly important when we reach carried interest. Carry is generally attached to the economics of a particular fund, investment programme or investment rather than simply to the continuing existence of the private equity firm.

4. The basic architecture

Although private equity structures can become extraordinarily complicated, the basic architecture is simple.

There are three central components.

The investors

These provide most of the capital.

They are conventionally called the Limited Partners, or LPs.

The fund

This is the investment vehicle through which capital is pooled and investments are held.

The manager

This identifies, executes, manages and eventually realises investments.

In simplified form:

LPs → commit capital → Fund → acquires investments

while:

GP / Manager → manages → Fund

The division between ownership of capital and management of capital is fundamental to the private equity model.

5. Why limited partnerships became dominant

Much of the terminology used throughout private equity derives from the limited partnership.

A traditional limited partnership contains at least two categories of partner.

The General Partner, or GP, manages the partnership.

The Limited Partners, or LPs, contribute capital but do not participate in ordinary day-to-day management in the same way.

The legal consequences vary by jurisdiction, and modern structures frequently interpose limited-liability entities. Nor is every private equity fund legally organised as a limited partnership.

Depending upon jurisdiction, funds may use:

• limited partnerships;
• corporate vehicles;
• contractual funds;
• unit trusts;
• or other structures.

Nevertheless, the language of GP and LP has become embedded throughout private markets.

Even where the precise legal structure differs, the investors are commonly described as LPs and the sponsor as the GP.

The terminology has therefore become economic as well as legal.

6. The Limited Partners

Historically, private investment was frequently financed by wealthy families and individuals.

Modern private equity is predominantly institutional.

LPs can include:

• public pension funds;
• corporate pension schemes;
• insurance companies;
• sovereign wealth funds;
• university endowments;
• charitable foundations;
• banks;
• development institutions;
• family offices;
• funds of funds;
• private banks;
• and wealthy individuals.

Increasingly, private wealth is also reaching private equity through feeder vehicles and other structures designed to accommodate investors who cannot practically participate in a large institutional fund directly.

These investors can have very different objectives.

A pension fund may have liabilities extending decades into the future.

An insurance company may face regulatory capital constraints.

A sovereign wealth fund may have an effectively perpetual investment horizon.

A family office may focus on preserving wealth across generations.

Yet they can all invest in the same fund.

The fund aggregates these different sources of capital into a common investment programme.

7. The General Partner

The General Partner sits on the other side of the structure.

Traditionally, the GP controls the partnership and has authority to make investments on its behalf, subject to the restrictions contained in the fund documents.

In modern structures, however, the legal GP can be a relatively thin entity.

The people who actually:

• source transactions;
• analyse investments;
• negotiate acquisitions;
• monitor portfolio companies;
• communicate with investors;
• and operate the organisation

may be employed by a separate management company or investment manager.

The GP, the manager and the private equity firm are therefore closely related concepts.

They are not necessarily the same legal entity.

8. The management company

The management company is normally the operating business behind the fund.

It employs people.

It rents offices.

It maintains technology.

It pays salaries.

It builds compliance systems.

It conducts fundraising and investor relations.

It supports investment teams.

Its principal recurring revenue source is normally the management fee.

If Atlas Capital manages several funds simultaneously, its management company may receive fees from several vehicles.

This creates an important distinction between:

the economics of managing funds

and:

the economics of investing through funds.

Management fees provide recurring revenue to operate the organisation.

Investment profits belong principally to the investors, subject eventually to the carried-interest arrangements.

The two should not be confused.

9. The carry vehicle

There is often another entity within the structure: the carry vehicle.

Rather than paying carried interest directly from the fund to individual investment professionals, the GP's carried-interest entitlement may be held through a separate partnership, company or other vehicle.

Conceptually:

Fund → Carry Vehicle → Carry Participants

The carry vehicle may:

• aggregate the team's economic entitlement;
• allocate participation among individuals;
• accommodate vesting;
• deal with joiners and leavers;
• facilitate transfers;
• and address tax and legal requirements.

The architecture can therefore contain at least four economically distinct elements:

1. the private equity firm;
2. the management company;
3. the fund;
4. the carry vehicle.

This distinction becomes increasingly important later in this book.

10. The commitment

Suppose Atlas Capital raises a €5 billion fund.

That does not normally mean that €5 billion arrives in the fund's bank account on the day fundraising finishes.

Instead, investors make commitments.

A pension fund might commit €300 million.

An insurer might commit €200 million.

A sovereign wealth fund might commit €500 million.

Other investors collectively commit the balance.

Together:

Total commitments = €5 billion

The commitment is a contractual promise to provide capital when properly requested.

It is not the same thing as actually transferring the money.

This distinction between:

committed capital

and:

contributed capital

is fundamental to private equity.

11. Why the fund does not take all the cash immediately

Suppose every LP transferred its entire commitment on day one.

The fund might require five years to invest it.

Billions could therefore sit in cash while the manager searched for investments.

That would be inefficient.

LPs are generally better placed to retain and manage their capital until the fund actually needs it.

The commitment structure therefore gives the GP certainty of access to capital without requiring the fund to hold all of that capital from inception.

When money is required, the GP issues a capital call.

This improves capital efficiency.

But it creates an obligation for the LP.

The LP must remain capable of satisfying future calls.

12. Capital calls

Suppose Atlas Fund IV needs €400 million of equity to complete an acquisition.

An LP representing 6% of commitments might, in simplified terms, be required to contribute:

€400 million × 6% = €24 million

The GP issues a capital call notice.

It normally specifies:

• the amount required;
• the payment date;
• the purpose;
• payment instructions;
• and relevant calculations.

The investor transfers €24 million.

Other LPs contribute their respective shares.

Capital calls can also finance:

• management fees;
• fund expenses;
• follow-on investments;
• broken-deal expenses;
• organisational expenses;
• and other permitted obligations.

The capital call is the mechanism that converts the LP's contractual commitment into actual invested cash.

13. Unfunded commitments

If an investor commits €100 million and has contributed €35 million, it may still have €65 million of unfunded commitment.

That €65 million matters.

It is not simply a memorandum item.

The fund may call it.

Institutional investors therefore manage both:

invested exposure

and:

future funding obligations.

Suppose an LP has:

€2.0 billion NAV in private equity funds

and:

€1.2 billion unfunded commitments.

