How to Set Up a Private Equity Fund

By: Giulio Rocca

Launching a private equity fund is a challenging process.

Michael Blann/Lifesize/Getty Images

Do you have a knack for investing? How about well-heeled connections? If so, then setting up a private equity fund can be lucrative, but challenging, endeavor. The term refers to a pool of privately raised funds dedicated to buying significant stakes in companies as investments or to have input into the operation of the entities. Private equity funds come in different flavors from venture capital funds, which focus on investing in early-stage companies, to leveraged buyout funds, which focus on buying large, established businesses. Whatever your particular interests, the steps to forming a private equity fund are similar.

Form an Investment Vehicle

Your first order of business is to determine the legal structure of your private equity fund. In the United States, most take the form of a limited partnership or limited liability company. The appeal is that they're "pass through" entities, meaning that they're not subject to corporate tax. Further, investors enjoy limited liability, which limits their potential losses to what they invest. You will also need to retain a lawyer to draft the necessary legal documents, such as the private placement memorandum, subscription agreement and partnership agreement.

Articulate an Investment Strategy

Crucial to success of your private equity fund is developing a viable investment strategy. It isn't enough to tell investors that you plan to buy early-stage or late-stage companies -- investors want to hear the whole story. Consider the geographic focus of your fund: Will you invest in a specific region, country or part of the world? Will you zero in on specific industries or seek out opportunities wherever they may be? Equally important is fleshing out how you'll create value. Some private equity funds help their portfolio companies through strategic and operational improvement while others focus on financial engineering.

Determine a Fee Structure

Many private equity funds charge a management fee and "carried interest," or a share of the profits above a hurdle rate. Historically, the management fee has been 2 percent of committed capital. If you operate a $100 million fund you would collect $2 million in management fees each year. However, if you don't have a track record you may choose to set your management fee lower to attract investors. Carried interest is often set a 20 percent above a certain return. If you set your hurdle rate at 10 percent, any gains beyond that amount would be split 20/80 between you and your investors. Like management fees, carried interest is often set lower for new funds.

Raise the Capital

Now for the most challenging part: convincing investors to hand over their money. Having a strong investment track record and investment strategy is half the battle. The rest of your success will depend upon how effectively you market your fund to investors. Since private equity funds are deemed risky, the government limits whom you can solicit. Typically, capital is raised from institutional investors such as pension funds, financial institutions, university endowments, sovereign wealth funds and insurance companies. You may also ask for commitments from wealthy individuals that meet the criteria set forth in the Securities Act.

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About the Author

Giulio Rocca's background is in investment banking and management consulting, including advising Fortune 500 companies on mergers and acquisitions and corporate strategy. He also founded, an online resource for graduate school applicants. He holds a Bachelor of Science in economics from the University of Pennsylvania, a Master of Arts in English from the University of Hawaii at Manoa, and a Master of Business Administration from Harvard University.

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