What Happens when a PE Fund Closes?
I know this is a very basic question, but I don't think I have a clear picture of what happens when a PE fund closes.
1) Does every PE firm have multiple funds, or do some close shop when the fund closes?
2) What happens to the employees when their fund is closed? Does every employee work on multiple funds?
3) When someone gets a job at a megafund, or middle market firm, does this mean they get a job at a firm with large funds, or a certain fund?
4) Does every employee work on every fund, or at some larger shops, is everyone given a certain (group of) fund(s)?
1) No. The number of funds that a PE has depends on the PE shop itself. PE shops will add/fundraise new funds as they establish a strong track record of investing and need more money to invest.
Therefore, a PE shop that has existed for decades will likely have a lot more funds than a recently established PE firm. This is because they are older so they likely have invested all of the money they fundraised, and they have established a strong track record to get investors to commit more money to their firm.
To your point about do they close shop when the fund closes, I am not sure what you mean. I think we are getting confused with closing a new fund and actually closing a fund. What you will typically see in the news is that a PE firm closes a new fund. If they close a new fund, then they have capital commitments put together. Therefore, they would be active to deploy the capital. They have 10 years from when the new fund closes before they have to return all the money they borrowed to invest.
This is much different than closing shop. Closing shop means actually closing the fund down and halting investing. This can be for a variety of reasons - mostly reasons where the PE firm sucked. Every PE firm has a track record that is closely monitored and if your investments suck, then your fund will likely close down. This is a negative event, whereas closing a new fund is a positive and celebrated event.
2) Once a new fund closes, then it is up to the PE firm on how they want to staff up the fund. If you are raising a new fund that is a continuation of the current investment philosophy, then the employees who were staffed on the previous fund will likely work on the new fund as well. This is pretty standard for several traditional PE funds.
Once you get into the bigger investment funds, it can be different. Bigger funds like to diversify their investment philosophy. A good example would be a big PE giant like Blackstone. Blackstone has multiple funds and some funds have different investment philosophies. Blackstone's traditional PE fund will do majority buyouts of companies while Blackstone's growth PE fund will do growth minority investments. If Blackstone raises a new growth fund, then only their growth investors will work on it. The same is true with the buyout funds and employees.
3) I have heard many ways to describe what a megafund is or what a middle-market fund is. Honestly, I don't know the specifics. From what I heard, a megafund is a PE firm who most recently raised a fund that exceeded $5B. A middle-market fund is one that invests in the middle-market which are transactions south of $1B. Lower middle market covers transitions that are smaller, I do not know the cutoff personally.
4) As mentioned in answer 2, it depends on how the fund is structured. If you are at a small PE shop that has one investment philosophy, then every member of the investment team will likely work on every fund that the PE firm has raised - given the fund is still active and not exited. If you are at a large PE firm like Blackstone, then the investment team will be split up between buyout and growth. Buyout investors work only on active buyout funds and growth investors work only on active growth funds.
The first reply is great. I'll add a bit more color.
The business model in private equity is to cover your costs while operating the firm long enough to realize meaningful economics from the incentive fees earned as a portion of the returns you generate for your investors.All of that is accomplished through the fee structure. You cover your costs by charging a management fee, which is a fixed percentage of the assets in the fund. The fee is usually 2%, and you charge it every year.
Some firms will charge a flat fee all the way through the entire lifecycle of the fund. Others will charge the fee on capital commitments during the investment period and on invested capital during the harvest period. The point of that is that the firm shouldn't be receiving fees on dollars it didn't invest; for example, if you had a $1b fund but you only used $800m, you should charge the fees on the $800m.
There are multiple funds within a firm because each fund has its own lifecycle. A buyout fund typically has a ten-year lifespan broken into a five-year investment period and five-year harvest period.
Those numbers might vary depending on the how long the firm tends to hold its investments. Growth equity and venture capital funds tend to skew the opposite way, three or four-year investment and six or seven-year harvest. It makes sense intuitively, they're investing in businesses that take a longer time to return the investment.
Illustratively, if Blackstone raises a $10bn fund in 2010, they have put all the money to work by 2015. Even though they have yet to fully exit all the investments they made and recoup all the profits, they announce a new fund in 2014 or 2015 in order to keep making new investments.
So you can see that private equity is not just about constantly investing capital, but about constantly raising it as well. This leads to the term 'velocity' - capital has to get turned over.
This pressure is how poorer investments get made sometimes. Performance is a lagging indicator. A big pension fund or any other prospective Limited Partner trying to decide whether to invest or not is looking at numbers that show truly 'realized' returns from five or more years ago - because everything more recent than that is incomplete in that it does not show how every single deal invested in out of the prior fund turned out.
The incentive fees (also called the 'carry', the 'promote', or the performance fees) are where you can really make money. It's typically 20% of the gains on invested capital. If a $1b fund returns a 3x MOIC, there are $2b in gains [$3b in total returns - $1b capital invested] and therefore $400m in performance fees [$2b in gains * 20%) for the firm to share.
The problem is a potential misalignment of incentives. As you can immediately see, it's impossible to predict how a fund will perform, but management fees are guaranteed. Since the costs of running a firm do not scale linearly with the assets it manages, you can raise successively bigger and bigger funds and thus guarantee yourself correspondingly larger guaranteed annual income. To top it off, your ability to raise those funds is predicated on numbers that can be fairly dated.
Your confusion probably comes from the colloquial term 'closing a fund'. In the industry, that refers to accepting money from investors in order to start the timer on the investment period, and with it, the management fee stream.
Shutting the doors on a shop is called a 'wind down' or some similar term.
In the context of a successful firm that is still operating, funds end when they have exited the final asset they hold. This often takes well past the last day of the ten-year total period, so fund documents always have language governing how extensions work. Usually the GP gets one or two years at their discretion, and for anything after that, they have to get permission from a majority of their investors.
If it's a single-strategy firm, the typical thing is that every team member is working on a mix of new deals and prior deals. Intuitively, new deals will receive capital from the most recent fund while active deals may be spread across the most recent fund as well as the one or two prior ones.If the firm has diversified into multiple strategies, that's not the case. Some of the bigger platforms now offer private equity, private credit, public equity, public credit, real estate, and secondaries. There you'll see employees specialize in one strategy, but within that, they'll probably span multiple funds like I just described above.
This is terminology to delineate what size of transaction the firm pursues. There is no hard and fast rule.Historically, megafund referred to the narrow group of firms that were exclusively able to pursue the megacap opportunities.
In more recent years, especially with the advent of the internet and everyone beginning to discuss everything more transparently, younger people have started trying to pinpoint AUM thresholds that qualify firms as middle market, upper middle market, megafund, or whatever.
When you hear about someone getting a megafund job, it means they went to one of the biggest shops. It implicitly signifies how competitive the process was; those firms are very prominent and have very exacting and selective recruiting standards.
I covered this above.