How Do Private Equity Partnerships Work?

How Do Private Equity Partnerships Work?

Private equity funds are typically structured as limited partnerships. At the outset, a General Partner (GP) forms the partnership and drafts a Private Placement Memorandum (PPM), which outlines the fund’s strategy and terms. The GP then raises capital commitments from institutional investors, who join as Limited Partners (LPs).

The partnership agreement sets out a fixed term—usually between 8 and 12 years—within which all investments must be realised and proceeds distributed. Since investments haven’t yet been made at the time of fundraising, the fund is often referred to as a “blind pool”. In some cases, the fund may include a few early or “seed” investments, but this is not the norm.

Once a critical amount of capital has been committed, the fund reaches its first close and the GP begins deploying capital. This phase—typically lasting three to five years—is known as the investment period. During this time, the GP will usually invest in 10 to 20 companies, creating a diversified portfolio.

Initially, investments are recorded at cost, and early returns may be negative due to start-up expenses and management fees. This phenomenon is known as the J-curve effect, where returns dip before turning positive as investments mature and are realised.

By the mid-point of the fund’s life, early investments may begin to generate liquidity through sales, IPOs, or other exits. Any capital returned from these exits is typically not reinvested, but rather distributed to the LPs according to the partnership’s distribution waterfall.

As the fund nears the end of its term, the GP will aim to liquidate the remaining portfolio holdings. This structure ensures that private equity funds are inherently self-liquidating, with capital returned to investors gradually over the fund’s life—usually by year 10 to 12.