Saying that the investor has “€2 billion invested in private equity” provides only part of the economic picture.

It also has €1.2 billion of contractual future funding obligations.

Private equity portfolio management therefore requires liquidity planning as well as asset allocation.

14. Defaulting on a capital call

The entire fund structure depends upon commitments being reliable.

Suppose the GP has signed an acquisition.

Other LPs fund their shares.

One large investor refuses to contribute.

The problem is no longer confined to that investor.

The fund itself may have a contractual obligation to complete the transaction.

LPAs therefore typically contain strong remedies for default.

Depending upon the documentation, these can include:

• default interest;
• suspension of rights;
• forced transfer;
• dilution;
• forfeiture;
• loss of distributions;
• or other economic penalties.

The precise mechanism varies.

The principle does not:

A commitment must be capable of being relied upon.

15. The blind pool

Most traditional private equity funds are blind pools.

When LPs commit capital, many or all of the eventual investments are unknown.

An investor committing to a 2027 fund may be financing a company that the GP does not discover until 2030.

The LP is therefore not primarily selecting individual companies.

It is selecting:

• a manager;
• a team;
• a strategy;
• an investment process;
• a governance framework;
• and a set of contractual rules.

It delegates subsequent investment selection to the GP.

This is one of the most important characteristics of the private equity fund.

16. The Limited Partnership Agreement

The central constitutional document of a traditional fund is the Limited Partnership Agreement, or LPA.

The LPA establishes the rules governing the relationship between GP and LPs.

It may address:

• fund term;
• investment period;
• investment mandate;
• concentration limits;
• commitments;
• capital calls;
• distributions;
• management fees;
• carried interest;
• expenses;
• recycling;
• borrowing;
• GP commitment;
• reporting;
• valuation;
• transfers;
• conflicts;
• key-person provisions;
• investor defaults;
• LPAC arrangements;
• extensions;
• removal provisions;
• and dissolution.

The LPA is therefore not administrative paperwork surrounding the investment.

It is part of the investment.

LPs may be bound by its rules for well over a decade.

And those rules can determine how hundreds of millions or billions of euros are ultimately allocated.

17. The Private Placement Memorandum

The Private Placement Memorandum, or PPM, principally explains the investment proposition.

It may describe:

• the manager;
• strategy;
• market opportunity;
• previous funds;
• track record;
• team;
• sourcing;
• investment approach;
• fund structure;
• principal terms;
• risk factors;
• tax considerations;
• and conflicts.

Where the LPA principally establishes contractual rights, the PPM explains the proposition being offered to investors.

Institutional LPs do not simply accept that proposition at face value.

They conduct extensive due diligence of the manager before committing capital.

18. Subscription agreements

An investor formally joins the fund through a Subscription Agreement.

This generally establishes the amount of its commitment and contains information and representations concerning matters such as:

• legal status;
• regulatory classification;
• investment authority;
• tax position;
• beneficial ownership;
• anti-money-laundering requirements;
• and eligibility.

A large fund may therefore represent hundreds of separate investor relationships assembled around one common investment vehicle.

19. Side letters

Not every investor necessarily participates on precisely identical terms.

An LP may negotiate a side letter.

This can contain investor-specific provisions relating to:

• reporting;
• tax information;
• regulation;
• confidentiality;
• excuse rights;
• co-investment;
• LPAC representation;
• fee arrangements;
• transfer rights;
• or other matters.

A large cornerstone investor may possess negotiating leverage that a smaller investor does not.

The fund can therefore have one principal LPA while simultaneously containing a network of investor-specific contractual rights.

20. Most-Favoured-Nation provisions

Side letters create an obvious fairness question.

If one investor receives a favourable right, should others receive it too?

This is addressed through Most-Favoured-Nation, or MFN, arrangements.

Eligible LPs may be allowed to elect certain provisions granted to other investors.

But MFN rights are generally not unlimited.

Eligibility may depend upon:

• commitment size;
• investor category;
• jurisdiction;
• regulatory status;
• or the nature of the provision.

The LP base is therefore collective without necessarily being economically or contractually uniform.

21. The first closing

A manager does not necessarily wait until the entire target fund has been raised before beginning operations.

Suppose Atlas targets €5 billion.

It may hold a first closing with €2 billion.

Those investors become LPs.

The fund can begin investing.

Fundraising continues.

Later investors join through subsequent closings.

Eventually the manager reaches its final closing.

This creates an equalisation issue because early investors may already have funded investments, fees and expenses before later LPs arrive.

Fund documents therefore establish mechanisms designed to place subsequent-closing investors into the appropriate economic position.

22. The final closing

At the final closing, fundraising for that vehicle substantially ends.

The fund may close:

• below target;
• at target;
• or at its agreed hard cap.

Where demand exceeds capacity, the GP may need to allocate available fund commitments among investors.

This reveals an important feature of fundraising.

The objective is not always to maximise the number of investors.

Managers may also care about:

• LP quality;
• long-term relationships;
• geographic diversification;
• strategic importance;
• future fundraising;
• and the stability of the investor base.

The LP base itself becomes part of the manager's franchise.

23. The investment period

A traditional buyout fund might have an investment period of roughly four to six years, often around five, although actual terms vary.

During this period the GP is generally permitted to initiate new investments within the fund mandate.

The investment period prevents the manager from possessing indefinite authority to deploy commitments.

LPs committing to a 2027 fund do not expect ordinary new platform investments still to be initiated in 2040.

Once the investment period ends, the nature of permissible activity changes.

The fund increasingly moves from:

building the portfolio

toward:

supporting and realising the portfolio.

24. The investment mandate

GP discretion is broad but not unlimited.

The LPA defines the mandate.

A fund may focus on:

• European mid-market buyouts;
• North American technology;
• global healthcare;
• infrastructure;
• growth equity;
• or another strategy.

Restrictions may address:

• geography;
• sector;
• investment size;
• concentration;
• public securities;
• debt investments;
• related-party transactions;
• and other matters.

LPs delegate investment selection.

They do not necessarily delegate the right to transform the strategy into something fundamentally different after commitments have been secured.

25. Portfolio construction

A fund is a portfolio.

Suppose a €5 billion fund intends to make twelve major investments.

