The way a private equity fund is established is by creating a limited liability partnership (LLP) which pools together money collected by investors and creates a closed end fund.
The partners that run and manage the fund are called General Partners (GP) and the investors are labeled as Limited Partners (LP).
LP’s include state pension funds, university endowments, institutional investors as well as high net worth individuals. Retail investors do not have easy access to private equity funds although there are funds which are listing on exchanges. LP’s are set up and sold as shares using private placements under Regulation D, similar to how hedge funds are sold.
The first stage in the life of a fund is when they raise capital from investors. In 2004 there was an average of 24 investors in funds this figure has grown to 42 in 2006. After money has been raised it then needs to be deployed to investments. This can start from the close of the fund to 5 years after although it can be shorter. Diversification of risk is important, especially with private equity which is considered very risky. For this reason most funds will not deploy more than 10% of capital in one project.
Once a fund has invested money in a company it will involve itself with decision making including changing management as well as dealing with finances (see below for detail). The LP generate money from the profit the fund makes either by selling the company or by receiving dividends from the net income. GP’s generate income in two ways. Like hedge funds they charge a management fee of 1-2% of invested capital and they also receive a percentage of the profits, above the hurdle rate.
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