How Do Private Equity Funds Make Money

Exploring the world of
Private Equity

An educational series brought to you by Maitland

How does a private equity fund work and who is involved?

In this knowledge sharing platform we will explore the private equity universe, delving into a myriad of topics affecting investors, managers or anybody interested in private equity. We will tap into the knowledge of industry experts and local and institutional investors as we try to provide insight on everything you need to know about this exciting and growing industry. As we're right at the start of this knowledge journey, it's important to set-off with a shared understanding. Here Jacolene Otto, Head of Private Equity & Real Estate, will be explaining what private equity is, who the key players are and how the manager makes money.

Defining Private Equity

Private equity is defined as capital that is not listed on a public exchange and is composed of funds and investors that directly invest in private companies. Private Equity funds invest in businesses that are more established, usually with some profit history. In contrast, while venture capital funds are also not usually listed on a public exchange, the point of difference is that they are usually invested in newer and smaller businesses, often start-ups or tech companies.

How does a private equity fund work and who is involved?

A private equity fund has Limited Partners (LP), who typically own 99 percent of shares in a fund and has limited liability, and General Partner (GP), who owns one percent of shares and have full liability. The GP is also responsible for executing and operating the investment.

In most countries the fund structure is either unregulated or very lightly regulated. Although there are industry standards, the holy grail of any fund is the fund documentation (Limited Partnership Agreement) that sets out exactly what the LPs and GP agreed to.

The LPs will generally be institutional investors or high net worth individuals that can commit substantial amounts of money to the fund for up to 10 or 12 years.

The GP will be responsible for the day-to-day management of the fund and will appoint all the various service providers to assist with the management of the fund. This includes but isn't limited to:

An investment adviser – to employ the investment professionals that will identify, acquire and manage the investment strategy
Legal counsel – to structure the fund itself, as well as the deals
Valuer – to perform an independent valuation of the underlying assets
A third-party party administrator – who performs the accounting and administration function in relation to the fund, including communication to the investor
Bankers / a depository

How does the manager make money?

The private equity manager will generally charge two fees to the fund – an annual management fee and a performance fee (called carried interest) that will be paid out based on performance and certain hurdles set in place by the investors.

Look out for our next article where we will be exploring the evolution of Private Equity.

As we delve into the myriad of topics affecting investors, fund managers and new entrants into the market, this educational series will uncover the mystery of the private equity universe:

The Ecosystem that surrounds a Private Equity fund

The role and history of PE

Understand the exciting and growing industry of Private Equity

Clearing misconceptions about Private Equity

What a fund manager should know before starting a PE fund

Introducing third party valuations

Fund structuring and the role of your administrator

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