Private Equity: Fund Structure,

Fundraising & Fees

Business 9452
Winter 2020
How are PE Funds Structured?
 Vast majority use the private partnership model
 Tax efficient
 Limited liability

General Partner
(managers)

MASTER PARTNERSHIP
Limited Partners
(investors)
What is the Minimum Fund investment of
the General Partners?

1. 0%
2. 1%
3. 5%
4. 10%
How are PE Funds Structured?
 General Partners must invest at least 1% of the fund
 Based on US tax law
 May be in the form of notes
 Larger funds often see higher levels
 Eg. Blackstone VI - $13.7B fund – 5%
 Usually a maximum number of investors allowed
 Less than “a few hundred”
 Otherwise the GP’s may be labelled “investment advisors”
 Acts as a conduit
 Think of a water pipe, with cash flowing both ways
 The fund only holds onto a small amount of cash
 Must have a finite life
 Usually 10 years
Types of Capital
 Allocated
 The amount an investor nominally allocates to private equity
 Eg. May be 10-15% of all funds invested
 Committed
 Maximum amount which may be called from an investor
 Usually does not reach 100%
 Investment process ends before maximum funds are required
 Cash flows start to “net out” as companies in the portfolio are
sold
 Drawn Down
 Amount of committed capital which has been called
 Invested
 Likely a bit less than Draw Down until later in the fund’s life
LP Agreement: Key Terms
 General agreement on investment focus (industries,
excluded sectors, VC vs. buyout, etc.)
 Maximum size of a single investment (10 - 15%)
 Limitations on future fundraising (usually minimum
time period since last fund launch and/or minimum
percentage of prior fund invested eg. 75/80%)
 Duties of GP’s, including outside commitments
LP Agreement: Key Terms (continued)
 Ability of GP’s to co-invest
 Drawdown terms
 Life of fund (and extensions)
 Defaulting LP’s
 Role of Advisory Committee
 Voting matters
 Fund size
 Replacement of GP’s
 Fees
The Fundraising Process
 For newer funds, usually involves meeting with
potential investors
 For existing funds, often done on a three year cycle
 May take up to a year or more to close
The Fundraising Process
 Offering memorandum
 Min/max fund size
 Minimum investment size (for LP’s)
 Investment by GP’s
 General fund focus (industry, stage of development,
geographic, etc.)

 May use a placement agent

 Investment Bank
 Investment Advisor (eg. Horsley Bridge Partners)
 Placement fee of 1-3%

 Potential LP signs a subscription agreement

How much money was committed to PE
Funds in 2018?

1. $100 billion
2. $200 billion
3. $300 billion
4. $400 billion
5. $500 billion
PE Fundraising by Year ($US Billions)
US
Global

600
500
400
300
200
100
0

Source: Lerner, Pitchbook, Prequin

2018 Saw Continued Strength
 $426 billion committed globally
 Includes $40 billion committed to VC funds
 Many “Mega-Funds” created
 A closing of >$5 billion usually considered a “mega-fund”
 45% of all fundraising completed by large funds
The Rise of the “Megafund”
Recent Funds Raising > $10 Billion

TPG 12.0
Thoma Bravo 12.6
KKR Americas 13.9
Warburg Pincus 14.0
Silver Lake Partners 15.0
Advent International 15.0
Vista Equity Partners 16.0
Hellman & Friedman 16.0
Carlyle Group 18.5
CVC Capital Partners 19.4
Apollo Partners 24.7
Blackstone 25.0
Softbank Vision Fund 98.0
What has Made PE so successful?
 As an asset class, consistent delivery of above-
average returns
 Why?
 Brings a sense of urgency
 Defined strategy with clear exit plan
 5-7 year timeline: not concerned with quarterly performance
 Adaptable: can make changes quickly (including
management)
 Can engage powerful resources to improve business
operations
 Can deploy capital for additional acquisitions, business
improvements
Who are the Buyers?
 Endowment Funds (Universities, etc.)
 Pension Funds
 Insurance Companies
 High Net Worth Individuals/Family Offices
 Banks (to support relationship with PE firm)

 May also use “Fund of Fund” investors

 Sourced through investment advisors

 Possibility of secondary sales in the future

 Usually requires approval of GP
 Often at a significant discount to intrinsic value
First Time Funds

 Unique challenges
 May mitigate through:
 Lead investor(eg. NBF/Edgestone Capital)
 May get a lower management fee and/or a portion of the
carry
 Larger commitment by GP’s
 Reduction in Fees
IRR vs. Fund Number
25

20

15
IRR (%)

10

0
1 2 3 4 5 6 7 8 9 10 11
Fund Number
Source: Lerner and Schoar, 2005
Fees, Fees and Fees!
 Majority of funds charge:
 Management fee – usually 2% of committed capital
 Carried Interest (“carry”) – usually 20-30% of profits

 Additional fees:
 Transaction fees (0.5-1.5% of acquisition)
 Monitoring fees
 These are paid by the acquired company
 Often shared with LP’s

 Clawback
 Used to ensure carry does not exceed agreed maximum
Management Fees by Fund Size
2.5

1.5
2005
1 2006
2007
0.5 2008

Source: SCM Strategic Capital Management

Fund Size
Lessons for Investors
 Once you have made the decision to invest in PE, be disciplined

 Maintain investment levels every year – do not try to market

time, or reduce your annual allocations

 Try to invest only in 1st quartile funds – once you are in them,
stay there!

 The only return that matters is the IRR achieved at the end of
the fund life

 In the interim, compare performance across funds using the J

curve and vintage year returns

 Be aware of other valuation methods such as multiples, but use

them cautiously