Private Equity Fund Accounting

Private Equity (PE) refers to investments made into privately held companies or a controlling stake in publicly traded companies that result in the restructuring of the company’s operations or management to improve financial performance and ultimately achieve a profitable exit for the investors.

The key features of Private Equity are:

• Private Equity funds offer the potential for higher returns.
• PE investments may involve a higher level of risk.
• These investments are for longer period of time usually from 5 to 10 years or more.
• Investors may not easily access their capital until a maturity period.
• Subject to regulatory oversight, but regulations are generally less stringent compared to mutual funds.
• PE charges management fees which are based on committed capital and also performance fees which is based on profits.
• PE funds are pooled investments that are generally not open to small investors.

The Private Equity Fund Lifecycle

Private Equity (PE) Fund lifecycle begins with fundraising and ends with the final distributions to investors and can be classified into following phases:

1. Subscription Agreement: The subscription agreement is required when launching a private equity fund and is a formal agreement between a company and an investor. Investors agree with the terms and conditions of the fund and also commit for capital contribution for their share.
2. Fundraising: After agreement enforced the fund manager raise capital from investors.
3. Capital Calls: Private equity funds intended for institutional investors do not have the subscribed capital amounts paid in full when an investor is admitted to the fund, but instead called down from investors in multiple tranches on an as-needed basis to make investments during the Commitment Period and to cover costs. When the fund identifies a suitable investment, it issues a drawdown notice to its investors to fulfil their commitments.
4. Investment: The capital collected is then invested in target companies.
5. Management of the Portfolio: The PE firm manages the portfolio companies to enhance their value and when venture matures distributes profits.

PE Fund Accounting: Key Principles and Practices

Capital Commitment

Capital Commitment or Commitment are the amount an investor obligates itself to pay to the fund in its subscription agreement. The aggregate amount of the commitments of all investors (plus any commitments of fund management) is equal to the total fund volume.

Capital Calls / Drawdowns

Capital calls, also known as drawdowns, are requests made by the fund to its investors to provide their share of the capital for investment purposes. When investors commit capital to a private equity fund, they do not contribute the entire amount upfront. Instead, the fund “calls” capital from investors over time as it identifies investment opportunities and needs funding for those investments. This is usually done by capital call notices to the investors detailing the amount to be contributed as per their commitment and the purpose of the call.

Management Fee

Subscription agreement usually designates that investment manager will be entitled a fee for managing the fund as he/she is responsible for making investment decisions on behalf of a fund. An investment management agreement states the rate of management fee to be paid which is based on the size of the fund as a percentage of net assets. Fund managers often earn a management fee at a rate of 1.50 % to 2.00%. Management fee is payable regardless of whether the fund has a positive or negative return and these fees are meant to cover operating expenses like their overhead, some of their employee costs and other G&A costs.

Performance Fee

Another fee that fund managers may receive is Performance Fee but it usually payable if the fund generates a positive return. If the investment manager generates a positive return, he/she gets a performance fee. The amount of the fee depends on the fund but it is often 20% of the profits made by the fund.

Gross Asset Value (GAV)

The GAV is the total fund value before performance fees payable have been taken into account.

Net Asset Value (NAV)

NAV is the total value of the fund’s assets less its liabilities. It’s a critical metric as it is used to determine the value of the shares/units held by investors.

NAV = GAV less Performance Fee.

Equalization Interest

The subsequent investors are required to compensate the initial investors for the fact that the initial investors have had their capital tied up in the fund for longer. This is an interest compensation charge and based on the capital amount from the subsequent investor. This equalization interest is not due to the fund but incurred by the subsequent investors and paid to the initial investors.

Waterfall

The term Waterfall refers to the method used to distribute profits from investments among the various stakeholders in a private equity fund. The waterfall describes how much of the fund’s distributions each party receives and what the priorities are between them.

Investor Reporting

Investor reporting is a vital part of PE fund accounting as Investors require regular and transparent information about the fund’s performance. These reports typically include details on capital calls, distributions, NAVs, and updates on the portfolio companies’ performance.

There are more than 6000 Private Equity funds are working globally but US enjoyed a far larger market size as compared to rest of the world and out of top 50 PE’s around 36 are based in US and the Blackstone Group is the largest in terms of funds raised in 2023.Private Equity Fund accounting entries are complex and my blog on entries please view: Private Equity Fund Accounting Entries | Humayun Atif CMA,CPA

Private Equity Fund Accounting Entries | Humayun Atif CMA,CPA

For more info please also visit: https: //www.privateequityinternational.com/pei-300/

Commodities investments please visit: https://accountingblogger.com/how-to-invest-in-commodities/

Final Thought

Private equity firms offer unique investment opportunities to high-net-worth investors.PE plays a significant role in the economy by providing capital and expertise to companies that need funding for growth or restructuring. It can be a crucial source of financing for companies that may not have access to public markets or bank loans. However, PE also involves high risks that require careful due diligence and management by both investors and fund managers.

ABOUT THE AUTHOR

Humayun Atif | CMA, CPA, CA (FIN), MS-IT, CA Articles from Big 4, Certified Forensic Accountant (USA), Six Sigma & Oracle Certified.

Atif is passionate about Business, Tech, and the written word. He is the author of the book ‘IFRS Made Easy’. He is a Tax and IFRS coach and the founder of accountingblogger.com