The GP must consider:

• position size;
• diversification;
• sector exposure;
• geography;
• timing;
• follow-on requirements;
• and available reserves.

An individually attractive investment can still be inappropriate if it makes the fund excessively concentrated.

The manager is therefore making two decisions simultaneously:

Is this a good investment?

and:

Is this a good investment for this fund?

Those are not necessarily the same question.

26. Concentration limits

LPAs frequently restrict how much capital can be exposed to one investment.

Suppose a €5 billion fund has a 15% concentration limit.

Ignoring detailed definitions and exceptions, approximately €750 million might represent the maximum exposure to a single investment.

The reason is straightforward.

LPs committed to a portfolio, not to a single-company vehicle.

Concentration restrictions ensure that the actual fund broadly resembles the investment proposition originally sold to investors.

27. Reserves

Not every euro available during the investment period is necessarily allocated to initial acquisitions.

Capital may be reserved for existing portfolio companies.

A company acquired with €300 million of equity might subsequently require another €100 million for:

• acquisitions;
• expansion;
• restructuring;
• debt reduction;
• or defensive financing.

Reserve too much and capital may remain unused.

Reserve too little and attractive follow-on opportunities—or urgent problems—may be impossible to finance.

Reserve management is therefore an important part of portfolio construction.

28. Follow-on investments

The distinction between new and follow-on investments becomes particularly important after the investment period.

The GP may no longer be permitted to acquire entirely new platform companies.

But existing portfolio companies continue operating.

They may require capital.

The LPA therefore normally permits specified follow-on investments after the investment period, often subject to limitations.

Fund life is not a sequence in which investment suddenly stops on a particular date.

Rather, the permitted purpose of additional investment becomes narrower.

29. Recycling

Suppose the fund invests €100 million in a company and sells it relatively quickly for €140 million.

Must all €140 million immediately be distributed?

Not necessarily.

The LPA may permit some proceeds to be recycled.

Recycling can allow specified realised amounts to be reinvested.

Depending upon the agreement, this may include:

• investment cost realised during the investment period;
• amounts previously used for expenses;
• or other permitted proceeds.

A €5 billion fund can therefore potentially make more than €5 billion of gross investments during its life.

Commitment size and total investment cost are not necessarily identical.

30. Management fees

Running the private equity organisation costs money before any carry is earned.

The management company needs to pay:

• salaries;
• offices;
• technology;
• compliance;
• fundraising costs;
• research;
• and organisational overhead.

It therefore normally receives a recurring management fee.

A fund might initially calculate the fee as a percentage of commitments.

After the investment period, the fee base may change to something such as:

• invested capital;
• acquisition cost of remaining investments;
• NAV;
• or another declining measure.

Terms vary substantially.

The underlying distinction is important:

management fees finance the investment-management business.

Carried interest participates in investment success.

31. Why the management-fee base changes

Suppose a €5 billion fund charged the same percentage of €5 billion throughout a fifteen-year life even after most assets had been sold.

LPs might reasonably question why they were paying a full investment-period fee for capital that was no longer being actively deployed.

Fee bases therefore commonly step down after the investment period.

As investments are realised, the fee base can decline further.

The management-fee structure thus reflects the changing nature of the manager's responsibilities over the fund lifecycle.

32. Fund expenses

Certain expenses are borne by the fund rather than the management company.

These can include:

• administration;
• audit;
• legal expenses;
• tax preparation;
• regulatory costs;
• valuation expenses;
• insurance;
• bank charges;
• and investor reporting.

The precise allocation matters because every euro charged to the fund reduces value available to investors.

Expense allocation is consequently both an accounting issue and a governance issue.

33. Broken-deal expenses

Private equity funds investigate transactions they never complete.

Suppose €2 million is spent on:

• lawyers;
• accountants;
• consultants;
• technical experts;
• travel;
• and diligence

before an acquisition is abandoned.

Those are broken-deal expenses.

The LPA and related policies determine how such expenses are allocated.

They are a normal consequence of private equity investing.

A manager must be able to investigate an opportunity seriously and still decide not to proceed.

The fact that an expense did not result in an investment does not necessarily mean it was wasted.

Sometimes the most valuable outcome of due diligence is the decision not to invest.

34. Organisational expenses

Creating the fund itself also costs money.

Lawyers draft documents.

Entities are established.

Tax structures are analysed.

Regulatory work is undertaken.

Subscription processes are created.

Service providers are appointed.

These organisational expenses may be charged to the fund up to an agreed amount, with excess amounts potentially borne by the manager.

Again, the documents determine where the economic burden falls.

35. The GP commitment

The GP and/or related persons normally invest alongside LPs.

This is the GP commitment.

Suppose:

LP commitments = €4.9 billion

and:

GP commitment = €100 million

Total fund commitments are:

€5.0 billion.

The GP therefore has capital at risk alongside external investors.

The source, financing and allocation of GP commitment can become complicated in practice.

Its significance for incentive alignment belongs principally in Part IX.

For present purposes, the important point is that the manager is normally also an investor in the fund.

36. Parallel funds

A single legal vehicle may not accommodate every investor efficiently.

Tax, regulatory and legal considerations can require different structures.

A manager may therefore establish parallel funds.

For example:

Atlas Fund IV LP

and:

Atlas Fund IV Parallel LP

might invest side by side in substantially the same investments.

Economically they form part of one programme.

Legally they remain separate.

This is one reason private equity structure charts can become considerably more complicated than the underlying investment strategy.

37. Feeder funds

A feeder fund allows investors to participate indirectly in the main structure.

Conceptually:

Investor → Feeder → Main Fund / Investment Structure → Portfolio

Feeders can be used for:

• tax purposes;
• regulatory requirements;
• aggregation of smaller investors;
• currency arrangements;
• or private-wealth distribution.

Different legal routes can therefore lead to substantially the same underlying economic portfolio.

38. Alternative Investment Vehicles

A particular investment may create tax, regulatory or legal problems if held through the main fund vehicle.

The LPA may therefore permit an Alternative Investment Vehicle, or AIV.

The AIV allows some or all investors to participate through another structure while preserving the intended economics of the investment programme.

The proliferation of entities in private equity is often therefore not evidence of economic complexity for its own sake.

It reflects the need to accommodate heterogeneous investors and investments.

39. SPVs and blockers

Private equity structures also use special-purpose vehicles, or SPVs.

