The Structure and Mechanics of Private Equity Funds

The global private equity (PE) industry—now managing billions of dollars each month—is often seen as a hallmark of 21st-century capitalism. Over the past few decades, it has grown exponentially and today includes thousands of specialist firms operating across different strategies (venture, growth, mid-market, large buyouts) and regions.

At its core, the private equity model is built on two key activities: raising capital and investing it in businesses. For investors, the appeal lies in the potential to outperform traditional asset classes. PE also plays a transformative role by providing capital to support restructurings, business turnarounds, innovation, or expansion.

Fund Formation and Capital Raising

Most private equity firms begin life as a limited liability partnership (LLP), raising capital from institutional and high-net-worth investors. The typical private equity fund is a closed-end vehicle with a lifespan of around 10 years.

Funds are marketed through internal investor relations teams or third-party placement agents. A Private Placement Memorandum (PPM) outlines the fund’s investment strategy, sector focus, expected returns, manager track record, and fee structure.

Fund sizes vary significantly—from small VC funds of a few million dollars to mega-funds exceeding $10 billion, such as those managed by Blackstone, Carlyle, KKR, and TPG.

Who Invests in Private Equity?

Private equity fund investors are known as Limited Partners (LPs). These include:

• U.S. state pension plans (a major capital source historically)
• Insurance companies and banks
• University endowments
• High-net-worth individuals

Retail investors have limited access, although public vehicles like 3i in the UK or listed entities by Blackstone, KKR, and Apollo have expanded access in recent years.

Fund Lifecycle: From First Close to Exit

The fund’s life begins with the “first close”, when enough commitments are secured to begin deploying capital. Multiple closes may follow before the final close concludes fundraising.

The first phase of a fund is the investment period—typically up to five years—during which the General Partner (GP) sources and executes deals. GPs rarely allocate more than 10% of the fund to a single deal to maintain diversification.

How Investments Are Financed

In buyouts, deals are usually financed with a mix of equity and debt—often one part equity and three to four parts debt. Some LPs also participate in co-investment opportunities.

PE firms seek controlling stakes and partner with management teams to restructure, grow, or expand the company through bolt-on acquisitions. In contrast, venture capital deals tend to be 100% equity financed and held for longer durations due to the higher risk and lack of financial history.

Exit Strategies

Private equity firms look to exit investments after 3–5 years (or more), aiming to generate returns through:

• Sales to strategic buyers or other PE firms
• Initial Public Offerings (IPOs)
• Dividend recapitalizations through new debt issuance

Revenue Model: Fees and Carried Interest

GPs earn revenue through:

• Management fees: Typically 1%–2.5% annually on committed or invested capital
• Carried interest: Usually 20% of profits, paid only after investors receive their committed capital back plus a hurdle return (often around 8%)
• Monitoring and transaction fees charged to portfolio companies

Management fees are front-loaded (years 1–5) and then typically step down. Carried interest is calculated on a whole-fund basis or deal-by-deal, depending on the fund structure.

Some funds must return all LP capital and fees before carried interest is paid out. This aligns GPs’ incentives with long-term fund performance.

Final Thoughts

Private equity’s appeal lies in its active ownership model and long-term value creation strategies. As the asset class matures, innovation in fund structures, access mechanisms, and investment approaches continues to reshape the market globally.