Typically, a private equity fund has a life of 10-12 years.
Return on investment in a private equity fund commonly exhibits a “J-curve” shape, where returns are low in negative early in the life of the fund with high returns coming late in the life of the fund as companies owned by the fund are exited.
Two common legal forms for private equity funds are:
- Limited Partnership: A general partner will manage the fund and will be legally exposed for liability of fund debts. The fund’s investors are limited partners, whose liability is limited to the loss of capital provided.
- Company Limited by Shares: Similar to limited partnership, but this structure may offer better legal protection to the partners, depending on the jurisdiction.
- NOTE: Under either legal form, private equity funds are frequently closed-end, which places restrictions on exit of current investors and entry of new investors.
Economic Terms of a Private Equity Fund
- Term: Ten years is a standard, but variations certainly exist
- Vintage Year: Year that the fund was started; performance is often compared to funds with the same vintage year.
- Target Fund Size
- Management Fees: Commonly 1.5-2.5% of some measure of fund assets paid each year to the general partner
- Transaction Fees: Fees for the general partner and potentially shared with the limited partners, for investment banking services.
- Carried Interest: Percentage of profits paid to general partner; 20% is something of a standard.
- Hurdle Rate: Threshold rate of return that the fund must generate before the carried interest is paid to the general partner.
Governance Terms of a Private Equity Fund
- Key man clause: Provides a policy framework for issues around succession of critical executives involved in the fund’s companies.
- Tag-along, drag-along rights: Offers protection to minority fund investors by allowing participation, in the event that an acquisition offer is made to the general partner.
- Removal of general partner for cause: Limited partners can vote out the fund’s general partner; possibly requires a super-majority of 75%.
- No-fault divorce: Allows for fund termination or general partner removal for cause.
- Co-investment: Gives limited partners the first right to invest with the general partner.
- Investment restrictions: Guidance for fund investments.
- Clawback provision: Returns capital to the limited partners from the general partner that exceeds the profit split agreement.
- Distribution waterfall: Limited partners receive payout prior to the general partner receiving carried interest. This can be done on a per deal basis or based on total returns.
- Disclosure and confidentiality