These may:

• hold particular investments;
• facilitate financing;
• segregate liabilities;
• or solve legal and regulatory issues.

Blocker entities can similarly be inserted where direct ownership would produce undesirable tax or regulatory consequences for certain investors.

When analysing a complicated structure, a useful discipline is repeatedly to ask:

Who owns this entity?

Why does it exist?

What cash passes through it?

Who controls it?

What would happen if it were removed?

The answers normally reveal the economic function behind the legal architecture.

40. Co-investment

An LP may also invest directly alongside the main fund in a particular transaction.

Suppose Atlas Fund IV wants to acquire a company requiring €1 billion of equity.

The fund contributes €700 million.

Selected LPs contribute another €300 million through a co-investment structure.

Co-investment can allow the fund to pursue a larger transaction while respecting concentration limits.

LPs may find co-investment attractive because the fee and carry economics can be lower than in the main fund.

But co-investment creates allocation questions.

Which LPs are invited?

How much is each offered?

What happens if demand exceeds capacity?

What happens when a transaction must be completed quickly?

Co-investment therefore adds another relationship between fund capital and investor capital.

41. Separate accounts

Large investors may also establish separately managed accounts with private equity managers.

Instead of investing exclusively through a commingled fund, the investor provides capital through a dedicated mandate.

This can permit customised:

• investment restrictions;
• geographic exposure;
• sector exposure;
• reporting;
• governance;
• and economics.

The closed-end commingled fund is therefore central to private equity, but it is not the only structure through which private capital is managed.

42. The LP Advisory Committee

LPs generally delegate investment decisions to the GP.

They do not ordinarily approve every acquisition.

But they may participate in specified governance matters through the Limited Partner Advisory Committee, or LPAC.

The LPAC may consider:

• conflicts;
• related-party transactions;
• valuation matters;
• key-person events;
• extensions;
• waivers;
• and other matters specified by the LPA.

It is not normally an investment committee.

Its function is oversight of particular fund-level issues rather than day-to-day management.

43. Conflicts are inherent in a multi-fund organisation

A successful private equity manager may operate many vehicles simultaneously.

Conflicts therefore cannot be completely eliminated.

Suppose Fund III and Fund IV could both make the same investment.

Which receives it?

Suppose Fund III owns a company Fund IV wants to buy.

At what price should it transfer?

Suppose two portfolio companies compete.

Suppose the manager creates a continuation fund to buy an asset from an older vehicle.

The same organisation can then have economic interests on both sides.

Private equity governance is therefore not principally about pretending conflicts do not exist.

It is about:

identifying, disclosing and managing them.

44. Key-person provisions

LPs invest partly because they trust particular people.

Suppose a fund is raised around three senior partners and all three subsequently leave.

Should the remaining organisation automatically retain unrestricted authority to invest the remaining commitments?

Fund documents frequently say no.

Key-person provisions identify individuals whose departure, reduced involvement or other specified event can trigger consequences.

The investment period may be suspended until an agreed resolution is reached.

The precise provisions differ.

The principle is that delegation of capital is partly delegation to identifiable human expertise.

45. No-fault remedies

Fund documents may provide LPs with collective rights that do not require proof of wrongdoing.

A sufficiently large majority might, for example, be able to:

• terminate the investment period;
• remove the GP;
• or take another specified action.

Thresholds are normally high.

A private equity fund could not operate effectively if small groups of investors could constantly override investment decisions.

But investors may nevertheless want an ultimate remedy if confidence in the manager collapses.

46. Removal for cause

Separate provisions may apply where serious misconduct occurs.

Depending upon the documentation, cause might include:

• fraud;
• wilful misconduct;
• gross negligence;
• material breach;
• criminal conduct;
• or other specified events.

The consequences can extend beyond management control.

They may affect:

• management fees;
• carried interest;
• GP economics;
• and succession arrangements.

The definition of cause can therefore have enormous economic importance.

47. Reporting

Once the fund operates, LPs require information.

Reporting can include:

• quarterly reports;
• annual financial statements;
• capital-account statements;
• investment schedules;
• portfolio-company commentary;
• valuation information;
• capital-call notices;
• distribution notices;
• ESG information;
• tax reporting;
• and investor-specific data.

Large LPs increasingly request data in their own formats.

Private equity has consequently become not only an investment-management business but also a substantial data-management business.

48. The administrator

Many funds appoint an external fund administrator.

Functions can include:

• maintaining investor records;
• capital-call processing;
• distribution processing;
• bookkeeping;
• capital-account maintenance;
• financial-reporting support;
• subscriptions;
• transfers;
• and other operational processes.

The division between in-house and outsourced administration differs between managers.

But institutional private equity depends upon substantial operational infrastructure behind the visible investment activity.

49. The auditor

Funds normally appoint independent auditors.

The annual audit provides external scrutiny of financial statements, including matters such as:

• investment valuations;
• cash;
• capital accounts;
• expenses;
• income;
• ownership;
• and financial-statement presentation.

Audit does not transform private-company valuations into objectively observable market prices.

Judgement remains.

But it provides an important layer of discipline around fund reporting.

50. The fund as a cash-flow structure

The fund itself generally does not need to accumulate large permanent cash balances.

Cash moves through it.

During investment:

LP → Fund → Investment

During realisation:

Investment / Buyer → Fund → LP

Other cash flows occur for:

• fees;
• expenses;
• borrowing;
• interest;
• co-investment;
• and carry.

Thinking about a fund as a network of cash flows is particularly useful because carried interest ultimately determines how certain of those cash flows are divided.

51. Subscription facilities

Funds may use short-term borrowing known as a subscription facility or subscription line.

Instead of calling LP capital immediately for every requirement, the fund can temporarily borrow against the creditworthiness and unfunded commitments of its investors.

This can:

• accelerate closings;
• consolidate capital calls;
• simplify treasury management;
• and reduce administrative frequency.

But it also changes cash-flow timing.

Because IRR is sensitive to the dates on which LP capital is contributed, delaying calls can increase reported LP IRR even when underlying investment economics have not changed.

This is one reason performance must later be examined using more than a single measure.

52. NAV facilities

A fund may also borrow against the value of its existing portfolio through a NAV facility.

This differs from a subscription line.

A subscription facility is principally supported by uncalled commitments.

