Private Equity Funds

What are private equity funds?

When you invest in a private equity fund, you are investing in a fund managed by a private equity firm—the adviser.  Similar to a mutual fund or hedge fund, a private equity fund is a pooled investment vehicle where the adviser pools together the money invested in the fund by all the investors and uses that money to make investments on behalf of the fund.  Unlike mutual funds or hedge funds, however, private equity firms often focus on long-term investment opportunities in assets that take time to sell with an investment time horizon typically of 10 or more years. 

A typical investment strategy undertaken by private equity funds is to take a controlling interest in an operating company or business—the portfolio company—and engage actively in the management and direction of the company or business in order to increase its value.  Other private equity funds may specialize in making minority investments in fast-growing companies or startups.   

Although a private equity fund may be advised by an adviser that is registered with the SEC, private equity funds themselves are not registered with the SEC.  As a result, private equity funds are not subject to regular public disclosure requirements.  Information about a private equity fund’s adviser that is registered with the SEC is available here

Who can invest?

A private equity fund is typically open only to accredited investors and qualified clients.  Accredited investors and qualified clients include institutional investors, such as insurance companies, university endowments and pension funds, and high income and net worth individuals.  The initial investment amount for a private equity investment is often very high. 

Even if you are not invested in private equity funds directly, you may be indirectly invested in a private equity fund if you participate in a pension plan or own an insurance policy, for example.  Pension plans and insurance companies may invest some portion of their large portfolios in private equity funds.

What should I know?

Illiquidity

Because of their long-term investment horizon, an investment in a private equity fund is often illiquid and it may be necessary to hold an investment in a private equity fund for several years before any return is realized.  Private equity funds typically impose limitations on investors’ ability to withdraw their investment.  Investors in private equity funds should be able to wait the requisite time period before realizing their return.  For an institutional investor, a private equity investment may represent only a small portion of its diversified investment portfolio. 

Fees and expenses

When investing in a private equity fund, an investor usually receives offering documents detailing material information about the investment and enters into various agreements as a limited partner of the fund.  These offering documents and agreements should disclose and govern the terms of the investor’s investment throughout the fund’s life, including the fees and expenses to be incurred by funds and their investors.  The SEC has brought enforcement actions, for example here, involving fees and expenses that were incurred by funds and their investors without being adequately consented to or disclosed.  Investors should be vigilant about the fees and expenses incurred in connection with their investment. 

In addition, advisers may be managing multiple funds that are jointly invested in multiple portfolio companies.  The adviser has a legal obligation to act in the best interests of each of the funds it manages and must allocate expenses among itself, its funds and the funds’ portfolio companies in accordance with this fiduciary duty.  The SEC has brought several enforcement actions, for example here, related to shifting and allocation of expenses.

Conflicts of interest

Private equity firms often have interests that are in conflict with the funds they manage and, by extension, the limited partners invested in the funds.  Private equity firms may be managing multiple private equity funds as well as a number of portfolio companies.  The funds typically pay the private equity firm for advisory services.  In addition, the portfolio companies may also pay the private equity firm for services such as managing and monitoring the portfolio company.  Affiliates of the private equity firm may also play a role as service providers to the funds or the portfolio companies.  As fiduciaries, advisers must make full disclosure of all conflicts of interest between themselves and the funds they manage in order to get informed consent. 

The SEC has brought several enforcement actions, for example here, related to an adviser’s alleged failure to disclose certain conflicts of interest to the funds it manages.  Through its various relationships, including with affiliates and portfolio companies, there exists opportunity for advisers to benefit themselves at the expense of the funds they manage and their investors.  It is important for an investor to be aware and alert about the conflicts that exist, or that may arise, in the course of an investment in a private equity fund.

Additional Information

Securities Enforcement Forum West 2016 Keynote Address: Private Equity Enforcement

Private Equity: A Look Back and a Glimpse Ahead – May 13, 2015

Spreading Sunshine in Private Equity – May 4, 2014 

Mutual Funds – A Guide for Investors

Investor Bulletin: Hedge Funds

Investor Bulletin: Accredited Investors