Private equity fund is a pooled investment from various private investors. Usually, investors bring along their funds and invest directly on private companies or business ventures or at other times, decide on buyout of public companies to facilitate a removal of a public equity.
The funds pooled together for a private equity fund is commonly secured from retail or institutional investors. The collected funds are then used to fund fresh business ideas, new business or enterprise technologies, expand working capital of an existing company, make further asset acquisitions and the like.
A person investing in a private equity fund is usually someone capable of committing large sums of money for long periods of time. As it is, private equity investments require long holding periods to facilitate a turnaround for a distressed company.
Typically, most private equity funds are structures as limited partnerships. Usually, the setup would require that the partnership be supported by a general partner who raises capital from cash-rich investors like pension plan and insurance companies, colleges and universities, foundations or high net worth individuals. These investors are identified as limited partners in the equity fund.
In this setup, it is normal that various components would first be agreed upon to establish the stake, claim and right of a limited partner. First of all, the term of the partnership is determined. On an average, this usually spans for ten years.
Secondly, management fees are usually settled in the case of a private equity firm’s decision to use the fund as an investment for expansion or further wealth generation. In this case, the management fee is used to pay the fund manager or fund generator.
Thirdly, as a matter of performance incentive (so as to increase the income-generation of the partnership, which is why partners invested in the first place), a carried interest is paid to the private equity fund’s management company. Here, a share of the profits of the fund’s investment is used.
Since it is expected that the private equity fund would later yield into profit, at the onset, it must be settled upon that part of the transfer of an interest must be secured to the fund. Since private equity funds cannot be openly traded, usually, they may be transferred to another investor amongst the involved partners.
It is most crucial during the legal structuring of the partnership, that the chosen fund manager be given enough power and discretion to conduct investments and control the affairs of the pooled fund. In this way, no influence by any limited partner may affect any investment option. Of course the fund manager would always have discussed restrictions, limitations and control which cancel out possibility of mismanagement of funds. In the end, it is important that restrictions on the General Partner be set.
It may be perplexing how some business investors would decide on investing their money on a high-cost, long-bond, long-pay of Return of Investment type of investment. However, since the 1970s, there has been a growing trend in the United States for this kind of setup, as apart from fostering business relations and strengthening existing companies, it has opened opportunities for private investors to obtain rights to huge public companies they cannot acquire individually.
By: Shawn Jacobs