A NAV facility is principally supported by existing investments.

NAV financing can provide capital for:

• follow-ons;
• portfolio-company support;
• liquidity;
• refinancing;
• or other permitted purposes.

It also introduces leverage at the fund level.

Cash received by LPs therefore does not always originate from the sale of a portfolio company.

The source of a distribution matters.

53. Distributions

When investments generate cash, the fund makes distributions.

Cash may arise from:

• company sales;
• dividends;
• recapitalisations;
• partial disposals;
• IPO sell-downs;
• or other realisations.

A distribution notice explains the amount and its treatment.

The direction of cash now reverses.

During investment:

LP → Fund

During realisation:

Fund → LP

Over the life of a successful fund, investors expect distributions substantially exceeding their contributions.

54. Not every euro is distributed in the same way

A €500 million realisation does not necessarily mean that €500 million simply passes proportionately to investors.

The LPA establishes a distribution waterfall.

Depending upon the arrangement, proceeds may be allocated toward:

• return of capital;
• preferred return;
• GP catch-up;
• carried interest;
• and residual profit sharing.

The precise architecture can differ enormously.

This is where the fund structure begins to connect directly to the subject of this book.

The fund does not merely pool capital.

It also establishes the rules governing how the resulting economic value is ultimately divided.

55. The fund term

Private equity funds normally have a finite contractual life.

A traditional fund might have an initial term around ten years, although actual terms vary and many vehicles continue materially longer.

A stylised lifecycle might be:

Years 1–5: principal investment period

Years 3–9: portfolio development and overlapping realisations

Years 7–10: increasing emphasis on exits

Years 10+: remaining assets and wind-down

Actual funds are much less tidy.

The last investment made during year five may still require many additional years before it can sensibly be sold.

56. Contractual term is not the same as economic lock-up

This point requires particular care.

It is common to say that an LP committing to a ten-year private equity fund has “locked up” its money for ten years.

That is a useful shorthand.

It is not literally correct.

The LP has made a long-term contractual commitment to the fund.

But the LP's economic interest can potentially be transferred before the fund terminates.

There is a secondary market for private equity fund interests.

The more accurate statement is therefore:

The fund itself is long-dated, while an individual LP may sometimes obtain liquidity by transferring its interest to another investor.

This does not make a private equity fund liquid in the public-market sense.

A transfer generally requires:

• a willing buyer;
• negotiation;
• valuation;
• documentation;
• and often GP consent.

Liquidity exists.

But it must be created through another private transaction.

57. Extensions

If the fund reaches the end of its contractual term while still owning investments, forcing an immediate sale may destroy value.

LPAs therefore commonly permit extensions.

A GP may be able to extend the term for one or more periods, sometimes subject to LPAC or LP approval.

This reflects a fundamental problem.

The legal life of the vehicle can be specified in advance.

The date on which every underlying investment can sensibly be realised cannot.

58. The tail

The final years of a fund are often called the tail.

They can be difficult.

The most attractive and readily saleable investments may already have been realised.

Remaining companies may be:

• underperforming;
• complex;
• difficult to sell;
• subject to litigation;
• or simply waiting for more favourable market conditions.

Meanwhile the manager may already be investing several successor funds.

The organisation therefore has to maintain attention on ageing vehicles whose fee economics may be declining but whose remaining assets still matter greatly to LPs.

59. The traditional solution: wait for the assets to exit

Historically, an LP seeking liquidity from a private equity fund was heavily dependent upon the GP selling portfolio companies and distributing the proceeds.

If a company remained in the portfolio for eight years, the LP generally waited.

If the fund needed extensions, the LP waited longer.

This created the traditional image of private equity as capital being “locked up” until the fund itself produced liquidity.

That description was once considerably closer to economic reality than it is today.

The development of the secondary market changed the position materially.

60. LP-led secondaries

Suppose an LP committed €100 million to a fund five years ago.

It has contributed €80 million.

It has received €30 million of distributions.

Its remaining interest has:

reported NAV: €75 million

and:

unfunded commitment: €20 million.

The LP decides that it wants to sell.

It may approach specialist secondary buyers.

A buyer can acquire the LP's fund interest, generally assuming both:

• its rights to future distributions;
• and its obligation to satisfy future capital calls.

The underlying portfolio companies remain in the same fund.

The GP continues managing them.

Nothing necessarily changes at portfolio-company level.

Only the identity of the investor changes.

This is the traditional LP-led secondary transaction.

61. What exactly does the secondary buyer acquire?

An LP interest is unusual because it contains both assets and obligations.

The purchaser may acquire:

• exposure to existing portfolio companies;
• rights to future distributions;
• exposure to investments not yet realised;
• obligations for remaining capital calls;
• future management-fee obligations;
• and exposure to the fund's carry arrangements.

Suppose:

NAV = €75 million

and:

unfunded commitment = €20 million.

The buyer is not merely deciding what €75 million of existing assets are worth.

It must also estimate:

• when the €20 million might be called;
• what remaining capital will finance;
• when portfolio companies may be sold;
• how reliable reported valuations are;
• what fees remain;
• and what future distributions may occur.

The asset being purchased is therefore effectively a portfolio of future cash flows and obligations.

62. Secondary pricing and NAV

Secondary pricing is often expressed as a percentage of reported NAV.

An interest might trade:

at 100% of NAV;

at a 10% discount;

or:

at a premium.

But NAV is merely a reference point.

Suppose reported NAV is €100 million and a buyer offers €90 million.

Calling this a “10% discount” is convenient but incomplete.

The buyer may be considering:

• valuation date;
• subsequent company performance;
• public-market movements;
• expected exits;
• unfunded commitments;
• remaining fees;
• portfolio concentration;
• currency exposure;
• and manager quality.

A secondary price is therefore not simply a mechanical discount to an accounting number.

It is a negotiated valuation of future cash flows.

63. NAV can be stale

Private equity NAV is periodic rather than continuous.

Suppose a transaction is negotiated in September using a 30 June NAV.

During the intervening months:

• a company may have outperformed;
• another may have lost a customer;
• debt may have been repaid;
• currencies may have moved;
• an acquisition may have occurred;
• or an exit may already have been agreed.

Secondary buyers therefore often need to roll forward the reported NAV.

The transaction itself becomes a form of price discovery.

