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Private equity funds: horizon, access and conflicts

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Private equity builds companies over years. Expect a long wait, limited exits, no public reports and an adviser who must disclose its conflicts.

Long money, private terms, a fiduciary adviser

A private equity fund pools investors’ money under an adviser, the private equity firm. A typical fund takes a controlling interest in an operating company and works to raise its value. Other private equity funds specialize in minority stakes in fast-growing companies or startups. The horizon is long, typically ten years or more.

Access is narrow. Funds are typically open only to accredited investors and qualified clients, including institutions such as insurers, endowments and pension funds, and minimum investments are often very high. Many people are exposed only indirectly, through a pension plan or an insurance policy whose sponsor invests in such funds. The fund is not registered with the SEC even when its adviser is, so it has no regular public reporting.

The money is tied up. An investor may wait several years before any return, and funds typically limit withdrawals. Investors usually sign the fund’s agreements as limited partners, and those agreements govern fees and expenses for the life of the fund.

Conflicts are built in. The fund pays the adviser, and the companies it owns may pay the adviser too, for monitoring or management. As a fiduciary, the adviser must fully disclose conflicts to get informed consent, and must allocate shared expenses among itself, its funds and their companies according to its duty to each fund.

Exam terms

Private equity fund
An unregistered pooled fund that takes stakes in companies for a long horizon.
Portfolio company
A company the fund has invested in.
Minority investment
A stake without control, often in a fast-growing company or startup.
Informed consent
Agreement given after full disclosure of a conflict.
Expense allocation
How shared costs are split among the adviser, its funds and their companies.

Two private funds side by side

Hedge fundPrivate equity fund
StrategyFlexible strategies, which can include leverageTakes stakes in companies to build value
Getting outSet dates after a lock-upWithdrawals limited; returns take years
Public reportsNoneNone, even with a registered adviser
Adviser’s dutyFiduciary to the fundFiduciary to each fund it runs
Both are private; private equity ties money up longer.

Try it: Name two ways a person could have private equity exposure without owning a private fund in her own name. Then write one question she should ask about any fees the fund’s companies pay the adviser.

The rulePrivate equity: control or minority stakes held for a long horizon, limited withdrawals, no regular public reports. The adviser must disclose conflicts to get informed consent and must allocate shared expenses by its duty to each fund.

The closest contrast

Registered adviser.

Unregistered fund.

This decides questions about what investors can see. The adviser’s registration puts its Form ADV in public view; the fund itself still files no regular public reports.

Worked example

Cassius Montgomery-Achebe, an accredited investor, commits money to a private equity fund that buys a regional bakery chain.

  1. He signs the fund’s agreements as a limited partner. They set the fees and expenses for the life of the fund.
  2. The fund pays the adviser an advisory fee, and the bakery chain pays the adviser a monitoring fee. The adviser must disclose that conflict fully to get informed consent.
  3. He gets no public reports on the fund, even though the adviser is SEC-registered.
  4. He may wait several years before any return, and he cannot withdraw at will if he needs cash.

Check yourself

Try a question, then read the explanation to review the rule.

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Summary

  • Private equity funds take control or minority stakes in companies and hold them for many years.
  • Access is typically limited to accredited investors and qualified clients; many people are exposed only through pensions or insurers.
  • The fund files no regular public reports, even when its adviser is SEC-registered; withdrawals are limited.
  • The adviser must disclose conflicts, such as fees from portfolio companies, and allocate shared expenses by its duty to each fund.

Related practice

  • Private equity fund features: strategy, access and horizonPractice this
  • Private fund disclosure, valuation and adviser dutiesPractice this
  • Hedge fund antifraud and fiduciary protectionsPractice this

Sources

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