Private equity (PE) fund is an important alternative investment vehicle for institutional investors and high net worth individuals. Understanding the typical life cycle of a private equity fund can help investors better evaluate investment opportunities in this asset class. There are usually five main stages in the life cycle of a private equity fund: fundraising, investment, management and value creation, exit, and liquidation. Each stage involves different key activities and has unique considerations for private equity investors. This article will provide an overview of the private equity investment life cycle.
Fundraising is crucial to secure committed capital from investors
The fundraising stage is the first step in a private equity fund’s life cycle. The fund managers, known as general partners (GPs), raise capital commitments from investors, known as limited partners (LPs). The LPs are usually large institutional investors like pension funds, endowments, foundations, insurance companies, and high net worth individuals. A fund’s size typically ranges from hundreds of millions to billions of dollars. The fundraising process can take 12-24 months as the GPs market the fund’s investment strategy, performance track record, and team credentials to potential LPs. Securing reputable anchor investors early on can help demonstrate fund credibility. The length of the fundraising period and total funds raised depend on factors like investment focus, track record, market conditions, and relationships with LPs.
Investment period is when capital gets deployed into deals
Once fundraising is complete, the fund enters the investment period, typically lasting 5 years or less. This is when the GPs actively source, evaluate, and execute private equity investments using the committed capital. The fund will aim to deploy the capital in a disciplined manner based on the stated investment strategy. For instance, a fund focused on growth equity may invest in 8-12 promising startups over 3-4 years. A buyout fund acquiring mature companies may do 4-6 large buyouts during this period. The GPs have fiduciary duty to invest capital in the LPs’ best interest. Thorough due diligence, reasonable valuations, and structural protections are key. Any capital not deployed by the end of the investment period must be returned to LPs, so there is pressure to invest.
Active management and value creation occur during holding period
After making an investment, the fund will actively manage the portfolio company during its holding period to improve operations and create value. This usually involves measures like expanding into new markets and geographies, improving financial controls and reporting, bringing in new talent and expertise, implementing operational efficiencies via technology, and pursuing add-on acquisitions to support growth. The fund may have seats on the company’s board to help guide strategic decisions. Portfolio management takes considerable operational resources. The ultimate goal is to enhance the business fundamentals and make it more attractive for an eventual exit.
Exiting investments via IPOs or M&A is key for returns
Exiting investments profitably is crucial for generating returns in private equity. The fund will aim to sell or distribute its ownership stakes in portfolio companies after 3-7 years of holding. Exit routes include an IPO on a stock exchange, or an acquisition by a strategic buyer or another PE fund. The exit timing depends on factors like achieving business milestones, overall market conditions and valuations, IPO windows, and buyer interest. IPO exits provide more upside but are riskier than a trade sale. GPs may take a staged exit approach, selling partial stakes first. Strong exits can help establish a fund’s track record and aid future fundraising efforts.
Liquidation winds down the fund and distributes proceeds
As investments are exited, the proceeds are distributed to LPs per the waterfall structure. After the fund’s termination date, often 10-12 years, the liquidation period begins. Any remaining investments still in the portfolio will be exited or written off. The GPs collect carried interest subject to achieving return hurdles. Once all deals are liquidated, audits completed, and expenses settled, the fund makes a final liquidating distribution to LPs. Investors can then assess overall fund performance and recycled capital into new PE funds. The PE investment life cycle thus comes full circle, overlapping with the fundraising for successor funds.
The private equity fund life cycle progresses through five main stages: fundraising, investment, management, exit, and liquidation. Key activities include securing LP commitments, deal sourcing and execution, value creation initiatives, profitable exits, and distribution of liquidation proceeds. Understanding this investment journey provides helpful perspective on the PE asset class for LPs.