This is an important difference from listed markets, where a continuously observable market price normally exists.

64. Why LPs sell

A secondary sale should not automatically be interpreted as evidence that the seller dislikes the fund.

LPs sell for many reasons.

They may want to:

• rebalance allocations;
• generate liquidity;
• reduce unfunded commitments;
• simplify manager relationships;
• dispose of legacy portfolios;
• change strategy;
• reduce exposure to a geography;
• respond to regulatory requirements;
• or finance new commitments.

Secondary sales have consequently evolved from something once associated heavily with distressed or motivated sellers into a mainstream portfolio-management tool.

65. The denominator effect

A particularly important example is the denominator effect.

Suppose an investor owns:

€10 billion total assets

of which:

€1 billion is private equity.

Its private equity allocation is therefore 10%.

Public markets then fall sharply and total portfolio value falls to €8 billion.

Private equity valuations may adjust more slowly.

If private equity remains reported at €1 billion, the allocation becomes:

€1 billion / €8 billion = 12.5%.

The investor has made no new private equity investment.

Yet it is suddenly overweight.

Meanwhile capital calls continue.

Selling fund interests in the secondary market can help restore liquidity and rebalance exposure.

Private equity portfolio management therefore interacts with the LP's entire balance sheet.

66. Specialist secondary funds

The other side of the transaction is often a specialist secondary fund.

Secondary investing differs materially from primary fund investing.

A primary investor commits before most investments exist.

A secondary investor may acquire a fund interest after much of the portfolio has already been constructed.

It may therefore know:

• the underlying companies;
• historical performance;
• debt levels;
• holding periods;
• and potential exit prospects.

Blind-pool risk can be lower.

Distributions may begin sooner.

The J-curve may therefore be shorter or substantially reduced.

Secondary investing has consequently developed into a distinct private-markets strategy rather than merely a mechanism for distressed sellers.

67. Portfolio sales

An LP can also sell many fund interests simultaneously.

Large institutional investors may dispose of portfolios containing dozens or hundreds of funds.

The reasons may include:

• removing older vintages;
• reducing non-core managers;
• simplifying administration;
• rebalancing strategies;
• or restructuring an entire alternatives portfolio.

Such transactions can involve billions of euros.

But scale does not make them frictionless.

Buyers must analyse numerous funds and potentially hundreds of underlying companies.

Transfer restrictions must be examined.

GP consents may be needed.

Interim cash flows need to be reconciled.

Private equity secondary markets can provide substantial liquidity while remaining fundamentally negotiated markets.

68. The reference date and interim cash flows

A secondary transaction generally needs an economic reference point.

Suppose:

Reference-date NAV = €100 million

and the parties agree:

Price = 95% of NAV.

The initial purchase price is therefore €95 million.

But several months may pass before legal completion.

During that period:

• the fund may call capital;
• investments may be sold;
• distributions may be made;
• fees may be charged.

The final settlement therefore requires adjustments for interim cash flows.

The seller and buyer need to determine which economic movements belong to whom.

A transaction casually described as “95 cents on the euro” can therefore require substantial reconciliation.

69. Transfer restrictions and GP consent

A willing seller and buyer cannot necessarily transfer an LP interest simply because they have agreed a price.

The LPA commonly restricts transfers.

GP consent may be required.

The proposed purchaser may need to satisfy:

• regulatory requirements;
• tax requirements;
• anti-money-laundering checks;
• sanctions screening;
• confidentiality requirements;
• and other eligibility criteria.

The fund may also need to consider whether the transfer creates consequences for other investors or the fund itself.

This produces an important distinction:

economic liquidity does not equal unrestricted legal transferability.

The secondary market provides a route to liquidity.

It does not transform the LP interest into a freely traded security.

70. Information asymmetry in secondaries

Secondary buyers also face an information challenge.

The seller owns an interest in the fund.

It does not control the underlying portfolio companies.

The GP controls much of the detailed information.

Confidentiality restrictions may prevent the seller from disclosing everything it knows.

Specialist secondary investors therefore need to underwrite positions using combinations of:

• fund reports;
• available company information;
• manager history;
• historical cash flows;
• portfolio construction;
• public data;
• and their own assumptions.

The secondary market improves liquidity.

It does not eliminate the informational characteristics of private markets.

71. GP-led secondaries

Secondary markets have evolved far beyond LP-to-LP transfers.

A major modern development is the GP-led secondary transaction.

Suppose an older fund owns a particularly attractive company.

The fund is approaching the end of its life.

The GP believes that selling the company now would sacrifice significant future value.

Historically, the choices might have been:

• sell anyway;
• or extend the fund and continue holding.

A GP-led transaction creates another possibility.

A new vehicle can acquire the company from the existing fund.

New secondary investors provide capital.

Existing LPs may generally be offered a choice between:

• receiving liquidity;
• or rolling some or all of their exposure into the new vehicle,

subject to the precise structure.

The underlying asset can therefore continue under the same sponsor even while investors in the original fund obtain liquidity.

72. Continuation vehicles

The most prominent form of GP-led transaction is the continuation vehicle.

Conceptually:

Old Fund → sells asset → Continuation Vehicle

while:

Secondary Investors → provide new capital → Continuation Vehicle

and eligible existing LPs may have the opportunity to:

cash out

or:

roll over.

This solves a genuine economic problem.

A good company does not suddenly become a bad investment merely because the original fund is ten years old.

The contractual life of the fund and the optimal ownership period of the company need not coincide.

Continuation vehicles allow those two clocks to be separated.

73. What is an exit?

Continuation vehicles complicate the meaning of the word exit.

Suppose Fund III sells a company to a continuation vehicle managed by the same private equity organisation.

From the perspective of Fund III:

• the asset has been realised;
• cash may be distributed;
• and carry may crystallise under the applicable waterfall.

From the perspective of the manager:

• the company remains under its control;
• ownership continues;
• and a new investment period effectively begins in another vehicle.

The same transaction is therefore:

an exit for one fund

and:

an acquisition for another.

The traditional assumption that an exit necessarily means the sponsor ceases owning the company is no longer universally valid.

74. The conflict in a continuation transaction

This flexibility creates a significant conflict.

In an ordinary transaction:

seller wants the highest price

and:

buyer wants the lowest price.

In a continuation transaction, the same manager may be connected to both sides.

