TL;DR: A pool of investors' money, run by a manager, that buys private companies, grows them for a few years and sells them. For tax it is almost always a partnership, so the fund itself pays no US income tax.

A PE fund is usually a limited partnership. The limited partners (LPs) are the investors: pension funds, endowments, insurers, sovereign wealth funds and family offices. They commit money up front and the manager calls it in as deals come along (a “capital call”). The general partner (GP) controls the fund, and an affiliated management company runs it day to day. Funds typically have a life of about ten years: roughly five to invest, then the rest to grow and sell.

The manager is paid two ways, often summed up as “2 and 20”: a management fee (commonly around 1.5% to 2% a year of committed capital) and carried interest (often 20% of profits above a preferred return, paid through the waterfall). Because the fund is a partnership, it files a Form 1065 and every partner gets a K-1 and pays tax on its own share. That is also why funds add feeder funds and blockers for foreign and tax-exempt investors.

How a PE fund fits togetherInvestors (LPs) commit capital to the fund, a limited partnership. The GP and manager run it for a fee and carry. The fund buys portfolio companies, and each year every partner receives a K-1.Investors (LPs)pensions, endowmentsGP and managerrun the fundThe funda limited partnershipPortfolio companiesbuy, grow, sellcommit capital2% fee · 20% carryEach year: a K-1to every partner
The investors own the fund; the GP runs it; the fund owns the companies.

Worked example

A buyout fund raises $1bn of commitments. A pension fund commits $50m (5%). In year one the GP calls 20%, so the pension fund wires $10m. A 2% management fee on $1bn is $20m a year, of which the pension fund bears $1m. Each year it receives a K-1 showing its 5% share of the fund's income, gains and fee deductions. Illustrative round numbers.

Where you'll see it: Every PE deal: the LPA, subscription documents, capital call and distribution notices, and K-1 season.

Code: IRC §§ 701, 702, 6031; Treas. Reg. § 301.7701-3 · Related: Distribution waterfall, Carried interest, Schedule K-1 (and K-3), Blocker

See all 53 terms in the glossary

This glossary is general information, simplified for learning. It is not tax, legal or investment advice, and real structures turn on facts and documents not shown here.