Private Equity Fund Structure: Complete Guide
Quick answer: Private equity funds are structured as limited partnerships. Key terms include management fees (1.5-2%), carried interest (20%), and fund life of 10-12 years.
This guide covers the structure of private equity funds, LP/GP relationships, key fund terms, and the investment lifecycle.
LP/GP Structure: Limited Partners and General Partners
Private equity funds are structured as limited partnerships with two key classes of investors. General Partners (GPs) are the fund managers who make investment decisions, source deals, and manage the portfolio. GPs typically commit 1-2% of total capital but have unlimited liability for fund obligations.
Limited Partners (LPs) are passive investors who provide the vast majority of fund capital (98-99%). LPs include pension funds, endowments, sovereign wealth funds, family offices, and high-net-worth individuals. Their liability is limited to their committed capital, and they have no management authority over fund investments.
Management Fees: The Cost of Professional Management
PE funds charge management fees to cover operational costs including deal sourcing, monitoring portfolio companies, and fund administration. The standard fee structure is:
- 1.5% to 2% of committed capital during the investment period
- Typically declines to 0.5-1% during the holding period as capital is deployed
- Fees calculated on committed (not invested) capital during early years
Management fees pay for team salaries, deal origination, legal costs, and fund operations. These fees are deducted quarterly from LP capital commitments before distributions are made.
Carried Interest: Aligning GP and LP Incentives
Carried interest (carry) is the primary mechanism through which GPs participate in fund profits. The standard carry is 20% of profits above a specified return threshold. Key concepts include:
- Preferred return (hurdle rate): Typically 8% annual return that LPs must receive before GPs earn carry
- High-water mark: Ensures GPs only earn carry on profits above the highest point the fund has reached
- Clawback: Contractual obligation for GPs to return excess carry if final returns fall below the hurdle
For example, in a fund with an 8% hurdle, if the fund returns 20% annually, GPs begin earning carry only on profits above the 8% threshold. This aligns GP and LP interests toward maximizing returns.
Fund Lifecycle: 10-12 Year Commitment
PE funds operate on a defined 10 to 12 year lifecycle organized into distinct phases:
- Investment period (3-5 years): GPs source and complete acquisitions using committed capital. Most funds have 5-7 year investment periods with provisions for 1-2 one-year extensions.
- Holding period (5-7 years): GPs actively manage portfolio companies through operational improvements, add-on acquisitions, and strategic guidance to maximize exit values.
- Extension periods: Unlikely to be exercised if capital is deployed on schedule, but some funds include optional 1-2 year extensions for exceptional circumstances.
- Harvesting and wind-down: Remaining investments are exited through strategic sales, IPOs, or secondary transactions. Proceeds distributed to LPs after GP carry is calculated.
Fund Raising, Deployment, and Exit Cycle
The typical PE fund follows a cyclical pattern. Fund raising takes 12-18 months as GPs market to institutional investors and negotiate fund terms. Once committed, capital is deployed over the investment period through a series of platform acquisitions and add-ons. The exit phase returns capital to LPs with profits, typically spanning 6-18 months as the GP sells each investment at optimal valuations.
This cyclical nature means GPs are constantly balancing active portfolio management with sourcing new opportunities—always with an eye on the fund's limited timeline.
