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90-Second Lesson: How Does a Private Equity Fund Work? Explaining Sponsors, General Partners and Limited Partners

What is the Role of Sponsors, GPs and LPs in Private Equity?

Although private equity funds can seem complicated, the basic structure is actually quite simple. This quick guide will explain everything you need to know about the wonderful world of private equity funds—including the roles of the sponsor, general partner and limited partner—in 90 seconds or less.

What is a Private Equity Fund?

Private equity is an alternative investment. Similar to venture capital or hedge funds, it consists of capital not listed on a public exchange. Instead, it is composed of private equity funds and investors that invest directly in private companies.

Like a mutual or hedge fund, a private equity fund is a pooled investment vehicle. The fund is managed by a private equity firm. Investing in private equity funds appeals to investors, because these funds can yield better returns than those achieved in public equity markets.

Sponsors, GPs and LPs: Who Are The Main Players?

At their core, private equity funds are a collaboration between three main players:

  1. The Sponsor: Also known as a financial sponsor, this is another term for a private equity investment firm. When a fund has a managing private equity firm, it is said to be “sponsored.” The sponsor makes the investments for the fund and is charged with generating additional value through management expertise or by navigating private capital markets.
  2. The General Partner (GP): Private equity firms operate under the guidance of a GP. GPs aggregate and manage investment opportunities, and source capital from the LPs. They typically own 1% of shares in a fund, have full liability and are responsible for executing and operating the investment. Examples of GPs include Blackstone, KKR and Apollo.
  3. The Limited Partner (LP): LPs arrange and invest the capital for the fund, but are not concerned about the fund’s daily maintenance. They typically own 99% of shares in a fund and have limited liability. They may be institutions, such as pension funds and banks, but can also include accredited investors.

How Does a Private Equity Fund Work?

Private equity funds have several moving parts. Here’s a quick overview of the investment process in five easy steps:

  1. A private equity firm, operated under the GP’s guidance, raises money from investors (LPs) for a specific private equity fund.
  2. The fund includes several “platforms,” or target companies that the private equity firm believes it can create value for.
  3. The GP manages the fund for the benefit of that fund’s LPs.
  4. Private equity firms can manage more than one fund at a time—each with different LPs. It is common for LPs to invest in multiple funds managed by the same firm.
  5. The private equity firm will manage a private equity fund for less than 10 years, ultimately exiting the company and selling it at, hopefully, a higher value.

A Unique Opportunity for the Everyday Investor

LPs used to consist mostly of large institutions,  such as pension funds, labor unions, insurance companies and universities. Very wealthy families—the kind of family names that appear each year on the Forbes 400 —were also typical LPs.

Now, LPs come from a broad array of entities and people. There are thousands of high-net-worth-individuals who qualify as accredited investors who can now invest in a private equity fund.  And while many traditional private equity opportunities are open only to accredited investors, a growing number of opportunities exist for non-accredited investors as well. Average investors can now invest in some private equity investments with smaller asset amounts. That means there are more opportunities for the everyday person to participate in a formerly exclusive class of investments.


[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: PE, VC, and Hedge Funds De-Mystified, Goal Based Investing- Planning for Key Life Events, Basic Investment Principles 101 – From Asset Allocations to Zero Coupon Bonds. This is an updated version of an article originally published on September 23, 2016.]

©All Rights Reserved. December, 2020. DailyDACTM, LLC d/b/a/ Financial PoiseTM

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