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Private Equity · Topic lesson

Fund Economics

How a private equity fund makes money for its investors and its managers: fees, the J-curve, DPI and TVPI, the carry waterfall and the GP commitment.

5 chapters About 51 minutes0 of 5 complete
Start chapter 1

Every buyout sits inside a fund, and the fund has its own economics. Interviewers expect you to know who puts the money in, what they pay for the privilege, how they measure what they get back, and how the profit is shared. This lesson is about the fund, not the deal: the deal mechanics are in LBO Returns and Debt & Leverage.

  • Two parties. Limited partners (LPs), such as pension funds, endowments and insurers, commit the money. The general partner (GP), the private equity firm, calls it, invests it and returns it over a fund life of about ten years.
  • What the GP is paid. A management fee, about 2% a year, and carried interest, about 20% of the profit. '2 and 20'.
  • What the LP watches. Cash going out and coming back over time (the J-curve), and the multiples of what it paid in (DPI and TVPI).
  • Alignment. A preferred return before carry, a catch-up after it, and the GP's own money in the fund.
The rule that solves every question

Follow the dollar in order. Fees come out of commitments before anything is invested; distributions come back years later; capital and the pref go to LPs before the GP sees carry. Get the order right and the arithmetic is simple.

A fund's life, from the LP's side

From committing the money to splitting the profit. Each step points to the chapter that practices it.

  1. 1
    Pay the fees

    On commitments, then invested capital; they shrink what is invested.

    Chapter 1
  2. 2
    Wait for the cash

    Calls and fees first, distributions later: the J-curve.

    Chapter 2
  3. 3
    Score it mid-life

    DPI is cash back; RVPI is value held; TVPI adds them.

    Chapter 3
  4. 4
    Split the profit

    Capital, pref, catch-up, then 80/20.

    Chapter 4
  5. 5
    Keep the GP honest

    The GP's own money earns the net multiple and falls with the fund.

    Chapter 5

Chapters

1

Management fees and fee drag

10 min

A $1bn fund never invests $1bn. Why gross and net multiples differ, before carry takes a penny.

  • Calculate lifetime management fees on commitments, then on invested capital
  • Turn a gross multiple on invested capital into a net multiple on commitments
  • Find the gross multiple a fund needs for a net target
  • Show what charging on invested capital from day one saves
2

The J-curve

11 min

Money goes out for years before any comes back. How deep the hole gets, and when the LP is back to even.

  • Run an LP's cash flows year by year: calls, fees and distributions
  • Find the trough and the year it happens
  • Find the year the LP is back to even
  • Work out the distributions needed to break even by a target year
3

DPI, RVPI and TVPI

9 min

Cash returned, value still held, and the two together. Why LPs read the split, not just the total.

  • Calculate DPI, RVPI and TVPI from paid-in capital, distributions and NAV
  • Say how much more a fund must distribute to return capital
  • Back out the NAV from a reported TVPI and DPI
  • Show what a markdown does to TVPI
4

The carried interest waterfall

12 min

Capital back, then the preferred return, then the GP's catch-up, then 80/20. Who gets which dollar.

  • Compound the preferred return and test whether the fund clears it
  • Run a European waterfall tier by tier to the GP's carry and the LPs' total
  • Find the proceeds at which the GP is fully caught up
  • Compare a catch-up with a hard hurdle
5

The GP commitment

9 min

Carry rewards the upside and ignores the downside. The GP's own money in the fund is the LPs' counterweight.

  • Calculate the GP's carry and the return on its own commitment
  • Compare the commitment with the carry it expects
  • Size the commitment an LP's skin-in-the-game test requires
  • Show what the GP loses when the fund returns less than its money