A high price benefits selling LPs.

A lower price benefits investors entering the continuation vehicle.

Some existing LPs may sell.

Others may roll.

New investors enter.

Existing carry may crystallise.

New carry arrangements may begin.

Management incentives may be reset.

Price discovery and governance are therefore critical.

Continuation vehicles demonstrate an important theme that will recur throughout this book:

financial innovation can solve one economic problem while creating another alignment problem.

75. Other forms of secondary liquidity

Secondary markets are not limited to whole LP interests and continuation vehicles.

Transactions can include:

• strip sales;
• preferred-equity structures;
• tender offers;
• portfolio sales;
• partial liquidity transactions;
• and other structured solutions.

The precise mechanics vary.

Their common purpose is to separate economic exposures and transfer them to investors willing to hold them.

This makes modern private equity considerably more flexible than the simple traditional description:

“Commit your money for ten years and wait.”

But flexibility does not mean simplicity.

The more ways liquidity can be engineered, the more carefully its economic cost and consequences need to be analysed.

76. NAV financing is not a secondary sale

It is also important to distinguish liquidity through sale from liquidity through borrowing.

A fund that needs cash might:

• sell a portfolio company;
• sell an interest through a secondary transaction;
• or borrow through a NAV facility.

All can generate cash.

But they are not economically equivalent.

A sale transfers investment exposure.

Borrowing retains the exposure while adding:

• interest expense;
• repayment obligations;
• and financial risk.

A distribution to LPs therefore does not necessarily represent a realised investment gain.

Understanding where the cash came from is essential.

77. Private-company secondaries

Secondary liquidity can also exist below the fund level.

Shares in private companies can sometimes be transferred between:

• founders;
• employees;
• early investors;
• venture funds;
• growth investors;
• and specialist secondary investors.

This has become particularly relevant where successful private companies remain private for extended periods.

Tender offers or organised liquidity programmes can allow employees and early shareholders to sell shares without an IPO.

But these markets remain private.

Transactions may require company approval.

Information can be restricted.

Different share classes can have different rights.

Trading may occur periodically rather than continuously.

Private-company secondary markets therefore improve liquidity without creating the equivalent of a public stock exchange.

78. Liquidity is a spectrum

The distinction between liquid and illiquid should therefore not be treated as binary.

Liquidity exists on a spectrum.

At one extreme is a highly traded listed security offering:

• continuous pricing;
• many buyers and sellers;
• standardised settlement;
• and very low transaction costs.

Further along the spectrum might be:

• a thinly traded listed security;
• a private-company minority stake;
• an LP interest in a mature buyout fund;
• a portfolio of fund interests;
• a controlling interest in a private company;
• or a complex distressed asset.

All may be saleable.

But the required:

• time;
• negotiation;
• information;
• documentation;
• discount;
• and transaction cost

can differ dramatically.

Private equity is therefore better described as structurally less liquid than as absolutely non-transferable.

79. The price of liquidity

An asset can have one expected long-term economic value and another immediate liquidation value.

Suppose an LP believes its fund interest is worth €100 million over time.

A secondary investor offers €90 million today.

The €10 million difference does not necessarily imply that one party is wrong.

The seller is asking the buyer to provide:

liquidity now.

The buyer assumes:

• valuation uncertainty;
• future funding obligations;
• timing risk;
• manager risk;
• and continued illiquidity.

Part of the discount may therefore represent the price of immediacy and liquidity.

That price is not constant.

80. Secondary liquidity has its own cycle

When secondary funds possess abundant capital and relatively few LPs want to sell, pricing can be strong.

When many LPs seek liquidity simultaneously, discounts can widen.

When uncertainty increases, buyers may demand greater compensation.

When private equity distributions slow, LPs may want liquidity precisely when secondary buyers become more cautious.

The secondary market therefore does not eliminate liquidity risk.

It prices liquidity risk.

And that price itself moves through a market cycle.

81. The correct meaning of private equity lock-up

We can now state the position more accurately.

An LP's commitment to a private equity fund is long term.

The underlying fund may exist for ten, twelve, fifteen or more years.

But an individual LP is not necessarily forced to remain the investor throughout that entire period.

It may be able to sell its position.

What it generally cannot demand is:

immediate redemption from the fund at an objectively observable NAV.

That is the crucial distinction.

Traditional private equity funds are generally closed-ended.

LPs cannot simply present their interest to the fund and require cash back tomorrow.

If they want early liquidity, they ordinarily need another solution:

• a secondary buyer;
• a structured transaction;
• or ultimately distributions generated by the fund.

Private equity therefore has liquidity mechanisms without having public-market-style liquidity.

82. The fund can outlive individual investors—and individual professionals

The long life of the vehicle creates another important feature.

A fund raised in 2027 may still exist in 2042.

During those fifteen years an investment professional may:

• be promoted;
• leave;
• retire;
• become ill;
• die;
• or establish another firm.

An LP may:

• merge;
• change strategy;
• face regulatory changes;
• sell its fund interest;
• or disappear as an institution.

Yet the fund continues.

This is one reason private equity documentation requires extensive provisions governing succession, transfers and long-term economic rights.

The life of the contractual vehicle can exceed the relationship between many of the people and institutions that originally created it.

83. Successor funds

Successful managers do not normally wait until one fund has been liquidated before raising another.

Fund I may still own most of its portfolio when Fund II is raised.

Fund II may still be investing when Fund III begins fundraising.

The organisation develops overlapping generations:

Fund III — harvesting

Fund IV — portfolio management

Fund V — investing

Fund VI — fundraising

all at the same time.

This creates the institutional rhythm of private equity:

raise → invest → manage → realise → raise again.

The private equity firm is therefore a continuing organisation managing a sequence of temporary capital pools.

84. Vintage years

Funds are commonly classified by vintage year.

The precise convention varies, but vintage generally identifies when the fund begins its investment life.

This matters because market conditions differ.

A fund investing heavily in 2006 experienced different:

• acquisition valuations;
• financing conditions;
• economic conditions;
• and exit markets

from one beginning in 2009.

Comparing funds without considering vintage can therefore be misleading.

Private equity performance occurs in time, not in a vacuum.

85. The J-curve

The cash-flow profile of a private equity fund is frequently described as the J-curve.

