Private Equity Fund

A private equity fund buys whole companies, not shares in them. It collects promises of money from pensions, insurers and endowments, then spends about five years buying businesses — mostly with borrowed money, which is why these deals are called leveraged buyouts. It spends the next five years fixing, growing or reorganising what it bought, and then sells: to a bigger company in the same industry, to another fund, or onto the stock market.

Investors do not hand over the cash at the start. They commit an amount, and the fund calls for it deal by deal, over years. The money comes back later, as companies are sold. In between, what you own is a valuation on a statement rather than something you can sell. Not being able to get out is the central trade-off of the whole business.

The argument for it: owning the whole company means you can actually change it, in ways a shareholder holding 2% never could; borrowing magnifies the gain on the money you put in; and nobody has to report earnings every three months. The argument against it: a lot of the past returns came from debt being cheap, from selling companies at higher multiples than they were bought at, and from accounting that flatters after fees — not from running the businesses better.

Fund mechanics

• Structure: 10-year closed-end partnership; GP (the firm) manages, LPs invest. Commitment → investment period (~5y) → harvest.
• Economics: ~1.5–2% management fee on committed capital, ~20% carried interest above an 8% preferred return, with GP catch-up. Deal, monitoring and transaction fees layer on top.
• The J-curve: early years show negative returns (fees, immature marks); distributions arrive in years 4–10.

The LBO template

Buy at 10x EBITDA with 50–60% debt; grow EBITDA, pay down debt, hope for multiple expansion; exit at year five. Returns decompose into exactly those three levers — leverage, operations, multiple — and honest attribution asks how much came from each.

Liquidity workarounds

Secondaries (selling LP stakes, usually at discounts to NAV), continuation vehicles (GPs selling companies to themselves — now a quarter of exits, with obvious conflicts), and NAV loans (borrowing against portfolios) — a growing engineering layer that regulators watch closely.

Valuation and performance measurement

Portfolio companies are marked quarterly by appraisal (comparables, DCF) — smoothed, lagged, and discretion-laden. Performance metrics each fail differently: IRR is gamed by subscription-line timing; MOIC ignores duration; the cleanest is PME (public market equivalent) — discounting the fund's actual cash flows at a public index's returns:

Academic consensus: median buyout funds roughly matched public equity net of fees in recent vintages; top-quartile persistence exists but has weakened. Selection and access are the entire game.

Risk you can't see

Reported volatility (~10%) is an artifact of appraisal smoothing; de-smoothed betas run 1.2–1.5 with public equity plus leverage. The illiquidity premium is contested — some estimates put it near zero after unsmoothing; the "volatility laundering" debate (Cliff Asness's term) is precisely about allocators paying for hidden beta.

Systemic footprint

PE-owned companies now employ ~12M Americans; leveraged-loan and private-credit markets exist substantially to finance PE. Rising rates post-2022 stress the model: interest coverage in portfolios fell sharply, exits slowed, and the industry pivoted to continuation funds and dividend recaps to return capital — the current cycle's live experiment.

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.