How are private equity funds structured, and what is the typical relationship between GPs and LPs?

Private equity fund structures are a key topic in CFA Level I Alternative Investments. Let's break down the mechanics.

The Limited Partnership Structure:

Most PE funds are organized as limited partnerships:

• General Partner (GP): The PE firm itself. Makes investment decisions, manages the portfolio companies, and operates the fund. The GP typically commits 1-5% of the fund's capital.
• Limited Partners (LPs): The investors — pension funds, endowments, sovereign wealth funds, family offices. They provide 95-99% of the capital but have no say in investment decisions.
• Fund term: Typically 10-12 years with optional 1-2 year extensions.

Fund Lifecycle:

Capital Calls and Distributions:

LPs don't wire their full commitment on day one. Instead:

1. LP commits $50 million to Ridgeline Capital Partners Fund IV
2. Over years 1-3, the GP issues capital calls (drawdowns) as deals are found — perhaps $15M, $20M, $10M
3. The GP invests in portfolio companies
4. As portfolio companies are sold, the GP distributes proceeds back to LPs

The J-Curve Effect:

In the early years, a PE fund typically shows negative returns because:

• Management fees (1.5-2% of committed capital) are charged from day one
• Investments are held at cost or marked down initially
• No exits have occurred yet to generate returns

As portfolio companies mature and exits begin, returns accelerate sharply, creating a J-shaped curve when plotting cumulative returns over time.

Fee Structure (2 and 20):

• Management fee: 1.5-2% of committed capital (investment period) or invested capital (post-investment period)
• Carried interest: 20% of profits above a hurdle rate (typically 8%)
• Preferred return (hurdle): LPs receive an 8% return before the GP gets carry
• Clawback provision: GP must return excess carry if later investments underperform

Exam tip: CFA Level I frequently tests the J-curve concept, the GP/LP relationship, and fee calculations. Remember that the J-curve results from fees and early markdowns, not from poor investments. Also know the difference between committed capital and invested capital for fee calculation purposes.

Learn more about PE fund economics in our CFA Level I alternatives section on AcadiFi.