In early years:

• LPs contribute capital;
• fees are paid;
• expenses are incurred;
• and few investments have been realised.

Cumulative cash flow is negative.

Later:

• portfolio companies are sold;
• distributions increase;
• and successful funds eventually return more cash than LPs contributed.

The cumulative pattern can resemble the letter J.

Secondary investing can alter this pattern because a secondary purchaser may acquire a more mature portfolio whose investments are closer to realisation.

This is one reason secondaries can offer a different cash-flow profile from primary commitments.

86. The fund as a portfolio of cash flows

It is useful to stop thinking about the fund merely as a collection of companies.

For the LP, it is also a sequence of cash flows.

Commitment

creates an obligation.

Capital calls

create negative cash flows.

Distributions

create positive cash flows.

A secondary sale

can convert the remaining future cash-flow stream into liquidity before the fund itself terminates.

Between these events sits the portfolio.

This cash-flow perspective becomes extremely important when we reach carried interest.

Carry is ultimately a contractual rule determining how particular economic cash flows are allocated.

87. The fund as a contract across time

A fund can also be understood as a contract connecting decisions separated by many years.

The LPA may be negotiated in 2027.

A company may be acquired in 2030.

It may be sold in 2037.

A clawback may be calculated in 2041.

A secondary investor may have replaced the original LP in 2034.

A continuation vehicle may have acquired one of the portfolio companies in 2036.

Yet rights and obligations created years earlier continue to influence every stage.

A seemingly minor definition written at fund formation can therefore move millions of euros a decade later.

This temporal dimension is one of the reasons private equity fund documentation is so consequential.

88. Why fund accounting is unusual

Private equity accounting must answer questions that ordinary corporate accounting does not.

Which investor committed what?

When did each investor join?

How much has each contributed?

How much remains unfunded?

Which expenses belong to which vehicle?

What proceeds are recyclable?

How are equalisation amounts calculated?

What is each investment worth?

How much has each investor received?

Has an investor transferred its interest?

Which economic rights transferred with it?

How much preferred return has accrued?

How much carry has been distributed?

Could some of that carry eventually need to be returned?

The accounting system therefore tracks both:

the fund

and:

each individual investor's economic history.

89. Every LP can have a different history

Two investors in the same fund may experience different cash flows.

One may enter at first close.

Another joins nine months later.

One may be excused from a particular investment.

One may invest through a feeder.

Another may have negotiated a special fee arrangement.

One may sell its interest after six years.

Another remains until liquidation.

A fund-level return therefore does not necessarily describe every individual investor's experience perfectly.

This becomes particularly important when economic arrangements are calculated at investor level.

The fund is simultaneously:

one pooled investment programme

and:

many individual contractual relationships.

90. Winding up

Eventually the remaining assets are realised or otherwise transferred.

Liabilities are settled.

Reserves are released.

Final distributions are made.

Accounts are completed.

The vehicle can be dissolved.

A fund that may have existed for fifteen years disappears.

The private equity firm may meanwhile be raising Fund IX.

This returns us to the distinction with which we began.

The firm is designed to continue.

The fund is temporary.

It is a long-term contractual machine established to receive commitments, acquire assets, manage them, return capital and eventually cease to exist.

91. The private equity fund as a machine

We can now assemble the entire structure.

Inputs

• LP commitments;
• GP commitment;
• investment expertise;
• organisational infrastructure;
• and time.

Processes

• capital calls;
• investment selection;
• acquisition;
• portfolio ownership;
• follow-on investment;
• fund financing;
• realisation;
• secondary transfers;
• and distributions.

Outputs

• return of capital;
• investment profit or loss;
• management fees;
• and carried interest.

The LPA defines the rules.

The GP operates the investment programme.

The LPs provide capital.

The administrator records the activity.

The auditor reviews the financial statements.

The LPAC provides specified oversight.

Secondary markets can transfer economic interests without requiring the underlying fund or portfolio companies to disappear.

And the portfolio companies provide the underlying economic engine.

92. Four layers of economics

It is useful to distinguish four levels.

Level 1 — The portfolio company

The underlying business generates revenue, earnings and cash.

Level 2 — The investment

The fund acquires and ultimately realises its ownership interest.

Level 3 — The fund

All investments, fees, expenses, financing and other cash flows combine into the fund-level result.

Level 4 — The investor and carry allocation

That result is allocated among LPs, the GP and carry participants under the governing agreements.

A fifth perspective can now also be added:

The secondary market

An existing investor can sell its claim on some of those future fund-level cash flows to another investor before the fund itself terminates.

The underlying economics have not disappeared.

The identity of the party receiving them has changed.

This distinction will matter later when we examine waterfalls, transfers and carried-interest entitlements.

93. Why the structure exists

The modern private equity fund can appear extraordinarily complicated.

Its underlying purpose remains simple.

Investors want access to specialist private investment capability.

Managers need reliable long-term capital.

Private companies require owners capable of committing capital for years.

The fund brings those requirements together.

LPs make commitments.

The GP receives discretion to invest.

The LPA establishes boundaries.

Capital is called when required.

A portfolio is constructed.

Companies are owned and developed.

Investments are eventually realised.

Cash returns to investors.

Secondary markets provide additional routes by which investor-level liquidity can occur before the underlying fund has completed its life.

And where the agreed conditions are satisfied, part of the investment profit becomes carried interest.

The fund is therefore much more than a legal wrapper.

It is the institutional architecture that makes large-scale private equity possible.

94. From the fund to the transaction

At this point the machinery exists.

The investors have committed capital.

The GP has authority to deploy it.

The mandate has been established.

The legal entities exist.

The administrator can call capital.

The investment committee can approve transactions.

But none of this creates an investment return by itself.

The fund must now buy something.

And this is where private equity encounters one of its defining economic characteristics.

A listed investor can decide to buy a security and execute the decision almost immediately.

A private equity fund generally cannot.

It has to find a company.

The owner has to be willing to transact.

Information must be obtained.

A price has to be negotiated.

Due diligence must be performed.

Financing must be arranged.

Contracts must be negotiated.

Regulatory approvals may be required.

And after years of ownership, much of the process has to happen again in reverse before the investment can be realised.

The fund gives private equity its institutional structure.

The private nature of the assets gives it its transaction friction.

That is the subject of:

Part IV - Illiquidity and Transaction Friction

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