How Private Equity Funds are Structured

Limited partnership model: GP and LP roles

At the core of a private equity fund is the limited partnership agreement (LPA), which formalizes the relationship between the GP and LPs. Private-equity funds are typically limited partnerships. GPs commit 2–5% of capital, source and manage deals, and earn fees plus carried interest. The rest is provided by LPs, pension plans, endowments, sovereign funds, and affluent individuals, who receive long-term returns in exchange for limited liability.

Fund hierarchy

Effective private equity fund structuring aligns tax, regulatory, and investor-type considerations by layering feeder, parallel, and co-investment vehicles around a master fund.

A tiered setup lets managers match structures to investor needs. An umbrella (master) fund holds the assets. Feeder funds pool money from specific groups—say, U.S. tax-paying investors or EU institutions—and invest in the master. Co-investment vehicles sit alongside the main fund, so LPs can back single deals, usually at reduced or zero fees.

Parallel funds and offshore entities for tax efficiency

To serve cross-border investors, managers often run parallel funds in low-tax hubs like Cayman or Luxembourg. These vehicles invest in lockstep with the on-shore fund, so every LP gets identical exposure and performance.

Fund lifecycle overview

A private equity fund progresses through clearly defined phases. Understanding where a fund sits in its lifecycle helps LPs gauge liquidity expectations, risk exposure, and near-term cash-flow demands.

Fundraising and commitments

Over roughly 6–18 months, the GP markets the fund and collects binding commitments. A first close occurs when the target is soft-circled; later closes hit the hard cap. Capital stays with LPs until called, preserving their liquidity.

Investment period vs. harvest period

• Years 1–5 – Investment: The GP draws capital to buy and build companies. Annual call limits and recycling rules in the LPA smooth cash flows.
• Years 5–10 – Harvest: Focus shifts to exits and distributions. New deals slow, and management fees often drop to a percentage of invested rather than committed capital.

Extension and wind-down phase

Most funds last 10 years, with two optional one-year extensions. These extra years give the GP time to exit tough assets. The final phase sees residual holdings sold, audits wrapped up, clawbacks settled, and a last distribution made.

Grasping where a fund sits in this timeline helps LPs match expected calls and payouts to their liquidity plans and risk appetite.

Capital commitments and capital calls

Private equity funds use a pledge-and-draw model—LPs commit capital up front but only wire funds when the GP issues a capital call. This keeps LP cash productive until needed and ensures a disciplined funding process.

Capital commitments and capital calls

Private equity funds use a pledge-and-draw model—LPs commit capital up front but only wire funds when the GP issues a capital call. This keeps LP cash productive until needed and ensures a disciplined funding process.

How LPs commit and how GPs draw capital

At closing, each investor signs a subscription agreement—say for €25 million—to be drawn over about five years. The GP issues capital calls only when cash is needed, with every draw taken pro rata from unfunded commitments. LPAs back this with default penalties such as interest charges, dilution, or forced sale of the commitment.

Notice the structure and timing of capital calls

Calls usually arrive by secure email 10–15 business days before funds are due and outline the amount, purpose, and remaining commitment. Many managers provide rolling cash-flow forecasts or cap annual drawdowns to help investors plan liquidity.

Recycling provisions and reinvestment mechanics

Early exit proceeds can be “recycled” during the first few years—often up to 100% of paid-in capital—so the GP can reinvest without raising new money. Recycled amounts are tracked separately, charged fees only once, and after the investment period, any further reinvestment needs LP consent.

Management fees and expenses

Typical 2-and-20 fee structure

Most funds charge an average of 1.74% of committed capital during the investment period. Performance fees remain the classic 20% carry above an 8% preferred return, though first-time or niche managers may discount headline rates to win anchor investors.

Fee offsets, expense reimbursements, and fund-level costs

Deal fees earned from portfolio companies usually offset 100% of the management fee. Organizational costs are capped (often 1% of commitments), while broken-deal expenses, subscription-line interest, and compliance outlays are also borne by the fund but within budget limits. The true cost to LPs is the net figure after these offsets and caps—not the headline “2 and 20.”

Carried interest and distribution waterfalls

Carried interest is the GP’s share of profits, typically earned after LPs receive a minimum return. The distribution waterfall outlines how proceeds flow from investments to LPs and the GP.

Preferred return, catch-up, and carry

First, LPs get their preferred return. Next comes a short “catch-up” stage where proceeds flow to the GP until its share of profits equals the agreed carry rate. After that, any remaining gains are split 80% to LPs and 20% to the GP.

