Private equity fund

Type of investment fund

A private equity fund (abbreviated as PE fund) is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity. Private equity funds are typically limited partnerships with a fixed term of 10 years (often with one or two year extensions). At inception, institutional investors make an unfunded commitment to the limited partnership, which is then drawn over the term of the fund. From the investors' point of view, funds can be traditional (where all the investors invest with equal terms) or asymmetric (where different investors have different terms). A private equity fund is raised and managed by investment professionals of a specific private equity firm (the general partner and investment advisor). Typically, a single private equity firm will manage a series of distinct private equity funds and will attempt to raise a new fund every 3 to 5 years as the previous fund is fully invested. Such funds have a general partner, which raises capital from cash rich institutional investors, such as pension plans, universities, insurance companies, foundations, endowments, and high net worth individuals, which invest as limited partners (LPs) in the fund. Among the terms set forth in the limited partnership agreement are the following:

Term of the partnership
The partnership is usually a fixed life investment vehicle that is typically 10 years plus some number of extensions. Management fees
An annual payment made by the investors in the fund to the fund's manager to pay for the private equity firm's investment operations (typically 1 to 2% of the committed capital of the fund). Distribution waterfall
The process by which the returned capital will be distributed to the investor, and allocated between limited and general partner. This waterfall includes the preferred return : a minimum rate of return (e. g. 8%) which must be achieved before the general partner can receive any carried interest, and the carried interest, the share of the profits paid the general partner above the preferred return (e. g. 20%). Restrictions on the general partner
The fund's manager has significant discretion to make investments and control the affairs of the fund. However, the LPA does have certain restrictions and controls and is often limited in the type, size, or geographic focus of investments permitted, and how long the manager is permitted to make new investments. The following is an illustration of the difference between a private equity fund and a private equity firm:

Private equity firm Private equity fund Private equity portfolio investments (partial list) Kohlberg Kravis Roberts & Co. (KKR) KKR 2006 Fund, L. P. ($17.6 billion of commitments) Alliance Boots Dollar General Energy Future Holdings Corporation First Data Corp Hospital Corporation of America Nielsen Company NXP Semiconductors

A private equity fund typically makes investments in companies (known as portfolio companies). These portfolio company investments are funded with the capital raised from LPs, and may be partially or substantially financed by debt. Some private equity investment transactions can be highly leveraged with debt financing—hence the acronym LBO for "leveraged buy out". The cash flow from the portfolio company usually provides the source for the repayment of such debt. While billion dollar private equity investments make the headlines, private equity funds also play a large role in middle market businesses. Such LBO financing most often comes from commercial banks, although other financial institutions, such as hedge funds and mezzanine funds, may also provide financing. Since mid 2007, debt financing has become much more difficult to obtain for private equity funds than in previous years. LBO funds commonly acquire most of the equity interests or assets of the portfolio company through a newly created special purpose acquisition subsidiary controlled by the fund, and sometimes as a consortium of several like minded funds.

The acquisition price of a portfolio company is usually based on a multiple of the company's historical income, most often based on the measure of earnings before interest, taxes, depreciation, and amortization. Private equity multiples are highly dependent on the portfolio company's industry, the size of the company, and the availability of LBO financing.

A private equity fund's ultimate goal is to sell or exit its investments in portfolio companies for a return, known as internal rate of return (IRR) in excess of the price paid. These exit scenarios historically have been an initial public offering of the portfolio company or a sale of the company to a strategic acquirer through a merger or acquisition, also known as a trade sale. A sale of the portfolio company to another private equity firm, also known as a secondary, has become a common feature of developed private equity markets.