Private Markets Pathway · Private Equity

Private Equity Overview and Fund Structure Explained

Updated 8 October 2026 · Fact-checked

Private equity is equity or equity-like investment in companies not traded on a public exchange. Most funds are limited partnerships: limited partners supply capital and have limited liability, while the general partner manages the fund, bears unlimited liability and earns fees and carried interest. Match strategy, structure and roles to the client.

Understand Private Equity Overview and Structure

Private equity (PE) is investment in the equity of companies that are not listed on a public exchange. It is also called private market equity. Because there is no daily market price, PE is illiquid, valued by estimate, and held for years. In return, investors hope for an illiquidity premium and the chance to influence the company.

The two broad strategy groups are venture capital (VC) and buyouts. VC backs young companies with high growth potential and little or no profit. It uses mostly equity, and many investments fail while a few produce very large gains. A buyout acquires a mature, cash-generating company, often a controlling stake, frequently using a lot of debt (a leveraged buyout, LBO). In a management buyout the existing managers buy the firm. Returns in buyouts come from earnings growth, multiple expansion, debt paydown and operational improvement.

Most PE funds are structured as limited partnerships. The general partner (GP) is the PE firm. It finds deals, manages the portfolio and has unlimited liability. The limited partners (LPs) are the investors, such as pension funds, endowments, sovereign funds and wealthy individuals. LPs commit capital, have limited liability up to their commitment, and take no part in day-to-day management. If LPs became actively involved, they could risk their limited liability protection.

LPs make a commitment, and the GP draws down (calls) capital when it needs money for investments and fees. Cash returns to LPs as distributions when investments are exited, for example through a trade sale, an IPO or a sale to another PE firm. The fund has a fixed life, often around ten years with possible extensions. This is why PE is a long-term, illiquid commitment that must fit the client's liquidity needs and risk tolerance.

The GP is paid through a management fee, usually a percentage of committed or invested capital, and carried interest, a share of profits above a hurdle. The GP usually also invests its own money in the fund. This aligns interests. Always link your answer to the client: does the investor have a long horizon, limited liquidity needs and the ability to tolerate uncalled commitments and loss?

Key rules to remember

Management fee: Annual fee = fee rate × fee base (committed or invested capital); The fee base depends on the fund terms. Read the question to see which base applies.
Carried interest (simple, no hurdle or catch-up): Carry = carry rate × profit (state whether before or after fees, as the question specifies); Use only when the question gives no hurdle. If a hurdle exists, carry applies only as the terms specify. Check whether the profit base is before or after fees. The first worked example uses profit after fees.
Net profit to LPs: LP profit = total profit − management fees − carried interest; Fees reduce LP returns. Check the order the question gives.
Unfunded commitment: Unfunded commitment = total commitment − capital drawn down; The LP must still be ready to fund this amount on request.
Liability in a limited partnership: LP: limited to commitment. GP: unlimited; Use this to explain why the GP bears more risk.

How to solve Private Equity Overview and Structure questions

Use this method for any question on PE characteristics, strategies or structure. Tie each point to the client.

1Read the command word (identify, explain, justify, calculate) and the number of responses asked for.
2Identify the investor: objectives (return, risk) and constraints (liquidity, horizon, regulation, tax, circumstances).
3Identify the PE strategy in the vignette: VC (young, equity-funded, high failure) or buyout (mature, cash-generating, leveraged).
4Identify the roles: who is GP, who is LP, who has control, who bears unlimited liability, and who pays or receives fees.
5If a number is needed, write the formula, insert the figures, and show each step, using the fee base given.
6State the conclusion or recommendation and link it to a client constraint in one short sentence.
7Check that you gave only the number of responses asked for, in the order requested.

Quickest way: Strategy, structure, client in three checks

When to use it: Use for item set questions where you must pick among options in about four minutes per question.

Strategy check: young and unprofitable means VC; mature with stable cash flow and leverage means buyout.
Structure check: capital provider with limited liability means LP; manager with unlimited liability means GP.
Client check: eliminate any option that ignores illiquidity, long horizon or unfunded commitments.
For calculations, find the fee base first, then compute fees, then carry.

Common mistakes in Private Equity Overview and Structure

Saying LPs manage the fund and the GP supplies most of the capital.
Candidates assume the larger party controls decisions.
Fix: LPs provide most of the capital but stay passive. The GP manages and usually invests a small share.
Stating that the GP has limited liability.
The words limited partnership suggest everyone is limited.
Fix: Only LPs are limited to their commitment. The GP has unlimited liability.
Treating VC and buyouts as the same except for size.
Both are described as private equity.
Fix: VC funds young, high-growth companies mostly with equity. Buyouts acquire mature companies, often with heavy debt.
Applying the management fee to the wrong base.
Candidates assume committed capital without reading the terms.
Fix: Check whether the fee is on committed or invested capital before calculating.
Ignoring the client's constraints when recommending PE.
Candidates list benefits without relating them to the client.
Fix: State liquidity, horizon and risk tolerance, and link the recommendation to them.

Worked examples

Example 1

A PE fund has total commitments of $200 million. The management fee is 2% per year on committed capital. After five years the fund has a total profit of $90 million before fees and carry. Fees paid over the five years are based on the commitment. Carry is 20% of profit after fees (no hurdle). Calculate the fees paid, the carried interest and the profit to LPs.

Show the solution

Annual fee = 2% × 200 = $4 million.
Fees paid over five years = 4 × 5 = $20 million.
Profit after fees = 90 − 20 = $70 million.
Carry = 20% × 70 = $14 million.
LP profit = 70 − 14 = $56 million.

Answer: Fees paid are $20 million, carried interest is $14 million and the profit to LPs is $56 million.

Example 2

A pension fund LP committed $50 million to a buyout fund. The GP has called 60% of the commitment. Calculate the unfunded commitment, and state why it matters for the pension fund's liquidity planning.

Show the solution

Capital drawn = 60% × 50 = $30 million.
Unfunded commitment = 50 − 30 = $20 million.
The GP can call this on short notice, so the pension fund must hold enough liquid assets to fund it.

Answer: The unfunded commitment is $20 million. The pension fund must keep liquidity available to meet capital calls.

Exam tips

Link every PE answer to the client's liquidity, horizon and risk tolerance, because that is where the points are.
Use the command word: identify needs only a name, while justify needs a reason tied to the vignette.
In calculations, show each step and check the fee base before computing.
Compare VC and buyouts on company stage, financing, leverage and return profile.
Give exactly the number of responses requested.

Private Equity Overview and Structure in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Private Equity Overview and Structure: frequently asked questions

What is the difference between venture capital and a buyout?

Venture capital invests in young, high-growth companies, usually with equity and little leverage. Buyouts acquire mature companies with stable cash flows, often using significant debt. VC returns rely on a few big winners, while buyout returns rely on operational improvement and deleveraging.

What do the GP and LP do in a private equity fund?

The GP manages the fund, selects and monitors investments, and has unlimited liability. LPs supply most of the capital, are passive and have liability limited to their commitment. The GP earns fees and carried interest.

Why are private equity funds usually limited partnerships?

The structure separates capital from management and limits the investors' liability. It also allows flexible terms for fees, drawdowns and distributions, and typically offers tax transparency in many jurisdictions.

Is this topic on the Private Markets pathway only?

Private equity detail is most relevant if you choose the Private Markets pathway. The pathway makes up 30-35% of the topic weight, shared among its pathway topics. The ideas are still useful for any candidate who wants to understand fund structures and client suitability.