Let’s take a moment to consider the reasons why private equity (PE) is financed this way.
Imagine you are starting up a new PE investment fund. You, as a general partner (GP), intend to raise $300 million. With that fund, you plan to invest in companies that you have identified and researched. After these investments are exited, you will distribute returns to your limited partners (LPs). These distributions are unlikely to happen for several years. In other words, the LP capital is locked with the fund for many years.
Why do you think this illiquidity is an intrinsic characteristic of PE investments?
First, the exit is a liquidity event. In other words, it is an opportunity for investors to recover the cash investment they made in the fund. This is how the fund realizes returns for its investors. Second, it provides a concrete measure of the performance of the GP––due to the illiquidity of the asset class, it is difficult to assess a GP’s performance in the absence of exits. If LPs are satisfied with the past returns, they can commit to the next fund offered by the GP.
One final consideration: Say that you are a pension fund or family office––why do you need a GP?
Why they would need a GP.