Deal-by-deal vs. whole-of-fund waterfalls

A deal-by-deal waterfall pays carry on each successful exit, letting the GP collect early but creating higher clawback risk if later deals underperform. A whole-of-fund waterfall waits until the entire portfolio clears the hurdle, delaying GP payouts but giving LPs stronger downside protection.

Clawbacks and escrow arrangements

If early distributions give the GP more carry than it ultimately deserves, a clawback clause forces repayment, usually within 90 days of final liquidation. To avoid messy give-backs, LPAs often escrow some percentage of each carry payment until the last asset is sold, and the results are final.

Understanding these mechanics helps investors gauge when they will see cash returns and how well their interests stay aligned with the GP throughout the fund’s life.

Co-investment and sidecar structures

Why GPs offer co-investments

Co‑investments let managers tackle deals too big for the main fund alone, spread risk, and give select LPs a closer look at underwriting. They’re in demand: a 2025 Adams Street survey shows 88% of LPs plan to boost co‑invest budgets.

How co-investments are structured and allocated

Most follow‑on money flows through a Special-Purpose Vehicle (SPV) that buys the same shares on the same terms as the flagship fund; investors wire cash within about ten days of notice. Some firms also raise small “sidecar” pools for future deals. Offers go out pro rata to interested LPs, with any leftover capacity filled first‑come, first‑served.

Governance and fee differences

Because LPs assume single‑asset risk, economics are lighter—often no base fee and only 1% management, 10–12% carry versus the standard 2% and 20%. Control stays with the GP, but co‑investors receive richer reporting, and any potential conflict with the main fund must clear the LP advisory committee review.

Continuation funds and secondary structures

The rise of GP-led secondaries

Secondary deal volume hit $162 billion in 2024, a record, with GP‑led transactions accounting for nearly half. Activity continues in 2025: Neuberger Berman closed a $4 billion GP‑led fund in June, quadrupling the size of its 2020 predecessor.

Structuring continuation vehicles

Continuation funds follow a four‑step process: GPs select strong‑performing assets, obtain an independent valuation and Limited-partner advisory committee (LPAC) approval, run a competitive bidding process, and offer LPs the choice to cash out or roll into the new vehicle. The structure includes capped leverage and a reset waterfall.

Impacts on fund performance and LP alignment

Properly executed, a continuation fund can boost near‑term distributions in the selling vehicle, give the GP more time to grow value, and let rolling investors avoid an untimely sale. Mismanaged, it can double‑charge fees or skew track‑record optics.

The key is transparent pricing, recycled carry that reflects genuine performance, and clear disclosure so every party can judge whether staying in—or stepping out—makes economic sense.

Legal and compliance considerations

Subscription agreements and LPA terms

Investing in a private equity fund starts with a subscription agreement, where LPs commit capital and confirm eligibility. The Limited Partnership Agreement (LPA) is the core contract outlining the fund’s rules, covering fees, investment limits, governance rights, and removal provisions. Understanding both documents is essential before committing.

Key-man provisions and fiduciary obligations

Key‑man clauses protect LPs by suspending new investments if certain senior managers leave the fund. This ensures continuity in leadership. Private equity managers also have fiduciary duties—they must act in the best interest of LPs. In the U.S., the SEC enforces these duties. In the EU and UK, regulations like AIFMD and FCA rules ensure similar oversight and transparency.

Regulatory oversight and disclosures (SEC, AIFMD, etc.)

Private equity funds must comply with regional regulations:

• U.S. (SEC): Focuses on disclosures, audits, and marketing rules.
• EU (AIFMD): Requires transparency on risks, fees, and leverage.
• UK (FCA): Enforces valuation and reporting standards.

Regulations evolve, so GPs must update LPs and adapt fund operations accordingly.

Final thoughts: What to know before committing to a fund

Questions LPs should ask about fund structure

Navigating private equity challenges—from opaque fee structures to evolving regulations—requires careful review before committing. LPs typically ask the GP how often capital will be called, whether fees fall after the investment period, and when carry is paid. Clarify what happens if key managers leave, how conflicts with co‑investments or continuation funds are handled, and how the firm stays ahead of shifting rules such as AIFMD II or new SEC guidance.

What makes a well-structured fund transparent and aligned

A robust fund pairs plain‑language documents with economics that reward true, portfolio‑wide performance. Fees taper as assets are sold, carry triggers only after LPs recoup capital plus the hurdle, and any recycling or secondary deals are fully disclosed and LPAC‑reviewed. Consistent, data‑rich reporting and a proactive compliance culture keep interests aligned from first close to final liquidation.

Looking to navigate private equity with confidence? Explore our private equity fund solutions to plan for predictable cash flows, fair economics, and long-term alignment.